Streetwise Professor

August 23, 2016

Carl Icahn Rails Against the Evils of RIN City

Filed under: Climate Change,Commodities,Economics,Energy,Politics,Regulation — The Professor @ 12:15 pm

Biofuel Renewable Identification Numbers–“RINs”–are back in the news because of a price spike in June and July (which has abated somewhat). This has led refiners to intensify their complaints about the system. The focus of their efforts at present is to shift the compliance obligation from refiners to blenders. Carl Icahn has been quite outspoken on this. Icahn blames everyone, pretty much, including speculators:

“The RIN market is the quintessential example of a ‘rigged’ market where large gas station chains, big oil companies and large speculators are assured to make windfall profits at the expense of small and midsized independent refineries which have been designated the ‘obligated parties’ to deliver RINs,” Icahn wrote.

“As a result, the RIN market has become ‘the mother of all short squeezes,”‘ he added. “It is not too late to fix this problem if the EPA acts quickly.”

Refiners are indeed hurt by renewable fuel mandates, because it reduces the derived demand for the gasoline they produce. The fact that the compliance burden falls on them is largely irrelevant, however. This is analogous to tax-incidence analysis: the total burden of a tax, and the distribution of a tax, doesn’t depend on who formally pays it. In the case of RINs, the total burden of the biofuels mandate and the distribution of that burden through the marketing chain doesn’t depend crucially on whether the compliance obligation falls on refiners, blenders, or your Aunt Sally.

Warning: There will be math!

A few basic equations describing the equilibrium in the gasoline, ethanol, biodiesel and RINs markets will hopefully help structure the analysis*. First consider the case in which the refiners must acquire RINs:

Screen Shot 2016-08-23 at 10.20.03 AM

Equation (1) is the equilibrium in the retail gasoline market. The retail price of gasoline, at the quantity of gasoline consumed, must equal the cost of blendstock (“BOB”) plus the price of the ethanol blended with it. The R superscript on the BOB price reflects that this is the price when refiners must buy a RIN. This equation assumes that one gallon of fuel at the pump is 90 percent BOB, and 10 percent ethanol. (I’m essentially assuming away blending costs and transportation costs, and a competitive blending industry.) The price of a RIN does not appear here because either the blender buys ethanol ex-RIN, or buys it with a RIN and then sells that to a refiner.

Equation (2) is the equilibrium in (an assumed competitive) ethanol market. The price an ethanol producer receives is the price of ethanol plus the price of a RIN (because the buyer of ethanol gets a RIN that it can sell, and hence is willing to pay more than the energy value of ethanol to obtain it). In equilibrium, this price equals the the marginal cost of producing ethanol. Crucially, with a binding biofuels mandate, the quantity of ethanol produced is determined by the blendwall, which is 10 percent of the total quantity sold at the pump.

Equation (3) is equilibrium in the biodiesel market. When the blendwall binds, the mandate is met by meeting the shortfall between mandate and the blendwall by purchasing RINs generated from the production of biodiesel. Thus, the RIN price is driven to the difference between the cost of producing the marginal gallon of biodiesel, and the price of biodiesel necessary to induce consumption of sufficient biodiesel to sop up the excess production stimulated by the need to obtain RINs. In essence, the price of biodiesel plus the cost of a RIN generated by production of biodiesel must equal the marginal cost of producing it. The amount of biodiesel needed is given by the difference between the mandate quantity and the quantity of ethanol consumed at the blendwall. The parameter a is the amount of biofuel per unit of fuel consumed required by the Renewable Fuel Standard.

Equation (4) is equilibrium in the market for blendstock–this is the price refiners get. The price of BOB equals the marginal cost of producing it, plus the cost of obtaining RINs necessary to meet the compliance obligation. The marginal cost of production depends on the quantity of gasoline produced for domestic consumption (which is 90 percent of the retail quantity of fuel purchased, given a 10 percent blendwall). The price of a RIN is multiplied by a because that is the number of RINs refiners must buy per gallon of BOB they sell.

Equation (5) just says that the value of ethanol qua ethanol is driven by the relative octane values between it and BOB.

The exogenous variables here are the demand curve for retail gasoline; the marginal cost of producing ethanol; the marginal cost of producing BOB (which depends on the price of crude, among other things); the marginal cost of biodiesel production; the demand for biodiesel; and the mandated quantity of RINs (and also the location of the blendwall). Given these variables, prices of BOB, ethanol, RINs, and biodiesel will adjust to determine retail consumption and exports.

Now consider the case when the blender pays for the RINs:

Screen Shot 2016-08-23 at 10.20.25 AM

Equation (6) says that the retail price of fuel is the sum of the value of the BOB and ethanol blended to create it, plus the cost of RINs required to meet the standard. The blender must pay for the RINs, and must be compensated by the price of the fuel. Note that the BOB price has a “B” superscript, which indicates that the BOB price may differ when the blender pays for the RIN from the case where the refiner does.

Without exports, retail consumption, ethanol production, biodiesel production, and BOB production will be the same regardless of where the compliance burden falls. Note that all relevant prices are determined by the equilibrium retail quantity. It is straightforward to show that the same retail quantity will clear the market in both situations, as long as:

Screen Shot 2016-08-23 at 10.20.35 AM

That is, when the refiner pays for the RIN, the BOB price will be higher than when the blender does by the cost of the RINs required to meet the mandate.

Intuitively, if the burden is placed on refiners, in equilibrium they will charge a higher price for BOB in order to cover the cost of complying with the mandate. If the burden is placed on blenders, refiners can sell the same quantity at a lower BOB price (because they don’t have to cover the cost of RINs), but blenders have to mark up the fuel by the cost of the RINs to cover their cost of acquiring them. here the analogy with tax incidence analysis is complete, because in essence the RFS is a tax on the consumption of fossil fuel, and the amount of the tax is the cost of a RIN.

This means that retail prices, consumption, production of ethanol, biodiesel and BOB, refiner margins and blender margins are the same regardless of who has the compliance obligation.

The blenders are complete ciphers here. If refiners have the compliance burden, blenders effectively buy RINs from ethanol producers and sell them to refiners. If the blenders have the burden, they buy RINs from ethanol producers and sell them to consumers. Either way, they break even. The marketing chain is just a little more complicated, and there are additional transactions in the RINs market, when refiners shoulder the compliance obligation.

Under either scenario, the producer surplus (profit, crudely speaking) of the refiners is driven by their marginal cost curves and the quantity of gasoline they produce. In the absence of exports, these things will remain the same regardless of where the burden is placed. Thus, Icahn’s rant is totally off-point.

So what explains the intense opposition of refiners to bearing the compliance obligation? One reason may be fixed administrative costs. If there is a fixed cost of compliance, that will not affect any of the prices or quantities, but will reduce the profit of the party with the obligation by the full amount of the fixed cost. This is likely a relevant concern, but the refiners don’t make it centerpiece of their argument, probably because shifting the fixed cost around has no efficiency effects, but purely distributive ones, and purely distributive arguments aren’t politically persuasive. (Redistributive motives are major drivers of attempts to change regulations, but naked cost shifting arguments look self-serving, so rent seekers attempt to dress up their efforts in efficiency arguments: this is one reason why political arguments over regulations are typically so dishonest.) So refiners may feel obliged to come up with some alternative story to justify shifting the administrative cost burden to others.

There may also be differences in variable administrative costs. Fixed administrative costs won’t affect prices or output (unless they are so burdensome as to cause exit), but variable administrative costs will. Further, placing the compliance obligation on those with higher variable administrative costs will lead to a deadweight loss: consumers will pay more, and refiners will get less.

Another reason may be the seen-unseen effect. When refiners bear the compliance burden, the cost of buying RINs is a line item in their income statement. They see directly the cost of the biofuels mandate, and from an accounting perspective they bear that cost, even though from an economic perspective the sharing of the burden between consumers, refiners, and blenders doesn’t depend on where the obligation falls. What they don’t see–in accounting statements anyways–is that the price for their product is higher when the obligation is theirs. If the obligation is shifted to blenders, they won’t see their bottom line rise by the amount they currently spend on RINS, because their top line will fall by the same amount.

My guess is that Icahn looks at the income statements, and mistakes accounting for economics.

Regardless of the true motive for refiners’ discontent, the current compliance setup is not a nefarious conspiracy of integrated producers, blenders, and speculators to screw poor independent refiners. With the exception of administrative cost burdens (which speculators could care less about, since it will not fall on them regardless), shifting the compliance burden will not affect the market prices of RINs or the net of RINs price that refiners get for their output.

With respect to speculation, as I wrote some time ago, the main stimulus to speculation is not where the compliance burden falls (because again, this doesn’t affect anything relevant to those speculating on RINs prices). Instead, one main stimulus is uncertainty about EPA policy–which as I’ve written, can lead to some weird and potentially destabilizing feedback effects. The simple model sheds light on other drivers of speculation–the exogenous variables mentioned above. To consider one example, a fall in crude oil prices reduces the marginal cost of BOB production. All else equal, this encourages retail consumption, which increases the need for RINs generated from biodiesel, which increases the RINs price.

The Renewable Fuels Association has also raised a stink about speculation and the volatility of RINs prices in a recent letter to the CFTC and the EPA. The RFA (acronyms are running wild!) claims that the price rise that began in May cannot be explained by fundamentals, and therefore must have been caused by speculation or manipulation. No theory of manipulation is advanced (corner/squeeze? trade-based? fraud?), making the RFA letter another example of the Clayton Definition of Manipulation: “any practice that doesn’t suit the person speaking at the moment.” Regarding speculation, the RFA notes that supplies of RINs have been increasing. However, as has been shown in academic research (some by me, some by people like Brian Wright)  that inventories of a storable commodity (which a RIN is) can rise along with prices in a variety of circumstances, including a rise in volatility, or an increase in anticipated future demand. (As an example of the latter case, consider what happened in the corn market when the RFS was passed. Corn prices shot up, and inventories increased too, as consumption of corn was deferred to the future to meet the increased future demand for ethanol. The only way of shifting consumption was to reduce current consumption, which required higher prices.)

In a market like RINs, where there is considerable policy uncertainty, and also (as I’ve noted in past posts) complicated two-way feedbacks between prices and policy, the first potential cause is plausible. Further, since a good deal of the uncertainty relates to future policy, the second cause likely operates too, and indeed, these two causes can reinforce one another.

Unlike in the 2013 episode, there have been no breathless (and clueless) NYT articles about Morgan or Goldman or other banks making bank on RIN speculation. Even if they have, that’s not proof of anything nefarious, just an indication that they are better at plumbing the mysteries of EPA policy.

In sum, the recent screeching from Carl Icahn and others about the recent ramp-up in RIN prices is economically inane, and/or unsupported by evidence. Icahn is particularly misguided: RINs are a tax, and the burden of the tax depends not at all on who formally pays the tax. The costs of the tax are passed upstream to consumers and downstream to producers, regardless of whether consumers pay the tax, producers pay the tax, or someone in the middle pays the tax. As for speculation in RINs it is the product of government policy. Obviously, there wouldn’t be speculation in RINs if there aren’t RINs in the first place. But on a deeper level, speculation is rooted in a mandate that does not correspond with the realities of the vast stock of existing internal combustion engines; the EPA’s erratic attempt to reconcile those irreconcilable things; the details of the RFS system (e.g., the ability to meet the ethanol mandate using biodiesel credits); and the normal vicissitudes of the energy supply and demand.  Speculation is largely a creation of government regulation, ironically, so to complain to the government about it (the EPA in particular) is somewhat perverse. But that’s the world we live in now.

* I highly recommend the various analyses of the RINs and ethanol markets in the University of Illinois’ Farm Doc Daily. Here’s one of their posts on the subject, but there are others that can be found by searching the website. Kudos to Scott Irwin and his colleagues.

Print Friendly, PDF & Email


  1. Over the years I’ve heard rich businessmen expound on all sorts of topics. Usually it’s been utter tripe. What they are good at, I infer, is running their businesses. Maybe they should stick to that. Unless, of course, an acute sense of duty requires one of them to attempt to save his country from Hellary.

    Comment by dearieme — August 24, 2016 @ 8:25 am

  2. Equation (1)

    E85, E10 pre-blend Typically purchased at the rack so factors are not 90/10.

    Equation (5) “just says that the value of ethanol qua ethanol is driven by the relative octane values between it and BOB”.
    Have to check your assumption because E10 blends are typically rated with octane numbers higher than BOB. opsss

    Equation (6)

    (8) and (3) is the same equation.

    Comment by wizard — September 8, 2016 @ 8:01 am

  3. Great analysis.

    I think your 17th paragraph is the equivalent of moving the deckchairs on the Titanic.

    But I think that a few points are overlooked; one is the operational structure of the refinery business:
    some are merchant refiners;
    some refiners capture part of their RIN requirement from their terminal/blending operations and need to then purchase or use banked RINs;
    some refiners capture in excess of their RIN requirement from their terminal/blending operations and can sell or bank them.

    Examples of the 1st are the PADD1 refiners (PES, Delta’s Monroe refining business, PBF – though now not exclusively PADD1), and I think, Carl Icahn’s HollyFrontier and CVR.
    Examples of the second are Valero, Marathon Petroleum, and ExxonMobil.
    Examples of the third are Chevron and BP.

    Those that run RIN deficts (examples 1 & 2) have been publishing their annual RVO obligation in their 10-Ks/S-4s going as far back as 2011 sometimes); the one exception is Exxon (they’ll tell you in private, but won’t disclose the number).

    Those that run RIN-rich will tell you in private, but won’t publish their income.

    Motiva, PdVSA, and a few others are mum on their RIN/RVO issues.

    So, if all RIN/RVO accounting costs were summed it would be interesting to see if it is positive or negative.

    The second possible oversight is the structure of the RIN markets; can you trust the published price by Argus, OPIS, or Platts? Are transactions actually taking place at these levels? If so, at what volumes?

    Essentially, the constructs of the RIN market are not those of the NYMEX, NYSE, or NASDAQ: it’s opaque, poor marketmaking, clearing (RINStar and RINAlliance are two that offer an ASP and consider themselves marketmakers/clearers).

    On your comment of administrative cost burden: the EPA decided to put the RVO on the refiners because there are only about 120 refineries vs blenders/terminals in the thousand(s) (don’t know the general number here). Their admission is that it would be *easier* for them (EPA), because minding those thousand or so terminals/blenders would be a greater challenge.

    RINStar and RINAlliance are ASPs; that means they’ve developed a web-based application for the different sides of the RIN market to transact, as well as report to EPA’s EMTS. But again, is this quality marketmaking/clearing? If the CFTC & EPA signed an MOU to “privately” share information in March 2016 on the RIN markets, this should make people wary. So far, neither organization has published anything on this MOU, but both agencies have published notifications on who their contacts are.

    Max Pyziur

    I’d be interested to read your comments to this.

    Comment by Max Pyziur — September 8, 2016 @ 8:02 am

  4. I re-read your text and your aim is to demonstrate the burden is placed on “the whole market”. Using a vast a theorem.

    Then you point out that the E10 is a tax on comsumption regardless of where the burden is placed.

    In a Nutsehll what should be said is that RVOS is applied by EPA to importers and refiners, and not the retailers, blenders who can catch out the RIN value that’s the arbitrage burden loophole.
    and CVR qualifies as a refiner but does also blending.

    “Under either scenario, the producer surplus (profit, crudely speaking) of the refiners is driven by their marginal cost curves and the quantity of gasoline they produce”.

    More exactly: The RINS market is determined by the size of the blending pool (C-EX), + rvos incurred on imports.
    Totally Seasonally squeezed in the summer. Recommendation 1: EPA goals mandates should be shorten seasonally.

    Recommendate 2: Rins should be segmented and simplified, you put them on a nice D6 ETF,
    – with a weekly report of the Rins pool published each friday.
    -with a fix amount of Physical Rins expiring in the next 6 months, then you let the market to guess the price fluctuations.

    Comment by wizard — September 8, 2016 @ 9:34 am

  5. Hi Max,

    Valero seems they have reached “net zero” rin balance since 2012. If they export it’s because they are Long in the U.S.

    What about Koch , biggest freetraders the Wichita boys. Both blender and ethanol producer (Flint Hills). And the koch are known to optimize every single drop of stream better than other engineer peers in the industry, like how to push the known limits.

    Isn’t interesting that two large refiners have turned large exporter of U.S ethanol ?

    What I hear daily from the Galleria:

    All the big names and even 2nd tier consider the fermentation, distribution and trading of ethanol as a profit center now.

    Alcohol-fuel is the future as an oxygenate, makes sense as an economic activity if you are a country like the United States with the access to a vast pool of cheap corn resources close to major city centers.

    Particularly, in the eastern corn belt, they are in the middle of an impoverished region “the rust belt”… However, they have maintained tradition for innovative industrial manufacturing in the veins, trying to move the new things around with the ethanol economy.

    In renewable fuels;
    2016 totally different animal than 2005.

    as a side note comment, if you study the market try sometimes to transgress the ideological dogmas.

    Comment by Wizard — September 8, 2016 @ 11:52 am

RSS feed for comments on this post. TrackBack URI

Leave a comment

Powered by WordPress