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Early Evidence of EPA-Induced Demand Destruction

April 13, 2018

           

Over the past few weeks our concerns have been confirmed that the Environmental Protection Agency (EPA) is secretly handing out RFS compliance exemptions to virtually every owner of a “small refinery” who comes knocking. One refining executive went as far as saying the EPA “…was handing out those exemptions like trick or treat candy.” It has also been reported that the beneficiaries of these “hardship” exemptions have not just been the truly small “mom-and-pop” refineries for whom the waiver provision was originally intended. Rather, EPA has also doled out exemptions to Fortune 500 companies like Andeavor (the nation’s fifth-largest refiner), HollyFrontier, and Delek. Collectively, those three companies took home $2.7 billion in net profits last year, obviously dispelling the notion of any “economic hardship.” Adding insult to injury, EPA recently waived more than half of Philadelphia Energy Solutions’ RFS compliance obligations for 2016 and 2017 as part of a bankruptcy court settlement agreement. PES audaciously claimed that its RFS obligations were a central factor in its financial woes, despite overwhelming evidence to the contrary. The current refiner bailout situation is made even more frustrating and perplexing by the fact that EPA itself has concluded RINs are not a financial burden or source of economic hardship for refiners. Just four months ago, Administrator Pruitt approved a document stating: “…obligated parties, including small entities, are generally recovering the cost of acquiring the credits necessary for compliance with the RFS standards through higher sales prices of the petroleum products they sell. This is true whether they acquire RINs by purchasing renewable fuels with attached RINs or purchase separated RINs.” As we have pointed out, these recent EPA actions are rapidly destroying demand for ethanol and corn. The small refiner exemptions, the PES settlement, and EPA’s failure to enforce the statutory 2016 RFS requirement (as ordered by the courts) have effectively reduced the 2016 and 2017 RFS volumes each by 1 billion gallons or more. The result has been a glut of unneeded RIN credits and sharply lower RIN prices. RINs are not only the mechanism by which RFS compliance is tracked, but the credits also provide a strong economic incentive for the expansion of ethanol blending beyond E10. Thus, when RIN prices collapse, the incentive to expand ethanol blending is also weakened. In fact, we are already seeing evidence that the wave of small refiner exemptions is beginning to erode ethanol blending demand. Yet, not surprisingly, the oil industry continues to mislead the public on the impact of the small refiner and PES bailouts, with a lobbyist for Andeavor and Valero recently telling OPIS, “Even as small refiner exceptions have exerted downward pressure on RINs, there has been no statistical reduction in blending according to the most up-to-date data.” Oh, really? Is that so? Every week, the Energy Information Administration (EIA) publishes data showing how much gasoline was supplied to the U.S. marketplace and how much ethanol was blended into that gasoline by refiners and blenders. From those two data points, we are able to derive an estimate of the average ethanol content or “blend rate” of the gasoline supplied to the market. A weekly blend rate above 10.0% obviously implies that in addition to nearly universal E10 blending, some meaningful portion of the fuel supplied to the market was E15, E85 and/or other blends containing more than 10% ethanol. The EIA data show that after peaking at a record of 10.57% in the last week of November 2017, the average ethanol blend rate has trended lower. In fact, the blend rate has been below 10.0% for 17 straight weeks dating back to mid-December 2017 (Figure 1).  Some might argue that the decrease in the blend rate is related to seasonal demand factors, but a comparison to year-ago levels shows that is not the case. Ethanol blending during the same 20-week period a year ago (late Nov. 2016- early April 2017) was very strong, with the blend rate topping 10.0% in six of the first eight weeks of 2017 (Figure 2). The 2018 year-to-date average blend rate has been 9.65%, down 0.3 percentage points from the same period last year. That may not sound like much, but over the course of a year it amounts to about 430 million gallons of ethanol!  The drop in current ethanol blending compared to year-ago levels might make sense if the ethanol-gasoline price relationship had changed in such a way that ethanol blending was less attractive economically. But that hasn’t happened—in fact, ethanol’s discount to gasoline has been much wider in recent months than it was during the same period a year ago (Figure 3). On average, ethanol has been 46 cents per gallon (cpg) less than gasoline blendstock (RBOB) in the 20 weeks since Thanksgiving 2017, compared to just a 2-cpg average discount during the same period the previous year. As such, there is currently a much stronger economic incentive for blenders and refiners to maximize ethanol blending.  So, why aren’t they blending more ethanol? The answer to that question can be found in EPA’s recent actions that have cratered the RIN market. RIN prices were around 90 cents in late November 2017 when the ethanol blend rate hit a record high. But secret small refiner waivers, the bankruptcy bailout, White House discussions of a RIN price cap, and other actions have torpedoed the RIN market, leaving prices at a three-year low near 30 cents last week (Figure 4). When recent RIN prices are overlaid with recent ethanol blending rates, there is indeed a clear correlation between the two.  Fresh off scoring huge exemptions from their 2016 and 2017 RFS obligations, small refiners likely believe they will also secure waivers from 2018 compliance. But even if they don’t get further exemptions, RIN stocks are now plump and RINs are cheap enough that many would opt to comply by purchasing RINs rather than taking steps to expand ethanol blending. That takes pressure off the blending market, which has already been reflected in recent lower blend rates.  Meanwhile, selling RINs is less lucrative for non-obligated blenders, so blenders at the margin may have also eased off the throttle. Finally, lower RIN prices mean the retail discount for blends like E15 and E85 is shrinking, potentially decreasing consumer demand and reducing retail station throughput of higher blends. This is why RINs matter. And this is exactly why recent EPA actions to artificially inflate RIN stocks and sink RIN prices are already affecting the ethanol market and destructing demand.