US Renewable Fuels:

Volatile markets drive demand for RINs and RVO risk management

Executive Summary

What are Renewable Identification Numbers (RINs)?

Renewable Identification Numbers (RINs) are credits used to track and enforce compliance with the US Renewable Fuel Standard (RFS) program, which is administered by the US Environmental Protection Agency (EPA). The RFS requires or mandates the use of renewable fuels in US road transportation fuels (i.e., gasoline and road diesel).

Renewable fuel producers generate RINs when a batch of renewable fuel is made for blending into the US gasoline and diesel pools. Once the blending takes place, RINs become usable, or “released”, as credits. After the RINs are released, they can be traded.

Refiners and importers of gasoline or diesel into the US are required to obtain RINs and to provide them to the EPA each year as evidence of compliance, based on the volume of gasoline and diesel that they supply into the US market. The refiners and importers mainly obtain RINs by purchasing them from the blenders as the blending occurs. RINs can also be traded in a secondary market. As with any other commodity, the trading among market participants is a key part of RINs price formation.

Each RIN credit is a 38-digit number; for each gallon of renewable fuel in the RFS program, one RIN is generated. As a result, while a RIN technically does not have a unit – it is just a number – prices are often expressed in dollars per gallon. RINs are valid for use in the year they are generated and the following year.

What is the Renewable Volume Obligation (RVO)?

As mentioned above, the RFS program is a US federal program that requires US transportation fuel to include renewable fuels. Each year, the EPA issues RFS rulemakings with volume requirements for different renewable fuel categories. It sets those volumes through the annual Renewable Volume Obligations (RVO). The RVO targets are set each year based on an estimate of what US fuel demand will be and a target for renewables use as a share of demand. Of the different renewable fuels, the biggest target by far is for ethanol, which is derived from corn and used for blending into gasoline. In recent years, this “conventional” ethanol has represented 72-73% of the total RVO (see below).

Price developments in the first half of 2021: a sustained surge driven by high agricultural feedstock costs, limited RINs supply, and regulatory policy uncertainty

Source: ICE

Starting in the latter part of 2020 and continuing through the middle of 2021, the prices for both D6 (ethanol) RINs and D4 (biomass-based diesel) RINs began a sustained surge which took prices to record-setting levels. Prices for ICE D6 (ethanol) RINs increased from around $0.80/gal at the start of 2021 to a peak of $1.97/gal in early June. Over the same timeframe, prices for ICE D4 (biomass-based diesel) RINs rose from around $1.00/gal to a high-point of $2.04/gal. For both D6 and D4, the peaks marked all-time record high prices since the RFS program began in 2013. The previous records had been set during the first year of the program in 2013.

Drivers for the surge included the following factors: high costs for agricultural feedstocks; limited RIN generation by renewable fuel producers; and regulatory uncertainty about the 2021 and 2022 RFS mandates.

High agricultural feedstock costs: In the first half of 2021, tight fundamentals drove up agricultural feedstock costs. The two primary feedstocks for biofuels production in the US are corn, which is used for fuel ethanol, and soybean oil, which is used for biomass-based diesel. For both corn and soybean oil, prices were pushed higher by strong demand in China and low supply, due to cold weather in the US Midwest, as well as hot and dry weather in Brazil and Argentina.

Limited RIN generation: As a result of lower 2020 refined product demand due to COVID-19, renewable fuel producers limited production of both ethanol and biomass-based diesel. RINs has its own supply and demand fundamentals, and limited RIN generation meant that – in effect – the supply or availability of RINs was constrained.

Then, as US refined product demand recovered in 2021, the demand for D6 (ethanol) RINs and D4 (biomass-based diesel) RINs increased; as noted above, refiners and importers buy RINs from blenders as physical biofuel blending occurs. The combination of limited RINs supply and growing RINs demand due to increasing blending needs exerted upward pressure on RINs prices.

Regulatory uncertainty: Any discussion of RINs demand involves the complex interplay between the RINs market and the regulatory policy environment for US biofuels. It may not be an overstatement to say that US biofuels policy – specifically, the RFS rulemaking and the RVO targets set by the EPA – is often the key underlying driver of the RINs markets.

The question, therefore, becomes “why was RINs demand increasing as 2021 began to unfold?” In our short explanation above, we focused on recovering US product demand and therefore the growing need for physical biofuel blending. However, it is not quite as simple as that, and looking at physical gasoline and diesel demand is not enough.

Although physical renewable fuel is blended into gasoline and diesel as the product is produced and readied for market, RINs demand is set by the EPA’s RVO target or anticipated target. As noted at the outset, the RVO targets are based on two factors: an estimate of what US fuel demand will be and also a target for renewables as a share of that demand.

In late 2020 and early 2021, there was a high level of uncertainty about future RFS targets and RVOs. At that point, the EPA’s last ruling had been at the end of 2019. The RVO for 2020 had been set at 20.09 billion gallons, an increase from the 2019 RVO of 19.92 billion gallons. In November of each year, the EPA is meant to set the RVO mandate for the following year. However, in late 2020, because of the uncertainty about COVID and projected US product demand, the Trump administration did not issue an RVO for 2021.

The consensus view in the oil markets was that the Biden administration would push for a stricter – in other words, higher – RVO mandate in 2021. This was clearly an unknown, but the widespread assumption was for an increased RVO and therefore higher demand for RINs.

In addition, court and administrative rulings had raised questions over the number of Small Refinery Exemptions (SREs) that would be granted. In the past, small merchant refiners under 75 kb/d, which typically lack blending capabilities, had been exempted from RINs compliance due to the disproportionate financial hardship it caused them. The bottom line is that market assumptions for a higher RVO mandate and a possibly lower number of SREs were both bullish for RINs prices. Without a clear mandate, many market participants simply erred on the side of caution and bought RINs.

Price developments in the second half of 2021 and early 2022: a decline and then broadly rangebound but still volatile trading, driven by changing expectations for regulatory policy

After June 2021, RINs prices continued to be quite volatile, but began to trend lower, as the high agricultural feedstock costs and limited RIN generation became priced in. Prices for ICE D6 (ethanol) and ICE D4 (biomass-based diesel) RINs declined from their peaks of around $2.00/gal. By October-November 2021, ICE D6 (ethanol) prices entered a broad and volatile range of $0.90-1.30/gal, while ICE D4 (biomass-based diesel) began to trade in a similarly broad and volatile range of $1.20-1.60/gal.

Why did this happen? The key price driver from the middle of last year onwards was changing expectations regarding the regulatory policy environment – in other words, market expectations for the 2021 RVO mandate. Again, the starting point in late 2020/early 2021 was that markets expected the Biden administration to propose a stricter or higher RVO mandate. However, this bullish expectation evolved as the year progressed.

In early summer 2021, biofuels market reporting said that the EPA was expected to propose 2021 and 2022 RVO requirements roughly flat with 2020, rather than higher, due to weaker US gasoline and diesel demand since the onset of COVID. By August and September of 2021, market reporting changed further, suggesting that the EPA would actually cut 2021 biofuel blending requirements, though it would increase requirements for 2022. This reporting included references to draft EPA documents that had been seen, including figures for possible RVO mandates that included a cut in 2021. These developments led to anecdotal reports in the trade press that oil refiners had slowed or stopped buying RINs and instead had begun to sell RINs, due to expectations of easing requirements.

In December 2021, the EPA issued its proposal, which was in line with the market expectations that had been set in August and September. The current RVO mandates/proposals for 2020-2022 are in the table below.

Table 1 - EPA RVO mandates

Source: Oil trade press (from US EPA)

As anticipated, the 2021 proposal was a cut from the old 2020 requirement – except that the 2020 figure was retroactively revised lower due to the impact of COVID on US product demand. The revised/new mandates now show annual increases this year and next year, which is in line with EIA forecasts for US gasoline and diesel demand. It should also be noted that while the 2020 and 2021 requirements are lower than 2019, the 2022 proposal marks an increase vs. 2019, which was the last pre-pandemic year.

Finally, we note that the conventional corn-based ethanol (D6) target represents a consistent 72-73% of the latest 2020-2022 requirements; for the 2022 proposal, the figure for corn-based ethanol is 15 billion gallons, or 72% of the total 20.77 billion gallons.

In short, RINs prices last year moved lower after mid-year, driven by changing expectations for 2021 and 2022 RVO mandates, with the outlook for 2021 requirements moving from higher vs. the old 2020 requirements, then to flat, and finally to lower. By autumn, renewable fuels markets had priced in information that turned out to be accurate. As a result, RINs prices have been volatile but broadly rangebound since then, including the first quarter of 2022.

High and Volatile RINs prices have a real impact on refined product markets

Prices for RINs – credits to track and enforce compliance with mandated renewable fuels blending into US road transportation fuels (gasoline and road diesel) – do not exist in a vacuum. RINs prices, particularly high and volatile prices as seen since late 2020, have a real impact on refined product market dynamics. As such, RINs hedging has become increasingly important to commercial market participants. Key impacts on refined product markets include the following:

US refiners: US refiners are generally considered to be net short of RINs. They usually buy RINs from the renewable fuel blenders as the renewable fuels are added to the gasoline and road diesel pools. RINs prices, or the cost of RINS, are then added to the cost of the product.

The issue seen during 2021, when RINs prices rose to record highs, was that US refiners said that they were not able to add in the full RINs costs because they were simply too high. As a result of not being able to fully pass those costs along, refiners said that RINs and the RVO were a serious headwind for the refining industry and materially reduced profitability. For example, some smaller refiners on the US East Coast said that the cost of RINs compliance was the main reason they lost money during 2Q21, when RINs prices peaked; some analysts calculated that RINs costs rose to $9-10/bbl during this period.

Importers: When traders buy and import finished road transportation fuels into the US, they have to buy RINs to cover the booked volume of fuel, in order to comply with the RFS. The best example is the New York Harbor (NYH) gasoline market, because the US East Coast relies heavily on imports of gasoline from Europe. (Europe is structurally long gasoline and short diesel.)

In other words, for trade economics to be profitable, the cost of RINs must be added to imports (or subtracted from exports) by buying (or selling) RINs. If the cost can successfully be added (or subtracted), then the net impact on trade should be zero. However, this is not always the case. In our example, if a US trader wants to import gasoline from Europe but cannot profitably add the cost of RINs because it is too expensive and cannot be passed along, then the import of that cargo will not take place.

Refined product differentials: In the US product market, the RVO mandate only applies to road transportation fuels, such as gasoline and diesel, meaning that RINs prices are only built into those products and product cracks vs. crude.

Specifically, RINs prices are part of ULSD prices and cracks (Ultra Low Sulphur Diesel); however, they are not part of ULSHO (Ultra Low Sulphur Heating Oil) prices and cracks. Despite the fact that ULSD and ULSHO are the same from a molecular or chemical perspective, unlike ULSD, ULSHO is not required to have biofuels blended in, because it is not a road transportation fuel. ULSHO is valued in the market as ULSD minus RINs.

Another example is NYH ULSD vs. ICE Gasoil. This is somewhat more complicated; as with any geographic differential (and similar to the gasoline example above), the spread is based on the relative fundamentals of the similar product in the two regions, as well as the freight costs. However, in this case, the spread also needs to account for RINs prices that are built into NYH ULSD, but not ICE Gasoil.

Increasing traded volumes and open interest for ICE RINs contracts in 2021 and into early 2022

In the analysis above, we discussed the factors that drove RINs prices to record-high levels last year, and the reasons why prices are still extremely volatile, even after moving into a trading range with lower, but still historically high, prices.

We also discussed how RINs prices have a real impact on the refined product markets, including on refining margins, product cracks, and key geographic differentials. Because of the high and volatile RINS prices, refiners, physical traders, blenders, and renewable fuel producers found it more important than ever to manage their RINs-related price risk.

Source: ICE

Strong growth in ICE RINs futures activity: As a result, there was very strong growth in activity for ICE financially settled RINs futures. We focus here on ICE D6 (ethanol) RINs. As noted above, the biggest renewable fuel category by far within the RVO is for ethanol, so D6 is naturally the most active market.

Monthly traded ICE D6 (ethanol) volumes grew from an average of around 13 million RINs in 2020, to 31 million RINS in May-July 2021, to a record-high of around 194 million RINs in February 2022 (see top chart above). ICE D6 (ethanol) open interest grew to record-high of 113 million RINs, compared to 22.5 million RINs in 2020 (see bottom chart above). The number of market participants more than doubled in 2021 vs. 2020, increasing from 11 to 23.

Benefits of central clearing: For rapidly developing and highly volatile markets like RINs, trading on an exchange offers benefits to market participants. Among the most important of these is the security of centralized clearing.

The risks of over-the-counter trading in the RINs markets were highlighted in a well-publicized incident early last year. It was reported in January 2021 that, according to publicly available court documents, Valero Marketing and Supply Company filed a lawsuit alleging that Sundive Commodity Group, a market-maker, failed to deliver RINs credits to them in September, October, and November 2020, after Valero had entered into a contract with Sundive. As a result, Valero said it had to go to the market to purchase RINs, paying over $10 million more than it would have had to pay if Sundive had delivered the credits on time; Valero said Sundive owed them that amount. Other companies including Marathon Petroleum and Monroe Energy also reportedly sued Sundive for failure to provide RINs despite contracts to do so. It was reported later in January 2021 that Sundive filed for Chapter 11 bankruptcy protection.

Trading financially settled RINs futures on ICE allows market participants to hedge their exposure to underlying physical RINs values; along with centralized clearing, this means that customers are not exposed to direct counterparty risk. Other benefits to trading on ICE include transparent pricing that comes from screen-based trading.

The contract codes for ICE RINs futures are shown in the table below.

Table 2 - ICE RINs futures contract codes

Source: ICE

Looking ahead to 2023 and beyond: huge uncertainty means RINs volatility is likely to continue

Short-term issues: Following the late 2021 proposals for the RVO requirements for 2020-22, there was a public feedback and comment period that took place in early 2022. More recently, the EPA has proposed June 3, 2022 as the deadline for finalizing mandates for 2021 and 2022.

Several factors could come into play. Gasoline prices are at multi-year highs in the US. Though down from the mid-2021 record highs, RINs prices are still elevated by historical standards. The Biden administration does not want to possibly add further upward pressure to domestic gasoline prices with stricter or higher biofuels mandates, particularly in an election year.

The Russia/Ukraine war has further increased prices for oil and other commodities from an already high starting point, making the situation even more complicated from a policy perspective. Some in the market expect that, in order to counter rising gasoline prices and broader inflation, the RVOs for 2021 and 2022 could be cut, which would be bearish for RINs prices.

It is also unclear how the RFS program will incorporate SREs going forward. As part of its proposals in late 2021, the EPA said that it intended to reject all 65 pending applications for SREs; however, the action is not final.

The politics are complex, both for the short-term and the long-term. Oil refiners, particularly small merchant refiners, say the requirement to blend renewable fuels or buy RINs is too costly, and the program needs to be reined in; some go so far as to say that renewable fuels growth should be market-driven, rather than mandated. In contrast, corn farmers and renewable fuel producers are in favor of the standards, as they have helped build a large market for their products. They would like to see requirements expanded.

Of course, the backdrop for both the short-term and long-term is that the White House has set aggressive targets to reduce carbon emissions and fight climate change. Increased renewable fuels consumption is one of the tools to try to achieve these goals.

Long-term issues: Stepping back, the US renewable fuel blending program – the RFS – was designed to mandate volumes of renewable fuels – the annual RVO – to partly replace or reduce the production and consumption of petroleum-based fuels. The RFS requires refiners to blend renewable fuels into road transportation fuels (gasoline and road diesel) or buy tradeable compliance credits – RINs – from those that do.

At the beginning of the RFS program, which was created in 2005 and expanded in 2007, the US Congress set yearly volume requirements through 2022 (obviously the RVOs were, and are, subject to change). That was the first phase of the program. This year, the US EPA will have to decide on the next phase of the RFS program, in coordination with the US Department of Energy and the US Department of Agriculture.

The original long-term target for 2022 set by Congress in 2007 was for 36 billion gallons. Clearly, the latest target for this year of around 21 billion gallons falls far short of this. Based on the large differences in the actual evolution of the RFS program relative to the original targets, some in the markets suggest that a long-term overhaul and reset of the RFS may be warranted.

Another relatively new wrinkle is that the EPA is considering making electric vehicle power generation eligible for renewable fuel credits – RINs. The Biden administration directed the EPA to study how using renewable fuels to power EV charging could generate tradeable credits.

One of the key difficulties facing policymakers currently is the apparent tension or contradiction between the immediate situation – the need to deal with high oil prices and a possible oil supply shock – and the longer-term situation – the need for the energy transition to deal with climate change. The first argues for more relaxed or lower RVO mandates, while the second argues for stricter or higher RVO mandates.

Market volatility expected to continue: Short-term issues (including high gasoline and diesel prices, the Russia/Ukraine war, and ongoing uncertainty about Small Refinery Exemptions), the complex politics of the RFS program, and the risks of a long-term overhaul and reset of the program all argue for continued RINs market volatility. Based on RINs market developments since late 2020 and an uncertain outlook, it seems reasonable to assume that RINs market volatility will continue. Corporate risk managers should plan accordingly and make use of the tools available to them to manage this exposure.