RINferno

August 16, 2016 |

BD TS RINferno smLet me see if we got this right.

Donald Trump loves the Renewable Fuel Standard
Carl Icahn loves Donald Trump
Therefore, Carl Icahn hates the Renewable Fuel Standard

With that, welcome to the 2016 United States Presidential election season. And welcome to something that used to be called RINsanity and now we had better call RINferno.

You see, prices for low-carbon fuel credits in the United States, under the Renewable Fuel Standard, have been spiking this year. Prompting a firestorm that has spilled over into the election season but is raging even more furiously amongst friends and foes of the RFS.

And at the very center of Hell, various actors in the petroleum fuels supply chain are engaged in a titanic battle between the forces of darkness and the forces of slightly less darkness, over who gets the bill.

RIN prices for renewable fuel (D6) and biomass-based diesel (D4) in 2016.

RIN prices for renewable fuel (D6) and biomass-based diesel (D4) in 2016.

Today, we’ll look at the battle amongst the supply chain. Tomorrow, we’ll look at how the RINferno is affecting the development of advanced biofuels.

The Icahn problem

Icahn’s stock is down 45 percent this year, the result of a disastrous series of investments in mid-size oil refiners such as CVR and Monroe. Disastrous because the refiners have gambled on a strategy to overturn the Renewable Fuel Standard and, for that reason, have not chosen investment strategies that would give them a strong position in RFS economics.

Which means, the trading in RIN credits that go on between oil refiners.

Icahn’s portfolio companies chose to be a buyer of credits instead of investing in low-carbon fuel production and distribution capacity. Which, of course, was the point of and the economic signal given by a Republican-controlled Congress and White House when it established the RFS ten years ago.

The net value of RINs is zero. But those who have renewable fuel-friendly strategies end up as sellers of RINs, and the others are net buyers. When RIN prices spike, the latter get hit with costs.

Icahn’s strategy? Isolate the refiners that are being hit with costs, add up the costs as a group, neglect to mention that the problem is management and strategy, paint the refiners as a victim, and issue a series of quotes to friendly reporters blaming the Environmental Protection Agency for excessive regulatory zeal that is sending America down the drain.

Enter Mark Cuban to explain

The billionaire investor and star of Shark Tank says Icahn is a fraud. Which is to say, he invests in companies and sectors that everyone knows are heavily regulated, like energy and AIG. What’s the point? Cuban asks. Plenty of sectors with less regulation are available to investors who hate the distortion that they claim regulation brings.

The point? Making money by narrowing and distorting the public’s focus on complex topics, painted as government failures in order to socialize the losses of investments in the private sector. Right out of the Trump playbook, and P.T . Barnum’s, we might add.

Step right up, there’s a sucker born every minute.

Icahn’s attack

This week, Icahn has launched an appeal to the EPA for “the Mother of all Short Squeezes” in its interpretation of the Renewable Fuel Standard. He’s part of a coalition that includes CVR, Valero, Alon USA, HollyFrontier, the Small Business Refiners Coalition, and the American Fuel and Petrochemical Manufacturers.

Interestingly, the American Petroleum Institute — no friend of the RFS — has failed to join the coalition. And here’s why.

About Short Squeezes

For those less familiar with a “short squeeze” in the parlance of the stock market, a short is someone who bets against a stock. On August 1st borrow, say, $1000 of stock in Chevron from a friend of yours, paying him a $20 fee and promising that you will replace the stock by August 16th. You then sell the borrowed stock for $1000. You hope to buy it back for, say, $800 when August 16th rolls around.

If everything works out, you replace your friend’s shares, pay the $20 fee, and pocket a $180 profit in a couple of weeks. Since you borrowed the stock, your investment was the $20 and you made a 9x return in a couple of weeks.

But what if the stock goes up instead of down? What if, instead of falling from $1000 to $800, the price for the block of shares jumps to $1200? Now, you’ve invested $20, and lost another $200 when you buy back the shares. You have to come up with a lot of extra cash in a hurry. Make a $1 million short bet, and if it goes wrong you can go bust.

Why “Mother of All Short Squeezes” is a great descriptor but nothing to worry about

A “short squeeze” is when someone bet against something and the bet went badly. In this case, the bet was against the Renewable Fuel Standard, the Congress, and the EPA. Some oil refiners — not all — bet on a do-nothing strategy vis-a-vis low-carbon fuels. Invest in little, make little, distribute little. If the RFS gets scuttled, you win big. If the RFS is affirmed, you lose.

But Icahn and friends do what all short sellers do when they are facing the consequences of a disastrous bet. They scream bloody murder. In this case, raising the specter of a general shortage of RINs.

If you have to borrow a cup of sugar from your neighbor, it doesn’t mean the world is short on sugar.

Is there really a shortage? As BIO spokesman Paul Winters described it, “the RIN shortages he predicts have not occurred – at least in aggregate. His problem is that he didn’t have the foresight to secure a supply of RINs.”

Where’s the American Petroleum Institute?

The API has been no friend of the RFS. Why are they not standing shoulder-to-shoulder with Icahn at the moment? Probably because, as we mentioned, the trade in RFS credits occurs solely between refiners and a couple of specialist traders, and in this case, the big winners are some very large integrated oil companies who can distribute far more low-carbon fuels than they are obligated to. So, they can buy fuels, detach the overstock in RINs, and sell them to smaller refiners.

The smaller refiners say they are paying as much as $1.8 billion in RFS compliance, which means that on the other side of the trade the counter-parties are making $1.8 billion. As we noted, the trade in RINs nets zero to the US government or renewable fuel producers.

Where’s the National Association of Truck Stop Operators, the Society of Independent Gasoline Marketers and the National Association for Convenience & Fuel Retailing?

Now, guys who sell petroleum-based for a living, you might think, would be natural allies in a move against the Renewable Fuel Standard.

Not this time.

You see, the fix that Icahn is proposing is not to end the RFS altogether, and return the US to a petroleum and gas monopoly. This group wants to shift the point of obligation from themselves to, well, someone else.

Namely, companies further down the supply chain. That’s the solution to the regulatory problem in America, I guess. Make someone else pay for it.

David Fialkov, NATSO’s vice president for government relations, isn’t having any of it.

In comments to the EPA, Fialkov said:

“The current policy creates a strong incentive for fuel marketers to blend renewable fuels into the fuel supply while lowering the price at the pump for consumers. Changing the point of obligation would have the opposite effect of discouraging fuel marketers from integrating renewable fuels into the fuel supply while simultaneously raising prices at the pump.

[The current approach] “creates a mechanism through the RIN,” he added, “that allow marketers and retailers to sell diesel or gasoline blended with biofuels to the end-user at a price lower than competitors who do not engage in blending activity.”

“Undoubtedly, some merchant refiners are not as competitive as other, more-integrated refiners, but that tends to be the result of business decisions they made after the RFS was already in place and the consequences were very predictable.

“Now that RIN prices have gone up, they suddenly don’t look like good business decisions and they are acting like they are victims who are not responsible for their current predicament.”

The E85 price conundrum

There’s clear evidence for Fialkov’s comments in the price data which the Iowa Renewable Fuels Association has been reporting for some time. Namely, there is huge disparity between the prices offered by various actors in the marketplace.

E85 price

Here, we see prices being offered by two of the companies pressing EPA to make changes. Holly Frontier is pricing E85 at $1.07 and Valero at $0.97. Yet, The Andersons-Denison is pricing E85 at $0.55 per gallon. (Slight difference in the ethanol content, 70% vs 83%, but it’s all qualifying E85). It’s the same molecules. And the discount to wholesale “clear regular gasoline” is as much as 66%.

The Bottom Line

Should anyone be worried about RINferno?

You? Not a bit.

Carl Icahn? You betcha.

His investments have gone south faster than you can say “too big to fail”. Which is kinda what he’s saying. Or, hoping someone is buying.

In the end, the EISA Act was passed in 2007, took effect in 2011, and here it is 2016. The companies in question have had nine years to figure out a cost-effective compliance strategy.

Maybe in the world of business, and in politics, Icahn will succeed. He;s got money, and money matters in Washington.

In the world of sports, it’s much easier to explain what happens to companies, and investors, who fail to prepare.

They prepare to fail. As Coach Wooden once said. He also warned:

“Don’t mistake activity with achievement.” 

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