Post-Coronavirus: What’s Next in the Environmental Commodity Markets – 23 Key Takeaways

By Mike Newman, Chief Operating Officer, Parhelion Underwriting Inc.

Special to The Digest

In a recent webinar hosted by Parhelion Underwriting and OPIS by IHS/Markit, we asked the question: Post-Coronavirus: What Next For the Environmental Commodity Markets?

At a time when we’re concerned about an uncertain future, a forum for open discussion with fellow-stakeholders in the environmental commodities market was timely and the questions from ‘the floor’ kept the discussion lively.

The environmental commodity markets, the emissions trading systems designed to reduce greenhouse gas emissions by promoting trading of credits and offsets between fossil fuel and clean energy, are now in place in more than 50 countries covering over one billion people.

The focus was on renewable fuels in the Renewable Fuel Standard (RINs) and California’s Low Carbon Fuel Standard (LCFS credits). Stakeholders came from all corners of the market, from the refining industry, power utilities and renewable energy sectors, as well as the regulators, bankers, traders and lawyers who make the trading systems efficient and transparent.

Beginning with views of the markets from the Renewable Fuels desk at Oil Price Information Service (OPIS), the discussion then evolved into opinions from seven leading market participants.

Here are some of the key takeaways:

1. Demand for transportation fuels has been slashed by roughly 40% during Coronavirus but the effect on the RIN and LCFS markets is relatively tame. After a blip in mid-March the market calmed because it is ultimately tied to regulatory requirements.
2. After the 10^th Circuit Court opinion on Small Refinery Waivers, RINs stabilized although there is still a lot of political pressure from the oil industry to roll back the regulations.
3. LCFS hit an all-time high of $218 on February 6, 2020 ; it slipped only a little and by May 1 had regained ground to just under $200/credit and so also just below the $200 cap that comes into effect on July 1, 2020.
4. With gasoline off by roughly 40% and diesel down 20%, we think refiners will come up short on covering their D6 (ethanol) obligations. Due to the drop in gasoline demand, deficit generation has also dropped – flipping the LCFS credit market from being short credits before the crisis to being long credits.
5. As heavy-duty vehicle travel continues to service supply chains during the crisis, renewable replacements for diesel like renewable diesel and renewable natural gas (CNG/LNG) will continue to generate credits. Because passenger vehicle travel is off during the crisis, renewable replacements for gasoline like ethanol and electric vehicles will suffer.
6. To understand why D6 RIN prices are so strong and D4 relatively weak (collapsing the spread), we modelled a simple refinery producing both diesel and gasoline and found that because diesel demand was down less than gasoline the net effect was to soften the D4 market and shorten the D6 market.
7. The LCFS market in long-term will be short credits and credits will tend to track with the cap of $200.
8. What support will governments give clean energy post-coronavirus?. We’ve seen politicians from oil-producing states make requests to waive part or all of the RVO requirements and American Prosperity and governments in the US and Canada are questioning the Green requirements and at sub-state levels there will also be post-coronavirus pressure on budgets. the question is are they going to blink after the recovery?.
9. California has been traditionally very willing to empower state administrative agencies to go out and implement policy. The original legislation, Assembly Bill (AB) 32, required GHG reduction to 1990 levels by 2020, a goal that was achieved by 2016. Follow up legislation, driven by Sen. Pavley, one of the legislators behind the original law, requires emissions to be 40% below the1990 level by 2030, principally by reducing CI in the transportation sector.
10. LCFS policy expansion – Legislation is pending in WA, NY, several mid-western states; RGGI and some Canadian provinces but these have all been sidelined by coronavirus.
11. Business support is crucial to LCFS politics – 150+ companies supported LCFS in letters to policymakers.
12. CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation) addresses CO2 emissions from international aviation. Airlines were growing annually at roughly 3.5% but they are now in a precarious position – which means that there is uncertainty around baselines.  That’s important because CORSIA targets growth in emissions above the baseline.
13. Before Coronavirus there were a lot of public announcements by companies such as BP, Jet Blue and others in support of Carbon Neutrality/Net Zero but we’ll see how this develops as the economy starts a slow recovery. Encouraging, though, that Shell added its endorsement during the CV shutdown.
14. In the last 6 months or so there has been a lot of speculation in the voluntary carbon market. Since Coronavirus, some of the chaos in the stock market has spilled over into CCA trades and CCA prices have taken a tumble. We’ve seen some traders leave the market.
15. RECs are closely correlated with the Power market where demand is down because of reduced day-time demand, offices are shuttered.
16. At the creation of the environmental commodity market, Biomass is the front-end feedstock that creates the biofuels that result in tradeable commodities like RINs, carbon credits etc.
17. The capital markets don’t understand the feedstock risk and if they can’t understand it, they can’t quantify it – so capital is restricted and expensive. To change this, we have been authorized by the US Dept of Energy to develop the Biomass Feedstock Standards, the due diligence tools for investors, to be certified by a new Biomass Ratings Agency.
18. The role that the exchanges have played in the last couple of months has been interesting. Exchanges are usually fairly staid institutions that hum along but in a crisis exchanges play a stabilizing influence. Despite the recent volatility the exchange model has continued to hold up. We have not seen any interruptions in trading; trades continue to clear and there have been no delays in deliveries. Volatility has increased and there have been some days with exceptionally high volume but prices have stabilized over the last couple of weeks.
19. There have been some instances of smaller FCMs (Futures Commissions Merchants) going out of business as a result of the margin requirements that the exchanges have had to implement (the margin has to be put on deposit and in volatility that margin goes up). The California Carbon market is the most liquid market. CCA went from roughly $18 down to $13 and then up to $16 over the course of six weeks. As a result, the initial margin went from about $150 million to almost $900 million, so over 5x the amount required on deposit – and some firms couldn’t come up with that. But that is how the system is intended to work.
20. In the fuels market, as crude prices have fallen and gasoline is cheaper than ethanol, the RIN price is now serving its intended purpose to incentivize the blending of ethanol. Some Ethanol plants are idle and there is increased uncertainty around the 2020 RVO.
21. The former Director of EPA’s Criminal Division. initiated the RINs-Fraud Task Force starting in 2012 in association with the Secret Service, IRS and the Department of Agriculture….. those enforcement cases have brought a level of stability to what was a “Wild West” market, particularly in the biodiesel space which is where most of the cases were. $1 billion fraud scam on tax credits – not complex, but audacious.
22. Couple of takeaways from the RIN-Fraud cases. If you are buying, selling or financing, do your due diligence. That was true then and it’s still true. Going forward, the Government and companies will be using data analytics to cut off frauds at an early stage so expect to see more money-laundering and financial analysis coming in earlier.
23. From a political standpoint, enforcement resources at the Federal level have been cut back in the current Administration so the EPA is pushing some of this responsibility on to the States but the reality is that the Renewable Fuels Standard is not a State program, so resources that were previously focusing on power plants etc have been diverted to work on these cases.

Mike Newman is Chief Operating Officer at Parhelion Underwriting Inc.

Parhelion Underwriting is a risk finance company insuring non-traditional risks impacting investment into clean energy, climate finance and environmental commodity markets.

Mike can be contacted at mike.newman@parhelionunderwriting or +1 323 459 5346