In yesterday’s Digest, we covered the topic of RINferno, the controversy over rising RIN prices and the impact on parties in the Renewable Fuel Standard — refiners, and potentially fuel terminal operators.
Today, let’s look at impact on producers — and specifically the catastrophic impact of current RIN prices on advanced biofuels.
The advanced biofuels problem
There’s a separate category of RINs for advanced biofuels. These are fuels that have at least a 50% reduction in fossil fuels compared to 2005 baseline gasoline. Overall, to qualify under the RFS, you need a minimum of a 20% reduction — but in theory, there’s an indirect incentive available to producers to maximize low-carbon advantage.
A few years back, Aemetis announced that it had figured out how to run its corn ethanol plant in Keyes, California using sorghum as a feedstock and renewable biogas for heat and power. By doing so, it could increase the carbon savings to more than 50%. At the time, advanced biofuels RINs were worth almost 50 cents more than corn ethanol (D6) RINs.
So, there was an economic return available for investing in advanced biofuels capacity and driving the reduction of carbon.
Then, corn ethanol RIN prices started to rise in 2013, in what was known as RINsanity at the time.
Refiners blamed the EPA, the RFS system of obligating refiners not downstream fuel distributors, and a whole bunch more. And, overwhelmingly, they blamed the E10 saturation problem.
Here’s what that is. Most cars made before 2012, according to most auto manufacturers, can tolerate only 10 percent ethanol blends. EPA and the renewable fuels industry disagree, citing a slew of research showing that a) vehicles made since 2001 can tolerate E15 blends and b) that there have been no substantive reports of E15 causing problems at any of the outlets that carry it.
The EPA falls for the story
However, the EPA bought the argument that the US would have to limit itself to 10 percent ethanol blends for some time to come, given the E15 debate and the low levels of E85 demand. EPA agreed that an ethanol distribution problem could only be solved by limiting the amount of biofuels in the US. That meant that the US would be limited to less than 15 billion gallons in the gasoline substitution pool — aside from any drop-in replacements that came along.
In the drive towards a low-carbon society, RINsanity and EPA’s response to it had two practical impacts.
One, as RIN prices rose, the differential between corn ethanol RINs and advanced biofuels RINs all but disappeared. Killing the incentive to bring 50 percent carbon-reduction fuels into the marketplace.
Two, as EPA sealed off the market for ethanol, cellulosic ethanol had no place to be distributed unless it displaced corn ethanol. So, renewable fuels were pitted against each other, instead of being jointly employed against petroleum-based high-carbon fuels. And, because the cost and risks of cellulosic are much higher in these early days, investor interest in deploying cellulosic fuels in the United States vanished overnight.
Attention in the US shifted to a) natural gas as a fuel feedstock and b) making renewable chemicals from biomass. Companies like Coskata, and Primus Green Energy shifted to natgas, and companies like Genomatica, NatureWorks, Verdezyne, Myriant and BioAmber drove the story of renewable chemicals to new heights.
OPEC joins the party
Then, oil prices crashed.
Both the natgas pathway and renewable chemicals came under significant pressure, because it was tougher than ever to compete with petroleum fuels and chemicals. And there’s no RFS for natural gas or chemicals.
And, at the same time, a little-discussed feature of the RFS started receiving a new level of attention., The Cellulosic Waiver Credit. It was designed as a counter-cyclical element in the RFS, because back in 2007, lawmakers were balking at approving an expanded RFS out of fear that, as happened in the 1980s and 1990s, OPEC would crash oil prices and strand all the investment in renewables.
The credit is complex — what you need to know is that the value goes up when oil prices go down. And it’s implied 2017 price is around $1.70 per gallon now. Compared to $0.25 when oil prices were high.
So, cellulosic fuels began to receive more attention. Especially as the California Low Carbon Fuels Standard began to bite hard. Earlier this year, consultants were adding up the credits and determining that, in California, a cellulosic fuel that delivered very low-carbon product could be worth as much as $3.75 a gallon wholesale — more than double the value of ethanol or gasoline.
America’s innovators respond
At the same time, the forces of innovation weren’t quite done yet.
A couple of companies, and the best-known of these are QCCP and Edeniq, brought forward a new generation of technology innovations designed to produce cellulosic fuels at astonishingly low capex and opex costs.
To use an example, Edeniq said that it could increase a corn ethanol plant’s overall output by 7 percent — including a 2.5% component comprising cellulosic fuels — for a fraction of the cost of building a greenfield cellulosic ethanol plant.
Companies like Pacific Ethanol and Aemetis, that produce and distribute in the California market, were especially taking notice. Investment started. Contracts were signed. In an historic deal announced earlier this year, Aemetis announced a deal to acquire Edeniq.
They saw the math.
“We expect to implement Edeniq’s cellulosic ethanol technology at our Keyes plant in the first quarter of 2017, which we believe will substantially improve cash flow by increasing the number of gallons of ethanol and distillers oil produced at our plant, as well as generating valuable D3 biofuel RINs when the EPA approves Edeniq’s company registration,” said said Aemetis CEO Eric McAfee.
Let’s look at what they see.
The value of cellulosic fuels in California can be simply expressed this way:
Gasoline (E0) + Cellulosic RIN + LCFS credit = The value.
You see, an obligated party in California, absent producing or buying a wet gallon of cellulosic fuel — for example, in order to distribute an ethanol-free gallon of E0 gasoline — would have to purchase those two credits to meet low-carbon fuel obligations at the state and federal level.
Per gallon, it works out this way right now:
Cellulosic RIN: $1.80
LCFS credit: $0.80
Rack average clear regular gasoline: $1.69
Total value: $4.29
(Thanks to IRFA, E85prices.com and consultant Michele Rubino for the data).
The corn ethanol price problem and the cellulosic conundrum
So, here’s the problem. By the same sort of math, a gallon of corn ethanol sold in the general US market would have this value:
D6 corn ethanol RIN: $0.90
E0 gasoline: $1.69
The problem is that corn ethanol is selling for nowhere near $2.59 per gallon. In fact, the September contract is selling for $1.43.
The Abject Fear
The abject fear amongst investors is that the same forces that are holding down ethanol prices will hold down cellulosic prices — to some extent, or ruinously to the same extent.
The ethanol problem
The ethanol and RIN price phenomenon is perplexing most observers. FAPRI, which tracks this market as closely as anyone, titled its latest bulletin, released last week, RIN Prices: Still (Mis)Behaving?
Bottom line, no one can quite model why corn ethanol RIN prices are spiking. In the September futures market, ethanol is trading at a $0.02 premium to RBOB gasoline. Which, theoretically means that you could buy a wet gallon for $0.88 per gallon less than you can buy the RIN and a gallon of wholesale RBOB gasoline.
On explanation? There’s a shortage of wet gallons, or a shortage of ways to blend and distribute wet gallons. That would produce a RIN price lift as obligated parties scrambled to find a form of alternative compliance.
The oil industry has been squawking about this — they point to “the blend wall”.
The biodiesel conundrum
Another problem? Biodiesel RIN values are spiking, too. They have risen exactly the same percentage this year as corn ethanol RINs. And there’s no blend wall problem with biodiesel.
But D4 RINs can be used to satisfy obligations under the Renewable Fuel Standard that D6 corn ethanol RINs work for. In other words, you can buy a biomass-based diesel RIN as an alternative compliance mechanism for corn ethanol.
So, that could be the explanation.
But there’s another one. It also could be the case that some obligated parties are buying wet gallons and banking the RINs.
How can banking RINs distort the low-carbon market?
The way that the Renewable Fuel Standard is set up, the obligated party doesn’t pay for a RIN when they buy a wet gallon. It comes attached, for free. So long as an obligated party can acquire more fuel fuel than their obligation, and in that case they can become sellers of RINs.
Why would you not trade a RIN you didn’t need? Lots of reasons. For one, because you fear a shortage later on.
So, what if some obligated parties are banking instead of trading their RINs? In this case, demand is steady and supply is shrinking, so the classic market response is a price spike. Like local water prices after a hurricane.
Is there evidence that there’s a lot of banking going on?
We don’t have visible data for 2016. The latest complete year-data we have from EPA is for 2013. The data is here, and BIO, in running the math recently, found that there are 1.38 billion unused 2013 RINs. Almost 10% of all those generated.
Meanwhile, we have a driver on hand for hoarding, which is uncertainty. An uncertain market for gasoline demand, uncertain EPA mandates for renewable fuels, an uncertain future for products like E85 or E15.
Here’s the nice thing about banking RINs, from the POV of an obligated party
If you have banked RINs and can use them not only for compliance this year, but compliance next year, then you have market power over the ethanol seller. You only need the gallons, if they come in at the right price. Conversely, the ethanol producer has limits on ethanol storage and on the credit they have with suppliers. They need to move ethanol more than you need to accept it. Classic response? Suffering ethanol prices compared to RIN prices.
Another form of market power
Here’s another item to consider. Under the RFS, you can buy and blend a gallon of biomass-based diesel as a form of complying with the corn ethanol mandate. That D4 RIN that comes with a gallon of biodiesel can be used for the overall renewable fuel obligation that D6 corn ethanol RINs are applied to.
Right now, an obligated party can buy a gallon of biomass-based diesel for $3.08 on the spot market. There’s a $1.01 blenders credit available now, netting the price out to $2.07 per gallon. That comes with 1.5 D4 RINs. To get 1.5 RINs via ethanol an obligated party would have to pay $2.14 (that’s the $1.43 wholesale price, times 1.5).
So, there’s a lot of pressure on the ethanol price.
Bringing this back to cellulosic ethanol
We’ve identified some real market forces that are spiking ethanol RIN prices, without spiking ethanol prices. So, why can’t obligated parties play the same games with cellulosic ethanol to drive the price down and rob companies like Aemetis of their anticipated margins? Why is cellulosic special, and insulated?
The major protection pertains to using biomass-based diesel d4 RINs to meet a cellulosic ethanol obligation. In two words, you can’t. So, that downward form of price pressure doesn’t exist in the cellulosic market.
To get a cellulosic TIN, you either have to buy and blend a wet gallon, or buy a RIN from someone who has. Or, buy that Cellulosic Waiver Credit we mentioned earlier.
Second, the low volume of cellulosic production to date means that wet cellulosic gallons have been hard to come by, and it’s been tough to bank RINs. Around 250 million RINs have been generated in the entire history of RFS, compared to roughly 100 billion for the other fuels, combined.
Fast forward to RINferno
The biggest problem facing cellulosic fuels today is the problem of distributing the fuels. And we’ve mentioned that to a great extent, so long as there is the perception of a blend wall and EPA aggressively limits ethanol distribution, corn ethanol and cellulosic ethanol are in competition. Not only with each other, but imported sugarcane ethanol from Brazil, which qualifies as an advanced biofuels because it delivered 50% carbon savings compared to 2005 baseline gasoline.
The more that ethanol prices sink or stay depressed, the worse for cellulosic ethanol because there’s a cheap way to get obligated fuels into the marketplace. Why buy a $4 fuel when you can buy one for $2.
So, the cellulosic credits are critical. That means there has to be a strong differential in the RIN price between cellulosic and corn ethanol.
The more than RIN prices for corn ethanol go up, the smaller that differential becomes.
The Bottom Line
Companies like Aemetis believe they can add up to 2.5% in capacity at existing corn ethanol plants in the form of cellulosic ethanol and up to 7% overall expansion in capacity. Taken across the ethanol fleet, that represents 375 million gallons at an incremental value compared to corn ethanol prices today of $2.63 per gallon in California and $1.83 elsewhere. Since California’s market is fully capable of taking all of the US cellulosic production at those volumes, there’s a total potential market value of $986 million.
For now, the $4+ value of cellulosic ethanol is real and compelling. But watch RINferno carefully. As ethanol mandates and RIN prices go, so goes the market. Many investors are staying on the sidelines until the picture is more clear.
Which is why the government, which controls those markets, has nothing on its low-carbon agenda more important than creating investor certainty on the value of cellulosic fuels, compared to corn ethanol.
To the extent that the world’s carbon problem cannot be solved without transportation, and cannot be solved in time without internal combustion engines, and cannot be solved in enough volume without cellulosic fuels, a lot is riding on EPA to get this right, and now.
Sea levels are rising. Earth to EPA: hurry.
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