EPA’s Mishandling of RFS Causing Real Ethanol Demand Destruction

Source: By Scott Richman, RealClear Energy • Posted: Friday, August 24, 2018

After rampant speculation and rumors throughout the spring, the U.S. Environmental Protection Agency (EPA) confirmed in June that it had secretly released dozens of oil refineries from their legal obligations to blend increasing volumes of renewable fuels with gasoline and diesel fuel.

The blending obligations stem from the Renewable Fuel Standard (RFS), a program adopted by Congress in 2005 and then expanded in 2007. Under the RFS, the EPA converts the annual volumetric renewable fuel requirements set by Congress into percentage requirements that obligated parties (typically petroleum refiners and importers) must meet.

Under former Administrator Scott Pruitt, the EPA disclosed in June that it had exempted an unprecedented number of refineries from RFS obligations. For the 2016 compliance year, 20 refineries were exempted, while at least 29 refineries were excused from their 2017 requirements. In effect, the exemptions meant those refineries did not need to turn in the compliance credits (called “RINs”) that represent renewable fuel gallons to show the EPA that they met their 2016 and 2017 obligations. RFS obligations that would have required 2.25 billion RINs were effectively wiped away. Additionally, the EPA released one refinery on the east coast, Philadelphia Energy Solutions, from a significant portion of its 2016-2017 RFS requirements as part of a bankruptcy proceeding.

Because these compliance waivers were issued retroactively for the 2016 and 2017 compliance years, some have argued that they have had no real impact on U.S. biofuel consumption levels. The surplus of unused RIN credits that resulted from the refinery exemptions, however, is indeed affecting U.S. ethanol consumption: those RINs can be used to meet this year’s RFS obligations in lieu of actual renewable fuels. In other words, the exemptions resulted in a flood of cheap credits that will allow some refiners to cut their blending of renewable fuels and still easily comply with 2018 RFS requirements.

Data from the U.S. Energy Information Administration (EIA) show that these exemptions have already caused the ethanol “blend rate” to fall below typical levels in recent months. The blend rate is a simple measure of demand that represents ethanol’s average inclusion level in the nation’s gasoline supply.

This timing of the drop in the ethanol blend rate coincides with the market’s realization that the EPA has been granting a substantial number of exemptions to small refineries from RFS obligations. As can be seen in the following chart, prior to the wave of small refiner exemptions, the ethanol blend rate in gasoline had been increasing over time. From 2013 to mid-2016, it approached 10 percent (E10), which until 2011 was the maximum allowed in non-flex-fuel vehicles, and at times during that period it hit 10.1 percent, although never exceeding that level. The blend rate finally pushed through the previous peak a handful of times between December 2016 and January 2018, hitting a record 10.8 percent in January, with escalating RFS requirements providing much of the impetus.

Shortly thereafter, however, recognition of the extent of small-refinery exemptions started to filter into the market. The blend rate slumped to 9.8 percent in February and fell further to 9.5 percent by April. In May, the latest period for which monthly data are available, the rate rebounded, as ethanol’s price relative to gasoline (and ethanol profit margins) plunged. It remains to be seen whether this will be sustained, but the four-week average of reported weekly data trailed off again by the end of July.

During the February-April period, the average blend rate was 9.7 percent, compared to an average of 10.1 percent for the prior 12 months. Given the volume of gasoline that was consumed in the U.S., ethanol consumption was 155 million gallons lower than it otherwise would have been during the three-month period, or 620 million gallons on an annualized basis. That’s demand destruction.

Moreover, in its proposed RFS rulemaking for 2019, the EPA did not reallocate volumes lost to small refinery waivers in 2016 and 2017, and no commitment was made to compensate for volumes that are likely to be lost to waivers in 2018 and 2019. To the extent that additional waivers are granted after the final percentage standards for the 2019 renewable volume obligations are set in November, there will continue to be demand destruction. Finally, RIN prices do come into the picture, in that substantially lower prices provide less incentive for future investment needed for blenders to expand the distribution and offering of blends above E10.

In summary, demand destruction is real and continuing, and any dialog about the RFS and the impact of exemptions for oil refineries should be based on a substantive look at the facts rather than reiterating well-worn canards.

Scott Richman is Chief Economist at the Renewable Fuels Association.