September 16, 2020
There are some things that people do, and we just fail to understand why. Putting pineapple on pizza or thinking pickles with peanut butter is a good idea, for instance. Sometimes, granting an entity a Small Refiner Exemption (SRE) can be a lot like that. It’s a little weird and a bit strange. In this month’s article, I am going to talk, somewhat briefly, about the “why” portion of SRE’s and, more importantly, what’s all the yelling about?
As I’ve discussed in a previous article, to receive a small refiner exemption, you had to be a small refiner and you had to show a disproportionate economic hardship. There are a few more details you should know, to get those, read Becoming the Outcast: The “What” Portion of the Small Refiner Exemption. You will also want to have a good grasp on the Renewable Volume Obligations (RVOs) and the Renewable Fuel Standard (RFS) before you continue to read. I figured I’d get the disclaimers out of the way from the start.
So, why all the yelling? We have to start somewhere, so let’s start with what happens to the RIN market when a large number of SRE’s are granted. When an entity is granted an SRE, a portion of the RIN market that would have otherwise been there has been excused. For example, if Small Refiner A applies for and is granted an SRE, it will not need to find RINs to fulfill their obligation. Small Refiner A’s compliance obligation for the applied year has been excused and Small Refiner A will not be held to that obligation. When this is done for a single entity or even a handful of entities, the effect is barely noticeable on the RIN market. It’s basically a single ripple in the large sea of the RIN market. However, when this happens in larger numbers, the effect is more like a tidal wave.
Before we get into talking about how demand affects the RIN market, there’s a couple of things that you need to keep in mind. First, the RIN market is not like the stock market. The RIN market is developed off of a compliance obligation, rather than an investment interest. This means, the thing that drives the market is a regulatory operation rather than an economical consideration. Second, EPA has sole authority in granting or denying an SRE. This means EPA decisions drive the RIN market similarly to the way rumors drive the stock market.
Traditionally, EPA was extremely selective in the number of SREs granted. For example, in 2013, EPA received 29 SRE petitions but only granted 8 of them. EPA granted 8 petitions in 2014 and 7 petitions in 2015. However, in 2016, EPA began granting SREs in much larger numbers. To put this in perspective, in 2016, the EPA granted 19 SREs. These numbers continued to increase with 35 SREs granted in 2017 and 31 granted in 2018. If you would like to take a look at the data for yourself, EPA makes publicly available the number of SREs granted for a given compliance year, as well as other public data.
As you may have noticed by the numbers, EPA seemed to be deliberately less selective in the number of SREs that they granted. Part of this is due to a court case that changed the way EPA evaluated how SREs petitions are analyzed. I’m not going to touch on that case in this article, but I might do so in the future. #suspense. The significance of EPA granting this number of SREs, is the way it affected the RIN market. Again, the RIN market is driven by the compliance obligation, not an investment interest. When EPA exempted tens of thousands of gallons, it essentially took away a portion of the demand, which drove RIN prices down.
Why is RIN prices being driven down a bad thing? This gets really complicated very quickly. Whether RIN prices being driven down is a bad thing is also entirely dependent on the position of the RFS market participant. For blenders of renewable fuel, the entities that allow RINs to flow from the point of generation to retirement, significant decreases in RIN prices make a blending operation less economically feasible. By making blending less economical, blenders will probably not blend as much fuel, which means there will be less RINs available to go to market.
Driving down RIN prices also can be economical harmful to producers of renewable fuel. Producers of renewable fuel look at the RIN market as a indication of demand. For example, if all obligated parties everywhere needed RINs to retire against their obligation, producers would have to ramp up the manufacturing of renewable fuel to meet those needs. If gallons creating an obligation are excused, then the demand for RINs is down, which means the demand for gallons of renewable fuel to blend could also be down.
Now, let’s point out a couple of obvious things. First, in the previous two paragraphs I’m assuming RINs are the only reason blenders blend and producers make renewable fuel, and that’s simply not true. Any well run fuel business probably has multiple revenue streams. The examples of what happens when RIN prices are down are feasible results and have been shown to happen, but are by no means the only reason a blender no longer blends or a producer ratches down production. Second, I’m inherently biased. I work with blenders of all shapes and sizes on a regular basis and I know the trials and tribulations they encounter. From my perspective, RIN prices being driven down is always going to be inherently bad, but you should know there are other sectors of the RIN market, such as refiners, that would not agree with me. The SRE saga is far from over. Just recently, EPA denied all “gap” SRE petitions, which was not an expected move for the renewable fuels industry. Will EPA continue to grant SREs in such large numbers? Your guess is as good as mine