The EPA announced preliminary RFS rulemaking for 2014 on November 15, 2013, and the proposal signaled a significant shift in EPA policy. The most surprising and controversial aspect of the proposal was a write down of the renewable (ethanol) mandate from 14.4 to 13 billion gallons. The proposal has been the subject of heated debate since it was released and the EPA received over 15,000 comments before the official comment period ended on January 28, 2014. Biofuels groups have sent strong signals that they will mount a legal challenge if the final RFS rulemaking for 2014 includes the write down of the renewable mandate. Previous farmdoc daily posts have examined the implications for grain, biofuel, and RINs markets of alternative scenarios for implementation of 2014 RFS rules (see the posts here, here, and here). The purpose of today's post is to show that the recent behavior of prices in the RINs market suggests the odds of the EPA reversing the proposed write down of the renewable mandate for 2014 in final rulemaking have increased sharply.
In order to understand the message from the RINs markets, we need to review a conceptual model of ethanol RINs pricing that has been used in several previous posts (for example, here and here). The version presented in Figure 1 is a general representation. The demand curve is assumed to be vertical (perfectly inelastic) at 5 billion gallons in order to represent the demand for ethanol as an MTBE oxygenate replacement. It is vertical since non-ethanol alternatives are prohibitively expensive. The demand curve then becomes flat (perfectly elastic) for ethanol prices equal to 110 percent of CBOB gasoline prices between 5 and 13 billion gallons. This breakeven point reflects Department of Energy research on the value of ethanol as an octane enhancer in gasoline blends. The demand curve becomes vertical again to reflect the E10 blend wall, which is assumed here to be 13 billion gallons. The intersection of market supply and demand in this case results in an equilibrium quantity of 13 billion gallons, equal to the E10 blendwall.
An interesting implication of the model presented in Figure 1 is that eliminating the RFS renewable mandate entirely would not impact the amount of ethanol consumed in the U.S. The reason is that it is profitable for gasoline blenders to blend ethanol with gasoline at least up to 10 percent blends. For the same reason, the model predicts that the price of an ethanol RIN is zero up to the E10 blend wall of 13 billion gallons. The situation is quite different if the renewable mandate is set above the E10 blend wall. For example, the statutory mandate for 2014 is 14.4 billion gallons, which results in a "renewable gap" of 1.4 billion gallons (14.4 - 13). If one is willing to assume that higher ethanol blends, such as E85, cannot be deployed in large quantities in the short-run, then the renewable gap effectively becomes additional biodiesel mandate (see the analysis here). In this model the only way to fill the gap and fully comply with the renewable mandate is by blending biodiesel, which is a higher nested biofuel in terms of RFS compliance. Under this circumstance the price of a D6 ethanol RINs equals the price of a D4 biodiesel RINs.