A new Environmental Protection Agency proposal has shaken the market for an esoteric asset underlying the fuel industry, as suppliers and financial speculators trade billions of federal credits aimed at cutting pollution and reliance on foreign oil.
Gasoline producers and importers receive these credits from the EPA for mixing corn and other feedstock into motor fuel for domestic consumption. Between the biofuel processors that earn the credits and the refinery operators that must buy them to meet quotas, a cottage industry of brokers and investors who buy and sell the credits like commodities has sprouted.
The program was innocuous enough when it began in 2005. The credits, known as renewable identification numbers—or RINs—initially cost just pennies. But as speculators flooded into the market and drove up prices and some refiners held the credits waiting for prices to rise, it became a big unintended expense for some refiners.
"We are hostage to the RINs market," says Ben Hirst, chief legal officer for Delta Air Lines Inc., which in 2012 bought a Pennsylvania refinery in hopes of liberating itself from fuel speculators it alleged were driving up prices. Last year, the carrier spent $111 million on the credits, and now is trying to disentangle itself from the renewable-fuel program.
In the past two weeks, more than 300 million credits were bought and sold, brokers said—about twice the norm. The market, prone to slumbers and surges, became frenetic just before the EPA recently proposed new quotas for the amount of biofuels that should be blended with gasoline.
The frenzy highlighted an unintended outcome of a federal policy to reduce fossil fuels used in cars and trucks. The program has generated tens of billions of receipts showing that fuel producers and importers comply with new renewable-fuel standards. These receipts are the hidden currency behind the nation's core renewable-fuel program.
On one side of these trades are "blenders"—refiners and importers that get credits for mixing ethanol into gasoline. On the other side are refineries that, because they don't blend, must buy credits to meet quotas. Those refineries include ones owned by Delta, private-equity giant Carlyle Group and Valero Energy Corp.
RINs are traded through private contracts. Prices have seesawed from pennies two years ago to more than a dollar. This year, brokers say, they were trading for an average of about 60 cents before sliding to 30 cents on May 29, when the EPA announced its proposal. The quotas are expected to be finalized in November.
Seven U.S. refiners collectively spent more than $1 billion last year buying these credits, according to public filings.
The EPA didn't intend for the program to create a speculative market, and an agency spokesperson declined to comment on RIN price movement.
"RINs are used to demonstrate compliance under the Renewable Fuel Standard program," the EPA said. The agency manages an electronic system that tracks the RINs, but not their prices on the open market.
"There is no way the system was ever meant to be this high-priced or controversial," says Scott Irwin, an economics professor at the University of Illinois. "How did this program get this out of control?"
The EPA launched the program in 2005 and expanded it in 2007 under a congressional mandate that a certain amount of corn and other renewable feedstock be blended into gasoline, with quantities escalating annually. This makes gas burn more cleanly.
A credit is earned for every gallon of ethanol added to gas. Last year, about 14 billion credits were generated. The EPA in late May proposed raising the quota to 16.3 billion this year and 17.4 billion in 2016.
The quotas are controversial; they fall short of goals made by Congress, riling some corn growers, environmentalists and elected officials. Democratic presidential candidate Hillary Clinton proposed expanding the program, in a op-ed late last month in The Gazette in Iowa, where she faces an important Democratic caucus in a farming state.
"We're going to Washington to push for more," says Jerry Mohr, president of the Iowa Corn Growers Association.
Refiners that don't blend aren't happy either. Depending on how much gasoline and diesel they produce for consumption in the U.S., they are required to buy a certain number of RINs. This, some have complained to government officials, make them captive buyers in an artificial commodities market.
Philadelphia Energy Solutions, owned in part by Carlyle, cited the volatility and cost of the credits as a risk in documents it filed in February with federal securities regulators as part of a public disclosure for an initial public offering. RINs had a "significant impact on our results of operations," it said, rising in cost to $116.3 million in 2013 from $19 million in 2011. For the first nine months of 2014, the refinery spent $101.4 million on the credits, the filing said.
The cost hinges, it said, on the amount of biofuels blended into transportation fuel, the price and availability of the credits for purchase, transportation-fuel production levels, EPA rules and other factors.
At Valero, the credits cost $372 million in 2014. In 2013, the San Antonio-based fuel company spent $517 million. It had $3.5 billion in earnings in 2014.
"It's not an investment," says Valero spokesman Bill Day."It's not something you get a return on. It's just an expense."
He says when the prices of the credits rise, Valero and other gasoline sellers export more gas. "The expense gets passed along," he says. "They go into fuel prices."
James Stock, a Harvard University economics professor, says RIN prices have a negligible effect on gasoline prices. But he and other economists say that the price of diesel, which is attached to another set of credits, is affected. That is because each gallon of diesel is blended with a smaller amount of renewable fuel and therefore producers are spending more on the credits.
The EPA occasionally grants exemptions to small refiners who can prove that RIN buying is a hardship.
Calumet Specialty Products Partners L.P. said in a March securities filing that it recouped $18.2 million spent on these credits in 2013, after the EPA retroactively granted exemptions for the firm's refineries in San Antonio and Shreveport, La. The firm proved a hardship as a small refinery.
Corrections & Amplifications
RIN stands for renewable identification number. A previous version of this article misstated the acronym.