Refining and Marketing
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That’s right. For Big Oil, Inc., the parent company of Big Oil Refining and Big Oil Marketing, and, in fact, for all marketers, RINs are free, not costing a single cent. For merchant refiners, Big Oil’s competing bulk fuel suppliers, RINs are a major expense often exceeding labor and second only to the cost of crude oil supplies. Current point of obligation supporters argue merchants could have free RINs, too, if they would just suck it up and blend. I’ll address this entitled fantasy in another post. Today’s post explains how EPA’s point of obligation grants free RINs to Big Oil, Inc. but not to merchant refiners and thereby corrupts competition in the bulk fuel supply market.
The previous post listed this take-away.
Usually, Big Oil refiners produce, sell and are obligated on much less bulk fuel than Big Oil marketers purchase, blend and resell at wholesale. In other words, many, if not most, vertically integrated Big Oil enterprises are serious net purchasers of bulk fuel. This fact drives the entire point of obligation controversy. Once this net buyer status is grasped, almost every conclusion I reach in this blog logically follows.
Take another look at the Big Oil portion of my industry flow diagram. Big Oil, Inc. owns two separate businesses in this system: Big Oil Refining and Big Oil Marketing. Big Oil Marketing wholesales more fuel than Big Oil Refining supplies. Of course, chain wholesale marketers refine no bulk fuel whatsoever. Nationwide, this supply gap is filled by merchant refiners, for whom refining is everything and marketing is trivial.
Big Oil Marketing’s larger wholesale volumes mean Big Oil, Inc. has more RINs than Big Oil Refining needs for compliance. Even if Big Oil Refining operates purely as a merchant and, therefore, obtains all of its compliance RINs through purchase, Big Oil Marketing sells that many RINs and more. When Big Oil Refining pumps $20 million into the RIN market to buy RINs, Big Oil Marketing pulls more than $20 million out selling RINs. RIN money simply shifts from one Big Oil, Inc. pocket to another.
Even more important are these three facts. First, because RINs are free, Big Oil, Inc. is immune and indifferent to RIN prices. Whether RIN prices go up or down, Big Oil, Inc. is unaffected because, for Big Oil, the effective RIN price is always zero. Big Oil, Inc., therefore, has no incentive to pass refining RIN costs through to the bulk fuels market. Second and most important is the fact that, as a bulk fuel purchaser, Big Oil, Inc. is actually worse off whenever refiners’ RIN costs are passed through. 100% pass through may hold Big Oil Refining harmless, but Big Oil Marketing actually suffers from higher prices on the larger volumes it must purchase. Big Oil, Inc., therefore, is better off when refiners’ RIN costs are NOT passed through. Third, being long on RINs, Big Oil, Inc. benefits when RIN prices rise since extra RINs, not needed for refining compliance, are worth more.
EPA’s RFS, therefore, provides Big Oil, Inc. these two RIN-related incentives: minimize RIN cost pass through in refiners’ bulk fuel prices and optimize any benefits from rising RIN prices. More about the second in a later post.
The implications of this situation for the over supplied and highly competitive Gulf Coast bulk fuels market, home to 50% of the United States refining capacity, explain why merchants are complaining and why Big Oil, Inc., through API – its industry trade organization, opposes moving the point of obligation. Bulk fuel suppliers in the Gulf Coast and satellite regions such as the mid-continent fall into two basic groups – Big Oil refiners and merchant refiners. The two compete to supply marketers at the lowest price, but they are not similarly situated. Big Oil, Inc. not only does not care if its RIN costs are passed through, it is worse off when that happens. Merchant refiners, however, have no avenue other than bulk fuel prices to recover their RIN costs. Big Oil has a built-in advantage to be the lowest-cost supplier courtesy of EPA’s point of obligation.
That advantage is significant. Today, ethanol RINs trade at about 90 cents for every gallon blended into gasoline. If the gasoline standard is 10%, the blending ratio is 1 part ethanol to 9 parts petroleum or 1/9 gallon of ethanol for every gallon of bulk gasoline. To comply in this scenario, merchant refiners must buy 1/9 of a RIN, i.e., pay 10¢, for every bulk gasoline gallon they produce. Big Oil, Inc., however, avoids that cost because its RINs are free.
So, we have two refining competitors. One, due to its affiliated marketing operation and free RINs, is incented to keep bulk fuel prices as low as feasible and the other, having no or trivial marketing operations and huge RIN expenses, is incented to move bulk fuel prices as high as possible. Together, both are necessary to supply the bulk fuels market; alone, neither is sufficient. Common sense suggests the market price resulting from this tension is somewhere in the middle. Some, but not all, refiners’ RIN costs, therefore, are recovered through bulk fuel prices. Any RIN cost not passed through is an unrecovered operating expense, up to 10 ¢/gal, harming merchant refiners’ bottom line, their return on investment and ability to finance efficiency and environmental upgrades to compete over the long haul. By the same token, the cost not passed through also benefits Big Oil, Inc. and chain marketers in the form of artificially low bulk fuel prices for their large marketing operations. EPA’s point of obligation is squeezing merchant refiners, transferring wealth to Big Oil Marketing, Big Oil, Inc., and chain marketers because Big Oil Refining’s bulk fuel market competition inhibits full pass through of RIN costs. Merchant refiners are subsidizing Big Oil Marketing, Big Oil, Inc. and chain marketers by paying full price for RINs while recovering much less in bulk fuel prices.
None of this would happen if the RFS blending obligation were placed on blenders instead of refiners. If such were to occur, Big Oil Refining would not receive free RINs and merchant refiners would not have to buy RINs. All refiners would compete on an equal footing unfettered by these arcane economics. Big Oil Marketing and chain marketers could obtain all the free RINs they need for compliance by blending to EPA’s standard at the blending facilities they already use. After all, the RFS obligation is a blending obligation, not a refining obligation, and must be moved from the point of refining to the point of blending.
This discussion begs some questions to be addressed in later posts.
- Why don’t merchants blend to obtain the free RINs they need?
- How do some economists conclude 100% of refiners’ RIN costs are, in fact, passed through in bulk fuel prices?
- What about small refiners who separate their own free RINs by blending at their refinery or nearby racks? Why are they harmed?
What other market distortions emerge as the effects of this corrupted competition filter downstream to the wholesale and retail levels?