Fuel economics – Why do Renewable Identification Number (RIN) costs pass through to fuel price?
A 9-year, multi-billion dollar legal dispute between EPA and refiners is rooted in disagreements about fuel economics. One of the roots is the RIN pass-through theory.
EPA says that, with the RIN credit system, market forces raise the equilibrium price of refined fuel blendstocks by an amount that offsets refiners’ cost for buying RINs. The disputing refiners disagree.
In the blizzard of paperwork generated in this dispute, it’s hard to find a clear answer to one important question about this theory: Why does RIN cost pass through?
Why does RIN cost pass through?
When a tax is imposed on producers, they want to increase their price to stay profitable. At some point, a higher price starts driving consumers away. Loss of sales is the market force that pushes back against producers’ urge to pass through the cost.
Will we cancel our weekend trip if gas price goes up 10 cents? Will our blending plant go broke if we don’t increase our price? A new market price emerges from decisions made by individual suppliers, consumers, motorists, refiners, truckers, and blenders.
The sum of these forces steers the market price to a new equilibrium that is higher than before the tax but lower than the previous price plus the tax. This is to say, the tax is fractionally passed through.
What determines the fraction? It is the relative strength of the competing forces: Suppliers’ urge to remain profitable versus consumers’ avoidance of higher price.
That’s the theory.
What’s the reality?
Here is a critical insight being mostly missed in the fray:
In the fuels market, the push-back from customers is weak.
In the fuels market, the push-back from consumers is weak. For example, in the US gasoline market, it takes a 50% increase in the price of gasoline to reduce aggregate demand by 1%.
That fact, plugged into the economic theory, explains why RIN costs pass-through. Taxes, RINs, and other industry-wide producer costs pass through unhindered until they cause consumers to quit buying fuel which they are very slow to do.
Connecting the dots between theory and reality helps resolve misunderstandings.
Other roots of the dispute
The RIN pass-through theory is one of five big disconnects I see in the mutual understanding of theory vs. reality in this debate. The second is the RIN discount theory. Correct answers exist for all five.
Recommendation
Anyone with a stake in RINs pricing and economics should get Hoekstra Research Report 10 which includes the Hoekstra ATTRACTOR spreadsheet spreadsheet that accurately calculates D4T, the theoretical RIN price, tracks it versus quoted market prices, and predicts how RIN prices will change with the variables that affect them. Why not send a purchase order today?
George Hoekstra george.hoekstra@hoekstratrading.com +1 630 330-8159
Anyone with a stake in RINs pricing and economics should get Hoekstra Research Report 10
George Hoekstra george.hoekstra@hoekstratrading.com
