(Bloomberg) -- A Trump administration plan to impose trading restrictions on biofuel credits would slash revenue for big oil companies and truck stops like those owned by Warren Buffett, while forcing Wall Street banks out of the market.
The draft proposal, now being reviewed by White House officials and set to be formally released by the Environmental Protection Agency as soon as this week, aims to quell wild price swings in credits that refiners use to prove they have satisfied annual government-mandated blending quotas for biofuels such as ethanol and biodiesel.
The plan was described by four people familiar with the document who asked not to be named discussing administration strategy. EPA spokesman John Konkus said the agency does “not comment on items under interagency review.”
President Donald Trump directed the EPA to develop the measure to aid some independent oil refiners as part of a political move that also helps agricultural communities by lifting summertime fueling restrictions on ethanol, a corn-based competitor.
The draft asks for public comment on four major possible restrictions in trading and holding biofuel credits known as Renewable Identification Numbers, or RINs, according to the people familiar with the document. The feedback is meant to guide a final EPA decision about which limits to adopt in the market billionaire Carl Icahn once blasted as “rigged.”
The prospect of sweeping changes to the thinly traded RINs market has unleashed fierce lobbying by refiners and integrated oil companies dueling over the idea. At stake: profits tied to a market worth $18 billion in recent years, including a revenue stream for truck stops such as those owned by Buffett’s Berkshire Hathaway Inc . (NYSE:BRKa)
Although the government created the RIN system to give refiners more flexibility in fulfilling U.S. mandates to use biofuel, the credits that are created along with each gallon of ethanol and biodiesel are now traded as commodities, with swaps negotiated among companies, traders and brokers via email and instant messages.
Under current rules, refiners and importers have up to two years to submit RINs to the government as proof they have satisfied biofuel quotas, but credits can change hands many times before they are submitted to the EPA and therefore “retired.” Companies that fall short of blending requirements must buy RINs to make up the difference.
Two of the EPA’s options seek to promote steadier trading volumes, block companies from hoarding credits and discourage refiners from shorting the market, by forcing traders to shed holdings quarterly. Refiners and importers that are obligated to blend biofuel would have to retire 80 percent of their obligation every quarter. Companies that don’t actually need to fulfill biofuel quotas -- but generate or trade RINs anyway -- would have to rid themselves of all of their credits quarterly.
Shorting the Market
The time limits could undercut some trading strategies, including refiners’ ability to short the market by betting RIN prices will fall and buying credits just before they are needed to prove compliance each March.
The EPA also plans to ask the public about imposing firm position limits or disclosure requirements meant to shine a spotlight on anyone with a large collection of RINs. Under the agency’s proposed two-part test, details would be revealed about companies holding at least 3 percent of the total credit pool as well as more RINs than needed to meet 130 percent of their individual biofuel quotas.
Another proposed provision would edge some traders out of the market by limiting the sale of credits to refiners and importers obligated to satisfy U.S. biofuel mandates.
Oil Industry Rift
The EPA is “trying to make the system more transparent,” said Wallace Tyner, an agricultural economist at Purdue University in West Lafayette, Indiana.
However, the effort has widened a rift in the oil industry, which could see uneven results from the changes. Independent refiners that must purchase RINs to satisfy quotas argue reforms will pare compliance costs by damping speculating and calming volatile prices. But the restrictions also could lower RIN-related revenue for large, integrated oil companies that generate more than enough of their own credits and sell the excess for profit.
The American Petroleum Institute, which represents some of the world’s largest oil companies, including BP (LON:BP) Plc and Royal Dutch Shell (LON:RDSa) Plc, argues the changes would limit liquidity while failing to solve more fundamental problems with the U.S. Renewable Fuel Standard.
Efforts to “cherry pick” aspects of the biofuel program for reform “both misdiagnose the problem and provide misguided and counterproductive cures,” said Frank Macchiarola, head of downstream operations at API. “The RFS is a broken program that needs significant reform, but parties have made capital investments and business decisions under the existing program structure.”
Under the current dynamic, some truck-stop owners such as Pilot Flying J Inc. and Murphy USA Inc., are able to sell RINs created by blending biodiesel and ethanol for sale at filling stations. Buffett’s Berkshire Hathaway purchased a 38.6 percent stake in Pilot Travel Centers LLC, owner of the Pilot Flying J truck chain, in 2017.
The Virginia-based trade group NATSO, which represents Pilot Flying J, Love’s Travel Stops and Country Stores Inc. and 1,700 travel plazas and truck stops, warns changes to the RINs market “would cause more harm than good.” RIN values are used to determine pump prices for biodiesel, which costs more than petroleum-based diesel. The group argues RIN revenue has provided an incentive to build out distribution infrastructure.
Price Swings
Independent refiners such as Valero Energy Corp (NYSE:VLO). insist reforms are necessary to rein in an irrational market in which economic transaction costs are estimated to dwarf those for oil, ethanol and other energy commodities. Policy news out of Washington has sparked violent swings in prices. RINs tracking ethanol consumption hovered at just a few pennies in 2012 but soared to $1.40 apiece in 2013 and have generally fluctuated between $0.20 and $1.10 since then.
Supporters of restrictions point to market anomalies documented in a 41-page analysis by NERA Economic Consulting spearheaded by former Commodity Futures Trading Commission member Sharon Brown-Hruska. The analysis, conducted for Valero, notes that when RINs near expiration dates, they historically cost more than credits with a longer remaining lifespan, even though the opposite should be true.
The unorthodox pricing -- akin to consumers paying more for eggs about to go bad than those that don’t expire for weeks -- suggests an inefficient market and possible hoarding of credits, NERA said. And just small amounts of hoarding can cause RIN prices to jump, creating an incentive for companies with excess credits to withhold supply, NERA said.