The Impact of EPA’s Policies Regarding RVOs and SREs

I. The Purpose and Structure of the Renewable Fuel Standard

The Renewable Fuel Standard (RFS) was designed to incentivize the replacement of fossil fuel gasoline and diesel with renewable biofuels. Each year, EPA sets the Renewable Volume Obligation (RVO) in gallons for each type of biofuel specified in the statute and converts those requirements to percentages based on estimates of fuel demand. Each producer or importer (“obligated party”) must then self-generate or acquire sufficient Renewable Identification Numbers (RINs) to meet their percentage requirements. RINs may be banked for the next compliance year, such that an obligated party who generates excess RINs in a particular year may retain them to enable compliance in the following year or sell them to another obligated party who may be in deficit. Obligated parties also may carry over a RIN deficit from one year to the next, a provision which serves a similar purpose to the bank. EPA may grant exemptions from these standards to certain petitioning small refiners (SREs), which effectively reduce their RVOs gallon-for-gallon.

The price of RINs, determined through trading between obligated parties and other entities, provides information about the cost of the RFS requirements, relative to a scenario without the program. If, for reasons unrelated to the RFS, every obligated party used a sufficient quantity of biofuels in the current year to meet the standard and expected to do so in subsequent years, then the market price for RINs would be zero. A non-zero price for RINs therefore is an indication that at least some fuel producers find the RFS constraints to be binding or expect them to be binding in the future with some positive probability. The RIN price provides an estimate of the marginal cost to the industry of reaching compliance, potentially moderated by expectations of such costs in the future.

Under this regulatory structure, EPA plays a critical role in determining the marketplace outcomes. The impact of EPA’s decisions can be seen in the movement of RIN prices. In the short run, the RIN market tends to respond immediately to announcements from EPA that affect the requirements for compliance, such as changes to the RVOs. For example, on August 6, 2013, EPA announced the publication of the 2013 Final Rule and indicated, for the first time, that future volume requirements likely would be adjusted downward to reflect difficulties in surpassing the 10-percent “blendwall” for ethanol in gasoline. By August 8, 2013, D6 RIN prices had dropped 38 cents, still the largest decline over any three-day period in the history of the program. In the longer run, the general level of RIN prices reflects the stringency of the current standards and expectations about those conditions in the future. The size of the RIN bank also provides evidence regarding the feasibility of compliance with the current standards and the market’s expectations about future standards.