What’s next for cellulosic biofuels and the D3 RIN?
A main objective of the Renewable Fuel Standard (RFS) in 2007 was to trigger development of a market of at least 16 billion gallons/year of transportation fuel made from cellulosic biomass. Cellulosic biomass consists of non-food crops and waste biomass such as corn stalks, corncobs, straw, wood, and wood byproducts.
Though often overshadowed by other biofuel categories in the past, the cellulosic biofuel market has now become a hot topic in the renewable fuels world.
The 16 billion gallons/year target for cellulosic biofuel was never reached. In fact, after 17 years, we are still producing less than 1 billion of the targeted 16 billion gallons/year.
Because this market never got off the ground, from 2010-2022, EPA was required to reduce the mandated minimum volume of cellulosic biofuel to a small fraction of the statutory volume, and set up a special credit called a cellulosic waiver credit. The cellulosic waiver credit provided a workaround for refiners to comply with the cellulosic biofuel volume mandate despite there being very little volume produced.
Consideration of any renewable fuels market inevitably leads to discussion of RINs, so here we go on cellulosic biofuel RINs.
The workaround
The “normal” way to comply with an RFS biofuel volume mandate is to either produce your assigned quota of that biofuel or buy a RIN credit, which in this case is a D3 RIN (RIN credits come in different categories for different biofuels, and D3 is the name of the RIN applicable to cellulosic biofuels).
As Hoekstra Trading clients and followers know, a RIN is both a tax and a subsidy. The RIN subsidy for a biofuel is funded by purchases of RIN credits that also serve as taxes on production of conventional petroleum fuels that, by design, raise just enough money to stimulate production of the mandated quantity of their corresponding biofuels.
This system has proven to work very will except in the case of cellulosic biofuel which, for several reasons (technical, economic, and political), fizzled, and the cellulosic waiver credit was called in from the bullpen as a workaround.
How does the workaround work?
The “normal” way to comply with the cellulosic biofuel mandate is to generate or purchase a D3 RIN. But because not enough D3 RINs would be generated to meet the statutory mandates, the mandates were replaced by lower, more achievable mandates and refiners were allowed to comply by buying a (cheaper) D5 RIN plus a cellulosic waiver credit instead. By rule, the cellulosic waiver credit has a fixed price that is set each year by the EPA according to rules set by the U.S. Congress when the RFS law was enacted.
The upshot is that the D3 RIN will, in theory, be worth no less than the price of a D5 RIN (which, for other reasons, sets a floor price for the D3 RIN) – and the D3 RIN will be worth no more than the sum of the price of a D5 RIN plus the price of a cellulosic waiver credit (which sets a ceiling price for the D3 RIN).
In this way, those required to meet the cellulosic biofuels mandate (mainly refiners) are protected from risk of non-compliance or runaway D3 RIN prices.
Figure 1 shows this theoretical relationship has held true in recent years.
The blue data shows the price of the D3 RIN which is bracketed below by the (red) price of the D5 RIN, which is a theoretical floor, and above by the (green) price of the D5 RIN plus the price of the cellulosic waiver credit, which is a theoretical cap on the D3 RIN price.
Hot topic
You can see on Figure 1 that the green ceiling does not appear beyond year 2022. That’s because quirks in RFS rules caused the cellulosic waiver credit to disappear from the picture after 2022.
It’s removal changed the cellulosic biofuels game and triggered new possibilities for RIN price volatility which put cellulosic biofuels back on the front burner because, as shown on Figure 1, there is currently no upper bound on the price of the D3 RIN.
More legal costs
In 2023, the American Fuel and Petrochemical Manufacturers (AFPM) requested EPA to issue a partial waiver of that year’s cellulosic biofuels mandate because of concern there would be insufficient domestic supply of D3 RINs to meet the mandate which could lead to severe economic harm in parts of the U.S.
That request was denied by EPA, which means the D3 RIN subsidy now remains the only mechanism to comply with the cellulosic biofuel mandate, and it must do that by rising in price to whatever level is necessary to stimulate enough additional cellulosic biofuel production to meet the mandate.
Because the cellulosic biofuels market has a historically sketchy history of delivering the expected volume growth, this makes those who have, in the past, been scarred by runaway RIN prices nervous.
As shown on Figure 1, while the legal back-and forth continues on how to address the lack of a workaround, the D3 RIN price has been moving up in its now partially-bracketed range while the D5 RIN, and the other RINs, have been falling. Another round of legal work begins this week.
What is happening on the ground in the cellulosic biofuels market? How high would the D3 RIN price need to go to to stimulate the currently mandated cellulosic biofuels growth? With the cellulosic waiver credit currently off the table, what other workarounds might prevent runaway D3 RIN prices? And what are the chances those workarounds will be implemented?
These questions are buzzing through the renewable fuels ecosystem. Stay tuned for more on this topic.
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