Ethanol mandate makes life difficult for small refiners

Nearly 15 years ago, when we thought America was running out of domestic crude oil, Congress passed the Energy Policy Act of 2005 with the goal of decreasing imports, reducing greenhouse gas emissions and enhancing energy security. Among other provisions, the law mandated the blending of renewable fuels, such as corn-based ethanol, into gasoline and diesel. Known as the renewable volume obligation (RVO), and administered by the Environmental Protection Agency (EPA), this quantitative obligation has jumped from 12.9 billion gallons in 2010 to 19.9 billion gallons in 2019.

In addition, Congress directed the EPA to generate a system of tracking numbers, known as RINs (renewable identification numbers), to ensure that mandated blending requirements are being met by “obligated parties.” To make the process even more convoluted, the obligated parties are refineries and gasoline-diesel importers, not the parties doing the blending.

Therein lies a major problem. Most refineries do not actually blend fuel. So in order to meet their obligations, they must purchase excess RINs from third parties, typically big oil companies and large gasoline retailers with blending facilities. The RINs market is both opaque and highly volatile, at times generating huge profits for sellers while imposing significant costs on refiners and importers who must purchase them.  

Two years ago, Philadelphia Energy Solutions, the largest refiner on the East Coast, cited the spiraling costs of RINs in its bankruptcy filing. As stated by former U.S. Energy Secretary Spencer Abraham, “The RIN system was not meant to create a multibillion-dollar commodity market that serves to subsidize large-scale blenders and vertically integrated oil companies at the expense of smaller and independent refiners.”

To help ease the financial burden of RINs acquisition, the EPA occasionally grants waivers to small refiners. These hardship waivers are only offered to refineries producing less than 75,000 barrels a day. In addition, the EPA is required to consult with the Department of Energy to determine whether an exemption is granted. Around 40 such exemptions have been allowed since 2017.

Perhaps not surprisingly, these exemptions have raised the hackles of organizations such as the Renewable Fuels Association (RFA), the leading trade group representing ethanol producers.  The RFA claims that the blending waivers are hurting family farms, decimating rural communities, despoiling the environment, and putting America’s energy security at risk. Several senators from farm-belt states have called on the EPA to stop granting exemptions, arguing they harm the ethanol industry at a time when farmers are suffering from low commodity prices.

Another trade organization, the Advanced Biofuels Association, recently sued to block the EPA from granting ethanol waivers; but the U.S. Court of Appeals for the District of Columbia denied the group’s request for a temporary injunction.

Despite claims that small refinery waivers are reducing the demand for ethanol, U.S. Energy Information Administration (EIA) monthly data show no backtracking on biofuel blending. In fact, the blend rate in the first quarter of 2019 was essentially the same as a year ago.

Ethanol producers may be hurting, but it is not because of the small refiner exemptions. Last year, U.S. ethanol exports reached a record 1.7 billion gallons, or 11 percent of total production.  However, exports are down so far this year as China and other countries affected by the escalating trade war have stopped or reduced their purchases of American ethanol.

The high cost for most small refiners to meet EPA’s blending requirements (RVOs) is but one of many defects in the renewable fuels program. For example, the ability of large gasoline retailers to “game the system” by selling excess RINs at a profit allows them to undercut small retail filling stations, which is one reason more than 12,000 have closed over the past decade.

What is more, even the environmental community is starting to question the benefits of ethanol, citing higher-than-expected carbon emissions in its production, fertilizer runoff, and reduced wildlife habitat.

The blending of ethanol with gasoline never has been subject to the market test and probably would not occur to a significant degree absent the EPA mandate. But with half the nation’s corn being converted to ethanol, and the farm states critically important in the upcoming presidential election, the program is likely to remain essentially intact for the foreseeable future.

Bernard L. Weinstein is associate director of the Maguire Energy Institute and an adjunct professor of business economics in the Cox School of Business at Southern Methodist University in Dallas. Follow on Twitter @SMUCox.