What’s Wrong With RIN Markets?

Renewable fuel producers have benefited from a variety of different federal incentives over the years. While Congress debates extending biofuel tax credits, one market-based mechanism has stepped onto center stage: Renewable Identification Numbers, or RINs.

As mandated by the 2010 Renewable Fuel Standards (RFS2) and implemented by the EPA, RINs are assigned to each new gallon of biofuel produced or imported into the continental US. The EPA segments them into different categories and converts them into ethanol equivalent gallons, based on energy value per gallon. 

The RINs are eligible for use by obligated parties, such as blenders or importers, to meet their targets.  The targets have a nested structure, with the cleanest fuels eligible both within their tier as well as those below it (see Table 1).  RINs, once separated from the biofuel, can trade like a financial security.

 Table 1: RFS Categories and Targets

Similar to other environmental commodities like RECs or carbon credits, the purpose of RINs is to utilize traded markets to move capital to the most effective clean projects, or in this case biofuel facilities.  Obligated companies purchase RINs to meet their blending requirements, and sell (or bank) their excess RINs. If production lags behind targets, RIN prices rise to provide a higher incentive to produce, and vice versa.

The traded markets for RINs reflect these underlying fundamentals, with prices varying widely depending on category.  For example, the D6 renewable fuel target is oversupplied with corn-based ethanol, and consequently the price has traded below $0.05 per gallon RIN since 2011.  On the other hand, cellulosic biofuels (D3 and D6) have been undersupplied, and EPA has allowed compliance entities to purchase waivers.

RINs for advanced biofuels (D5) and biomass-based diesel (D4) command the most attention, since the supply and demand are relatively in balance.  The prices are currently around $0.80 and $1.20 per RIN gallon respectively (see Table 2).

 

Table 2: RIN Fundamentals and Prices

 

Issues with Current RIN Markets

Though prices are relatively stable for D4 and D5 RINs, there are tremendous issues holding the market back.

Beginning late 2011, the EPA identified firms generating RINs without any physical biofuel to match it.  All in all, three firms–Absolute Fuels, Clean Green Energy, and Green Diesel—have sold close to 140 million fraudulent D5 RINs into the market in 2011 and 2012. The EPA subsequently notified holders of these RINs that they were in violation of the renewable fuel standards.

Once the news hit the market, trading halted as buyers inspected their RINs and took fresh looks at their counterparties. In effect, the new credo of RIN traders became “buyer beware”.  The RIN market, already weighed down by weak balance sheets and a lack of transparency and standard contracting, slowed to a trickle.

So what’s necessarily wrong with this?  First, small biodiesel producers have trouble selling their RINs. The buyer’s worry: is my counterparty a legitimate producer?  Those willing to purchase from a smaller company have to put extra effort into due diligence and also take on more risk. 

RIN fraud also affects larger firms.  With greater reputational risks and onerous due diligence procedures, many typically purchase the minimum they need, from as few sellers as possible. So in other words, many entities best capitalized to provide liquidity nevertheless prefer to tread lightly.

The market is then squeezed on both ends, with small players struggling to sell and large players unwilling to put much capital into active trading.  This leaves a fragmented middle to handle the bulk of the trades.  Consequently, transaction costs are high, transparency is low, and liquidity is spotty.  RINs in other words are not something that biofuel facility financiers have any faith in, making it difficult to push new projects forward.

But there is hope and even a suite of solutions.  The biodiesel and advanced biofuel RIN markets have the fundamentals to be strong, but need stronger infrastructure to thrive.

Potential Solutions

The clearest solution would be for the US government to take on the role of validator of RINs, not simply just a regulator. This would help reduce due diligence costs and risk. As an example, California Air Resources Board is playing a very active role in ensuring carbon offsets and carbon permits are credible within the emerging California cap-and-trade market, spelling out specific rules for monitoring and verification.

On the private sector side, exchanges such as GreenX or NYSE Blue could offer standardized exchange-traded futures and spot contracts for RINs as none exist right now. In North American REC and carbon markets, these organizations have already pioneered such contracts.  This would help provide more uniformity to the market, reduce counterparty risk, and increase transparency.  Importantly, the exchange could assist in creating safeguards to keep invalid RINs onto the exchange.  Most RIN transactions now however still occur in bilateral and OTC markets.

Another private sector solution is already taking shape, with the National Biodiesel Board partnering with Genscape’s RIN Integrity Network.  The service provides paying subscribers a view of the health and validity of each facility, so that RIN buyers can cross reference before they purchase.

In the long term, strong fundamentals will organically create strong controls, since the market will demand it.  But that is not a reason to wait for action, since these issues undermine the market and become an argument for those that want to weaken or even repeal it.  If supporters of RFS2 hope to achieve the security, environmental, and economic benefits of the targets, they’ll need a transparent and active RIN market to succeed.

Lead image: Biofuels via Shutterstock

Justin Felt is an Associate Director at Thomson Reuters Point Carbon in the Washington, DC office.  Learn more about him at this link.

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Dr. Rakesh Radhakrishnan is a Director, Advisory Services in the Commodities and Energy group at Thomson Reuters. He has worked in the energy industry for over ten years specializing in clean energy technologies. He was previously an Associate Director in the energy practice at Navigant where he supported the implementing of clean energy initiatives in several US states. He has also developed clean energy strategies and evaluated investment opportunities for a variety of private and public sector clients. Prior to Navigant he spent several years at United Technologies Research Center where he managed clean energy projects through collaborations between industry, national laboratories and academia in the field of renewable energy and energy efficiency. He is a former Secretary for the Division of Petroleum Chemistry in the American Chemical Society (ACS) and is a senior member of the American Institute of Chemical Engineers (AICHE). He is also a volunteer member for Victory Plant an organization that hopes to certify advanced biofuel projects while promoting their benefits to communities, counties, states and national governments. Dr. Radhakrishnan holds a PhD in chemical engineering from Virginia Tech, an MBA from the Tepper School of Business at Carnegie Mellon University and has been granted six patents with several patent applications pending that focus primarily on clean tech products.

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