When the Environmental Protection Agency set up renewable fuel mandates for US refiners, it didn’t intend for the underlying credits to become commodities.
That’s how Byron Bunker, director of EPA’s compliance division, put it to a room of biodiesel producers recently. He was explaining the agency’s attempt to reform the market for those credits after three cases of fraud roiled the biodiesel industry last year.
It sounded like a crazy statement at first. How could EPA not know that the credits — called Renewable Identification Numbers (RINs) — would be bought and sold for profit?
It’s a system refiners asked for when the EPA started rolling out the Renewable Fuel Standard in 2005. Refiners can either blend actual gallons of ethanol, biodiesel or other biofuels into their gasoline and diesel supplies, or they can buy paper credits on the open market to meet the mandate.
Bunker went on to explain that the agency never meant for RINs to be traded as though they were all identical products that should fetch the same price at the same point in the market.
“The way we set up the program, this whole ‘buyer beware’ approach, fundamental at its heart was that these shouldn’t be a commodity,” he told the National Biodiesel Board earlier this month in Las Vegas.
Bunker said refiners should have been scrutinizing each RINs deal individually, making judgments about the value of the credits based what they knew about the biofuel producers from past experience or vetting.
“There should have been a differentiation in price between the RIN from someone that you’re absolutely [sure is] valid and they’re going to backstop it, and that’s less risk so there should be a better price for that RIN,” he said. “For someone you can’t validate, there should be a risk premium.”
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That’s not how things went in the first few years of the biodiesel RINs market.
The credits traded freely from producer to broker to obligated party, sometimes back and forth among those ranks. Buyers sought little more information than the 38-digit codes that make up the RIN.
“Inherent in that ‘buyer beware’ was an assumption that that risk premium flows through in the RIN prices,” Bunker said. “Of course, that was not what happened in 2010 and 2011. They were traded as a commodity — all of them exactly the same, first in, first out in all of the trades as a pure commodity. But they weren’t. Some were fraudulent and some were valid.”
The first fraud case came to light in the fall of 2011. EPA put 24 companies on notice that more than 32 million RINs they had tried to use for compliance were bogus.
The credits were sold by Rodney Hailey, who tried to pass off an empty warehouse as a biodiesel plant called Clean Green Fuel. A federal judge in Baltimore sentenced Hailey today to more than 12 years in prison after a jury convicted him on 42 criminal charges of wire fraud, money laundering and violating the Clean Air Act during the $9 million scheme.
EPA later declared another 48 million RINs sold by Absolute Fuels of Lubbock, Texas, and 60 million RINs sold by Green Diesel of Houston as invalid.
The three cases shattered the biodiesel RINs market and made it nearly impossible for some smaller producers to find buyers for their credits, which had become essential to their bottom line.
In late January, EPA revealed its regulatory fix to get the RINs market moving again. The policy creates two new categories of credits that shield refiners from civil liability if RINs later turn out to be bogus.
The gold-plated RIN — which EPA gave the rolls-off-your-tongue name of QAP-A — will get issued to fuel made at facilities undergoing near-constant monitoring by third-party auditors. They will likely cost more than other RINs, but the higher price tag comes with the most liability protection, as auditors will be on the hook for replacing any invalid credits.
The second new RIN category, called QAP-B, would require only quarterly monitoring by an auditor. Refiners, not auditors, would have to replace any invalid QAP-B credits.
Bunker said QAP-A credits will approach what he considers a commodity, all essentially the same, with protections against fraud.
“So it doesn’t matter who produced them, they’re just good,” he said.
During the same presentation, Bunker got an earful from a RINs broker with commodity brokerage firm BTIG. A 20-year veteran of the NYMEX trading floor, the fired-up broker said EPA had commoditized RINs without standardizing the credits or offering a chance for price transparency and counter-party risk like traders have, for example, on contracts for West Texas Intermediate crude oil.
“You’re going forward and asking people on the fly to trade something that they don’t really know the value of because they don’t know the rules,” the BTIG broker said. “The rules might change. … We’re talking about millions of dollars going back and forth between these refineries.”
Larry Schafer, a consultant for the National Biodiesel Board, told the broker that refiners could easily exit the RINs market and simply blend biofuel to meet the mandate.
“We have a renewable fuels program where the marketplace has decided it wants to trade stuff back and forth,” Schafer said. “There’s nothing that requires you to do that. You chose to do that.”