While the oil market fell, RBOB gasoline futures have gone crazy. The main reason for the follow through pop before the ultimate drop was the rumor that Bloomberg News later confirmed about the Phillips 66 Sweeny lost power to on Sunday. The time to restart everything could take a couple of days and the rumors sent price in the wholesale market flying.
Yet behind the volatility are a story of record high renewable fuel credits, surging ethanol costs and the possibility of government mandated shortages. The story is one that Robert Campbell of Reuters has been following each day and writes a piece that explains not only the short term impact of the shortages of RINs (renewable identification numbers) but the long term threat as well.
He says that “Most American lawmakers love to complain about high oil prices. Taking a pop at "Big Oil" helps politicians project an image of caring about ordinary people without having to do anything. Best of all, they can rarely do anything to actually make a difference, so they cannot be criticized for inaction, sound and fury, signifying nothing. This time it is different. Gasoline prices may well surpass last year's levels soon. And while crude oil is costly — the usual and main reason for high fuel prices — the unintended consequences of bad legislation are becoming especially pernicious.
Last decade, under the administration of George W. Bush, political opinion coalesced around the need to "break America's oil addiction." For ideological reasons, conservation and demand reduction measures were largely eschewed. But biofuels and other alternatives to liquid hydrocarbons were heartily endorsed. One result was the Renewable Fuel Standard, which mandated the blending of an ever-rising volume of biofuels into the U.S. gasoline pool. A key assumption behind this policy was the belief that U.S. gasoline demand would keep growing.
That has not happened. Instead, the gasoline market has shrunk while the biofuels mandate has risen. This year, it may rise to the point where it causes a clash between reality on the ground and the command economics of the RFS. Although oil companies loathe the RFS, they have grudgingly accepted ethanol and other biofuels up to a point.
In the past, corn-based ethanol was a boon, providing cheap, high-octane blendstock for gasoline even as it was shielded by import barriers and supported with tax subsidies. The mandate was not a problem so long as the RFS volume quota amounted to less than 10% of gasoline consumption because there was no known product liability associated with selling gasoline containing 10% ethanol, a level known as the blendwall. However fuel blends with greater than 10% ethanol are not liability-free. Refiners are worried that older cars could suffer engine damage if they used high-ethanol blend gasoline, which would expose them to lawsuits.
Until last year, this strategy worked. But as the RFS mandate got bigger, the market neared the blendwall. Now, oil companies say, the risk is the biofuels mandate would require them to exceed the blendwall to comply with the law. But most are refusing to make a "blendwall plus" gasoline, arguing that to do so would unduly expose them to product liability because older cars have not been certified to run on these blends. So the market is running up against oil companies' refusal to incur a potential liability from owners of older cars and the law's requirement that more biofuels be somehow stuffed into the market.
To stay in compliance with the law while only producing gasoline with 10% ethanol, the companies must either use up blending credits saved from last year or buy them from other companies. When regulators drew up the 2013 version of the RFS rules, they argued that excess blending credits generated in 2012 amounted to some 2.6 billion gallons, making problems with the blendwall unlikely this year, although they admitted credits may become hard to come by in 2014. But what appears to be happening is that companies are hoarding credits for fear of being caught short in 2014, when even the government admits that compliance may become impossible.
Here's where the story gets interesting. There has been a lot of talk that the high cost of credits, known in the industry as RINs, are the reason why gasoline importers are balking at bringing fuel to the U.S. East Coast, a partially isolated region that depends on imports to meet local demand. It is true that RINs have shot up in value, but the market is thin and volatile. Importers do not arrange trades on the day-to-day action in RINs markets, but they are well aware of their liability under the RFS. Like refiners, they must show they met their share of the market quota for biofuels, either by blending ethanol into gasoline and generating 2013 RINs or by using older RINs either banked as credits or bought on the open market. Already the fear is that the market will be net short of RINs on an operating basis, i.e., every single participant will have to rely on credits to comply with the law. So those holding surplus RINs will only part with them at a good price. The effect is to discourage the accumulation of inventories because a company's RINs liability is based on its market share. If every gallon of inventory in excess of consumer demand means a higher use of RINs, why would anyone stockpile fuel? Thus we get the current situation on the gasoline futures market. RBOB gasoline futures for delivery in April are at a huge premium to contracts for delivery later in the year. The market is screaming for gasoline to be available now. But because of the penalty for exceeding local demand, the market will supply only what can be immediately consumed unless the price premium gets very strong.
And while the brunt of this unintended consequence of the renewable fuels legislation will mainly fall on U.S. East Coast consumers, it will have global ramifications. RBOB gasoline is the world benchmark for gasoline prices. As it goes higher, so too do gasoline prices everywhere else on earth, that in turn feeds into crude oil prices. If gasoline, a product made from crude, is worth so much more, crude oil sellers will be able to push prices up to capture some of those gains. In other words, bad policy, entirely the making of the U.S. Congress, is playing a key role in driving up world oil prices. But Congress can fix this error almost with the stroke of a pen. The problem, then, would be what to replace it with. Beware of future unintended consequences.” A must read on Reuters!
After the break on gas it is clear the market is still trying to find a seasonal bottom. We are seeing pressure from the fact that Saudi Arabia is raising production at a time when Asian demand is suspect. There was a report of a 25% drop in India's auto sales year-over-year and China industrial data is raising concerns about the future of demand growth. The charts look like a short term bottom is trying to form on crude but it looks tepid at best. Gasoline is living refiner to refiner and the eye will be on gasoline imports on the East coast to see if they can keep up with demand at a time when many are hoarding the RIN credits.