Ethanol Blending Pressures Already Shrinking Refiner Margins

Source: By Laura Blewitt, Bloomberg • Posted: Tuesday, May 17, 2016

Federally mandated ethanol blending is adding extra pressure to the faltering profits of U.S. refiners.

The worst crude oil downturn in a generation, which at first helped refiners’ profits, has now passed through to the fuel prices. Now, gasoline is cheaper than the ethanol that refiners have no choice but to use.

Ethanol averaged 30 cents above gasoline in Chicago during the first quarter, costing HollyFrontier Corp. $36 million. Chicago ethanol now runs at about a 2-cent premium to gasoline, while Los Angeles prices are 24 cents higher, David Hackett, president of energy consultancy Stillwater Associates said by phone. Ethanol futures on the Chicago Board of Trade averaged 21.5 cents above gasoline contracts on the New York Mercantile Exchange in the quarter, compared with an average 48-cent discount in the same period during the previous five years.

The Renewable Fuel Standard program, introduced in 2005 under the Energy Policy Act by the Bush administration, mandates the use of about 18.11 billion gallons of renewable fuels this year, 80 percent of which is ethanol. For the first time, EPA this year mandated consumption targets that would exceed 10 percent of projected gasoline demand. EPA’s proposed biofuel targets for 2017 are currently under review at the White House’s Office of Management and Budget, according to a government filing.

The mandates have boosted ethanol prices, according to Ed Hirs, an energy economics lecturer at the University of Houston. “The mandated increased volumes provide a way to drive up demand for ethanol which is otherwise non-economic to produce.”

The Renewable Fuels Association, a U.S. ethanol industry trade group, declined to comment.

RINs Cost

If a company doesn’t blend enough ethanol to meet its quota, it can fill the obligation by purchasing blending credits called RINs. Depending on the size of the refiner, RINs compliance can cost tens if not hundreds of millions of dollars per quarter.

RINs trade in an over-the-counter market and can swing dramatically when supplies are short. Valero’s first quarter RIN cost was 21 percent higher year-over-year, CFO Michael S. Ciskowski said. HollyFrontier disclosed its first quarter RIN obligation cost $46 million, while the larger independent refiner Valero Energy Corp. spent $161 million last quarter.

Ethanol RINs that meet current year compliance averaged 70 cents each last quarter, compared with 69.25 cents during the first quarter of 2015, Progressive Fuels Limited data compiled by Bloomberg show.

Concerns of a 2017 RIN shortage are mounting. A report released last month by Andy Lipow, president of Lipow Oil Associates, predicted the price of RIN credits could surge in a “sequel” to the 10-fold price run up seen in 2013. Lipow pointed to actual gasoline demand that’s come out stronger than forecast.

Whether blending higher volumes of ethanol or purchasing RINs, there’s no way around the legislation-induced losses for refiners like HollyFrontier.

“If ethanol blending isn’t economic, like it wasn’t in the first quarter, whether you own retail or not it’s still garbage,” HollyFrontier CEO George Damiris said on the company’s first quarter earnings call.