Earlier this week, equity analysts at Wells Fargo released a note to investors on the subject of the Renewable Fuel Standard and its compliance credit (RIN) market mechanism.
We wouldn’t typically respond to an investment bank research note, but we felt compelled to reply to the Wells Fargo update for two reasons. First, the note is so replete with factual errors, uninformed opinions, and outright falsehoods that we felt the responsibility to correct the record. Secondly, we understand the Wells Fargo note is being shared liberally around Capitol Hill by oil refinery lobbyists hoping to boost their unjustified case for “regulatory relief” (i.e., compliance bailouts). We want to ensure lawmakers and regulators are hearing both sides of the story.
To Pass Through or Not to Pass Through?
Within the span of just the first three sentences of the note, Wells Fargo says “RIN prices pass through to retail consumers,” then claims “merchant refiners struggle to recover elevated RIN costs.” The contradictions continue throughout the report’s introduction, with Wells Fargo stating that waiving renewable fuel blending obligations would cause an “immediate decline” in retail gas prices and somehow financially “benefit” refiners at the same time. Then a few lines later, the analysts admit that “refining profitability would not materially change” with an RFS waiver because “even merchant refiners are capturing” RIN values. Confused yet? So are we. So, which is it? Refiners either pass along (and fully recover) their RIN costs or they don’t. It’s one or the other. It can’t be both.
In reality, refiners who deliberately choose not to blend renewable fuels do indeed pass along their RIN costs – but not to retail consumers. Refiners don’t sell gasoline or other refined products to consumers; they sell gasoline blendstock to blenders on the wholesale market. It is well established that RIN costs are “baked into” gasoline crack spreads (i.e., refining margins). The wholesale price blenders pay for gasoline includes the refiner’s cost of the RIN. Those blenders—many of whom are owned by, or integrated with, oil refining companies—mix ethanol with the gasoline to produce the finished fuel that is sold to consumers at retail stations. And when the ethanol is blended in, the RIN cost attached to the gasoline is offset and erased.
A detailed analysis of RIN pass-through by EPA explains it this way: “When RIN prices rise, the market price of the petroleum blendstocks produced by refineries also rise to cover the increased RIN costs…The effective price of renewable fuels, however, decreases as RIN prices increase. When renewable fuels are blended into petroleum fuels these two price impacts generally offset one another…”
Similarly, a study by University of California-Davis and Iowa State University economists found, “…the net effect on the price of E10 of high RIN prices is zero: higher gasoline prices are offset by lower ethanol blending costs and the price of E10 remains constant.”
Throughout the analysis, Wells Fargo never really makes up its mind on whether refiners recoup their RIN costs or not (hint: they do).
Wells Fargo also asks investors to willingly suspend their disbelief by claiming that RIN prices have no impact on renewable fuel production, blending levels, or ethanol profit margins. Yet, data from the Energy Information Administration show that the average ethanol content in U.S. gasoline hit record levels in recent months as RIN prices began to increase. And data released by EPA just yesterday showed that RIN credit generation in May reached a 17-month high, up 8% from April and up 35% from the same month a year ago. In other words, RIN generators (i.e., renewable fuel producers) responded to higher RIN prices by increasing the production of renewable fuels, thereby increasing the supply of RINs. Increased demand for RINs resulted in increased supply of RINs…what a concept. Adam Smith would be proud.
Court Case Confusion
It is also clear the Wells Fargo analysts haven’t read up on the pending Supreme Court decision involving the Tenth Circuit Court’s opinion in Renewable Fuels Association et al. v. EPA. The authors say they “do not expect a long-term effect on the RINs market regardless of the [Supreme Court] decision, given SREs requests must be reassessed and issued annually.” Huh? It is widely believed—including by the refiners themselves—that if the Tenth Circuit decision is affirmed, no more than two or three small refineries would possibly be eligible for SREs moving forward (compared to the 30-plus exemptions handed out in recent years). If the Tenth Circuit decision isn’t expected to impact RIN prices, why then did refiners go to the trouble of appealing it to the Supreme Court?
That’s a Lot of Corn!
The report goes further downhill when it gets into the impacts of the RFS, RIN markets, and any potential regulatory changes on the corn market. The authors are correct that total cropland acres planted have declined since the RFS was adopted, as crop yields have risen. But they suggest U.S. corn production increased from 150 billion(!) bushels to around 175 billion(!) bushels during that time (that is 10-12 times larger than the actual U.S. corn crop and would be enough corn to produce more than 500 billion gallons of ethanol, entirely replacing global gasoline consumption…maybe ethanol really is taking over the world!)
Carbon Cost Controversy
Wells Fargo’s note then turns to a bizarre and impossible-to-follow analysis of the RFS program’s “cost of emissions reduction.” The authors assert that D6 RINs “offer an exceptionally expensive path to CO2 reduction.” Aside from the basic fact that RINs were intended to function primarily as RFS proof-of-compliance credits (not as carbon credits), the Wells Fargo carbon emissions abatement cost analysis falls completely flat. Based on some opaque calculations and faulty assumptions, the analysts suggest the cost of D6 ethanol RINs translates to a GHG reduction cost of $270 to $1164 per ton!
But a more straightforward and more transparent analysis shows that the RFS and its RIN mechanism are far more economical and efficient when it comes to GHG reduction—even though RINs were not originally intended to serve as carbon reduction credits. Here are the simple assumptions and calculations that should have been used:
- A recent analysis published in an academic journal by Argonne National Laboratory scientists found that corn ethanol had an average lifecycle carbon intensity of 52 grams of CO2-equivalent GHG emissions per megajoule of energy (g/MJ) in 2019, even including hypothetical land use change emissions. That compares to a conservative estimate of 93 g/MJ for gasoline. Thus, ethanol offered a 44% GHG reduction relative to gasoline in 2019.
- EPA data show that 14.75 billion D6 RINs were generated for conventional ethanol production in 2019.
- A gallon of ethanol contains 81.5 megajoules of energy and a gallon of gasoline contains 119.5 megajoules, according to DOE and the California Air Resources Board.
- On an energy equivalent basis, 14.75 billion gallons of ethanol would replace 10.1 billion gallons of gasoline in the fuel supply.
- Consumption of 10.1 billion gallons of gasoline would result in GHG emissions of 112 million metric tons of CO2e, while consumption of 14.75 billion gallons of ethanol would result in 62.5 million metric tons of CO2e.
- That means using ethanol in lieu of gasoline reduced GHG emissions by 49.5 million metric tons in 2019.
- The average D6 RIN price in 2019 was about 17 cents, meaning the total RIN value associated with 14.75 billion gallons of conventional ethanol was $2.5 billion.
- Thus, the D6 RIN value associated with GHG emissions reduction from conventional ethanol was $50.51 per ton. That compares favorably to carbon credit values of nearly $200 per ton under the California Low Carbon Fuel Standard (with each credit representing one metric ton of GHG reduction).
- Even if D6 RIN prices averaged 70-80 cents apiece, the implied cost of GHG reduction via conventional ethanol would be equivalent to the recent price of California LCFS credits.
- This simple analysis omits the fact that ethanol is typically priced lower than gasoline and other octane boosters, meaning ethanol’s economic efficiency for reducing carbon is even better than stated here.
Clearly, the RFS is doing a cost-effective job of reducing GHG emissions from the transportation sector, even though the RIN was not originally designed to primarily serve as an incentive for carbon reduction.
Be Careful What You Wish For!
In the end, Wells Fargo’s sloppy analysis leads the authors to the conclusion that EPA should just “eliminate ethanol RINs” to help refiners. The irony of this recommendation is that it was oil refiners who demanded that Congress include a compliance credit trading market in the legislation that created the RFS (and they worked with EPA to develop the RIN program). But let’s play this out: If EPA were to entirely do away with the RIN credit mechanism altogether (as Wells Fargo suggests), refiners would have no choice but to purchase and physically blend the required volumes of renewable fuels to comply with the law…which would be just fine with us.