Release of Hoekstra Research Report 11: The Tax-and Subsidize Interpretation of RINs
To order this report including 6 months of unlimited consultation by phone and E-mail please issue a purchase order using information in the Offer letter or contact [email protected] +1 630 330-8159
The tax-and-subsidize interpretation of RINs
By George Hoekstra / Hoekstra Trading LLC /
1 Contents
3.1 Is the RIN tax an extra cost for refiners?. 6
3.4 A ten-year legal battle. 7
4.1 Is the RIN subsidy a windfall profit for blenders?. 10
4.2 Murphy and Casey celebrate RIN profits. 10
4.3 Casey’s reinterpretation. 11
4.4 Two sides of the same coin. 13
5 Forcing renewables into fuel 13
5.1 How do RINs affect the price of E10?. 13
5.4 Quantifying the discount 15
5.5 RIN price equation in tax-subsidy form. 16
5.6 Murphy USA’s reinterpretation. 17
6.1 The RIN tax is an extra cost that hurts a refiner’s profits. 19
6.2 Some refiners don’t have pricing power to be able to pass through their RIN costs. 20
6.3 the RIN subsidy is a windfall profit for the blender 20
6.4 High, volatile RIN prices show the RFS is dysfunctional 20
6.5 Consumers pay more for E10 because of RINs. 21
6.6 An integrated refiner unfairly gets RINs for free. 21
7.1 Ethanol use in gasoline overflows. 22
7.3 The biodiesel solution. 24
7.6 The key principle of RIN pricing. 27
7.7 RIN nesting and step transitions. 28
7.9 Capturing profits from theoretical RIN price modeling. 29
8 Derivation of RIN pass-through and RIN discount equations. 31
9 An outstanding contradiction. 34
2 Summary
A Renewable Identification Number (RIN) is a tax and a subsidy that forces renewables into fuels.
The RIN tax increases the blend cost of refined blendstocks and the RIN subsidy decreases the blend cost of renewable blendstocks. These changes cause a decrease in demand for refined blendstocks and an increase in demand for renewable blendstocks.
The tax function of a RIN is imposed by mandates that require refiners and importers to turn in receipts showing they have acquired their annual quota of RINs by blending renewables into fuels or by purchasing RINs from others.
There is a long-running controversy over how the RIN tax affects the profits of refiners.
One camp, which we call Camp A, says the RIN tax is an extra cost that hurts the refiner’s profit. The other camp, which we call Camp B, says the RIN tax passes through from the refiner to the blender, offsetting the tax paid by the refiner, and resulting in almost no net impact on the refiner’s profit. Camp B’s theory is called the pass-through theory.
The subsidy function of a RIN is provided by placing a virtual attached RIN in every gallon of ethanol intended for use as fuel. This virtual RIN is captured and redeemed for cash by the blender when a gallon of ethanol is blended into fuel.
There is a long running controversy over how the RIN subsidy affects a blender’s profit.
On first consideration, this subsidy appears to be a windfall profit for blenders. How it actually functions as a subsidy is not immediately evident and requires some thoughtful analysis to understand.
To analyze these controversies we consider an example case
of blending 10% ethanol with 90% refined gasoline called BOB (blendstock for oxygenate blending) to produce the blended gasoline called E10. In this case, two of the financial impacts are tangible, easy to measure, and easy to understand – they are the payment of the RIN tax by refiners and the receipt of the RIN subsidy by blenders. Two other financial impacts are intangible, not easy to measure, and not easy to understand – they are the effects on the equilibrium market prices of BOB and E10. Misunderstanding of these two intangible effects is the root cause of the 10 year controversies over RINs which have gone all the way to the Supreme Court of the United States.
The RIN tax causes the price of BOB to increase by the value of the RIN. This offsets the tax paid by the refiner and increases the blender’s cost for the BOB component of its blend. The blender buys ethanol at the market price and, with it, receives the subsidy in the form of an attached RIN. The blender redeems the RIN for cash which offsets its higher cost for the BOB component of its blend, leaving the blender’s profit unchanged.
Competition in the E10 market prevents the blender from passing through the full market price of ethanol to the E10 market. The blend cost of its ethanol component is discounted by the value of the RIN. The blended cost for E10 is then the weighted sum of an inflated cost of BOB and a discounted cost for ethanol. Both the tax (a positive cost) and the subsidy (a negative cost) pass through to the E10 market, which leaves the price of E10 almost exactly unchanged. The RIN thus functions as a cross subsidy to artificially reduce the effective blend cost for ethanol, causing increased demand for ethanol, which is its purpose.
The RIN thus acts as both a tax and a subsidy.
The refiner sees a tangible cost in cash it pays out for the RIN and an intangible benefit in the higher price it receives for BOB. The blender sees a tangible benefit in the cash it receives for the RIN and an intangible cost in the higher price it pays for BOB. The increased price of BOB is the intangible part that connects the two tangible parts and clouds understanding of the impact on the refiner’s and blender’s profits.
It is important to recognize the prices of BOB and E10 are market equilibrium prices which are driven by the collective actions of all market participants, not controlled by the decisions or actions of any individual or company. The adjustments of these prices are intangible effects that are the root causes for misunderstanding of the effects of RINs on prices and profits.
Study of academic literature indicates that
this tax and subsidize interpretation, and the pass-through theory, conform with economic theory and are supported by the empirical studies of how market prices are affected by RINs.
Study of court cases and EPA rulings indicates that
the tax-and-subsidize interpretation and the pass-through theory apply in U.S. fuels markets. The main points of contention of market participants who disagree with the pass-through theory are not supported by economic theory or data. We conclude they reflect a misunderstanding of how the RIN tax and subsidy are both passed through the supply chain to affect the prices of BOB and E10.
Study of earnings conference calls indicates that
over a period of several years, market participants have come to accept the pass-through theory. The RIN tax was at first seen as an unfair tax on refiners that hurts refiners profitability; and the RIN subsidy was at first seen as an unfair windfall profit for blenders. Over time, market participants have gradually come to understand and mostly accept the pass-through theory. But there is still widespread misunderstanding of how the tax-and-subsidize system really works and we are told litigation will continue.
Those affected by the RIN credit system should
make the necessary investment and effort to develop a deep fundamental understanding of how the system works.
In 2013, the D6 ethanol RIN price skyrocketed 100-fold from its 2012 low.
This was caused by a step transition in the production pathway governing D6 RIN production, from the ethanol production pathway to the D4 biodiesel production pathway.
This RIN price increase was an intended outcome
of the nesting of RIN categories which allows some categories of RINs to substitute for others. The price increase was foreseen and predicted by some people with fundamental understanding of the system. But the fact it occurred so abruptly and after-the-fact, shows it was not foreseen by major RIN market participants, which adds to the evidence they did not fully understand the RIN system.
The general principle of RIN pricing is that
when a subsidy is necessary to meet a mandated volume of biofuel, the price of the RIN will be equal to the price differential between the incremental supplier’s cost to produce an additional gallon of biofuel and the market equilibrium price of the fuel being sold into the market; and if a subsidy is not needed, the RIN price will be zero.
Hoekstra Trading LLC uses a RIN pricing spreadsheet model
that applies the tax-and-subsidize interpretation to model the effects of economic variables on RIN prices based on their vintage (vintage refers to the year a RIN was created). Factors influencing RIN prices include the price spread between biodiesel and ultra-low sulfur diesel (ULSD) as well as the effects of the blender’s tax credit. This spreadsheet and related price modeling capability is used by our clients to study and interpret RIN price dynamics, capitalize on RIN price arbitrage opportunities, and make informed estimates of how changes will affect RIN prices.
Hoekstra Trading has derived two general equations
relating price and cost variables for the RIN credit system; for the case of blending 10% ethanol into gasoline, they are:
Equation 1: Pbob = Cbob + Pd6/9
Equation 2: Pe10 = 0.9(Cbob + Pbun/9) + 0.1(Peth-Pd6) + Cble
In its April 2022 Denial of Petitions for RFS Small Refinery Exemptions EPA contradicted
a refiner’s assertion that its local price data showed RIN pass through does not occur in that local market. EPA said the refiner’s economic analysis uses an equation that assumes RIN pass through does occur, and that therefore the data shows RIN pass-through does occur in that local market. But it is not evident how the refiner’s equation assumes RIN pass through does occur. This direct contradiction in the implications of the refiner’s analysis is not resolved, and we are told it will be resolved by more litigation. However
Hoekstra Trading has resolved that contradiction
and the solution is included in the delivery presentation that accompanies this report.
This report includes 10 attachments selected for those who want to understand RIN fundamentals
To order this report with six months of unlimited consultation by phone and E-mail
please issue a purchase order using information in the Offer letter or contact [email protected] +1 630 330-8159
