What’s a RIN and what does it matter to corn prices and ethanol producers?
A RIN is a Renewable Identification Number – a unique serial number that is attached to each gallon of renewable fuel produced. Each year, petroleum refiners are required to submit RINs to the EPA to prove that the required amount of renewable fuel (ethanol) has been blended into the gasoline the company has produced.
During any given year, some refiners use more renewable fuel than the mandate requires - those refiners are permitted to sell the excess RINs. This process insures, in theory, that the industry (collectively) will satisfy the Renewable Fuel Standard (RFS) quota as required by the Environmental Protection Agency. We have seen estimates of anywhere between 1.9 to 2.0 billion gallons worth of RINs carried over from 2012 to 2013 (we are going to come back to that number in just a bit).
A secondary market for RINs has emerged, and while not the most efficient market in the world (it is somewhat opaque and there is counterparty risk related to fraudulent RINs, among other things) it is a market and it has been telling us some interesting things in recent weeks - RIN prices have been melting up.
Due to the shortage of corn, a number of ethanol plants have been shuttered across the U.S. – this despite the fact that the RFS mandate increased from 13.2 billion gallons of ethanol in 2012 to 13.8 billion in 2013.
As it currently stands, under Federal regulations ethanol can be blended into gasoline and sold at levels of up to 10% (“E10”). Higher blending levels are possible (“E15” and “E85”) but require specially designed vehicles, so higher blends are consumed in very limited volumes. Gasoline consumption in the United States has been declining, but is currently about 130 billion gallons per year.
At a 10% blend rate, current gasoline consumption levels demand approximately 13.0 billion gallons of ethanol (note that, as previously mentioned, the RFS mandate of 13.8 billion gallons is already above projected demand – the “blend wall”). Not all of the demand for ethanol is demand for corn based ethanol – approximately 750 million gallons will come from sugar-based ethanol (imported).
Where does that leave us?
The bottom line is that the demand for ethanol from gasoline consumption at the 10% blend rate less imported ethanol will be below the RFS mandate to the point where the excess RINs that were carried over from 2012 to 2013 will be nearly exhausted by end of year as companies purchase those RINs to be in compliance with the blending mandate. To add insult to possible injury, the 2014 mandate is 14.4 billion gallons of ethanol blended.
Absent a rapid move to E15 (15% blend) – an initiative pushed through by the ethanol lobby, in our view – it would appear that something has to give. E15 is getting pushback because of potential damage to automobiles and the fuel infrastructure, so it would seem a move in that direction is unlikely. The EPA has beaten down all legal challenges to the RFS, but it would seem it may be left with little choice but to relax the mandate.
If the mandate isn’t relaxed, it represents a negative for consumers, as gasoline prices will likely increase regardless of the price of crude oil. The lack of ethanol will drive the price of RINS higher as blenders seek to satisfy the RFS, thereby increasing gas prices at the pump. In fact, there is some thought that speculation and manipulation may be driving RIN prices, in part in an effort to force the EPA’s hand.
If the mandate is relaxed, we suspect that corn prices and corn acreage will drop, to the detriment of farm level economics. Ethanol margins should improve, to the benefit of producers (ADM, for example). Fertilizer stocks are the names that are heavily levered to corn production and farm level economics, and were a significant beneficiary of the “ethanol pivot” – the continuing increases in the ethanol mandate over time. A relaxed mandate might be a “reverse pivot”, if you will.
This is a complex issue, with multiple moving parts, but one the bears continued scrutiny as we move through the year.
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HEDGEYE RISK MANAGEMENT, LLC