The Looming Crisis
For The U.S. Economy
A Message from CVR Refining, LP
If the EPA does not address the structural deficiencies of the RFS,
it will be the final nail in the coffin for a number of United States refineries.
The RINs program is broken and, if not fixed immediately, will cause devastating consequences for the refining industry – and for the national economy. When even one refiner has problems, gasoline prices can be drastically affected. As we all know, when gasoline prices spike, the rippling effects on our economy can be crippling and include lower consumer spending, decreased travel, higher shipping and transportation costs, increased unemployment, decreased consumer confidence, higher food prices, and budget cuts in vital areas, such as education and public transportation, among many other negative consequences. While this may sound dramatic, many scoffed at the few people who warned about the effects of the housing bubble prior to the 2008 financial crisis. The effects of spiking gasoline prices can be even more destructive and harder to correct.
Today, a large number of small and medium-sized merchant refineries are suffering, with some even on the verge of collapse, due to the escalating costs of RINs. As we approach the November 30 statutory deadline for publication of the latest unachievable renewable volume obligation (RVO), this Administration, and the EPA in particular, have a stark choice: (1) continue with the same fatally flawed RFS point of obligation, which will lead to the strengthening of “Big Oil” oligopolies, large retail chains and Wall Street traders, spike gasoline prices for consumers, and hammer small fuel retailers; or (2) at long last start a process for changing the point of obligation to blenders at the fuel rack, which will reduce fraud and speculation in the market, incentivize the proper actors in the fuel sector to blend more renewable fuel and ensure a continued robust and competitive U.S. refining sector.
As many other stakeholders and analysts have pointed out, the point of obligation must be changed such that the blenders (including large retail chains, some of which are owned and controlled by large integrated oil companies) – who are actually in control of how much renewable fuel gets blended – are the parties who must demonstrate compliance with the RINs program, rather than the small and medium-sized merchant refineries who don’t have nearly enough market power to force the type of infrastructure investment actual compliance with the mandates would require. Unless the EPA takes immediate action, the associated costs of compliance through the forced purchase of RINs from those major oil companies, large retail chains and Wall Street firms seeking extortionate rent will surely precipitate the failure of many small and medium-sized refineries. As the Administration must surely understand, when a refinery closes it doesn’t only impact the company and its employees, it also impacts an entire region of the country that now must replace the lost gasoline production. As we have seen during previous moments of crisis in the sector (e.g. Hurricane Katrina, Hurricane Sandy, etc.), even a brief shutdown leads to spikes in the gasoline market and immediate pain and suffering for consumers and the entire U.S. economy. It is simply unbelievable that the EPA would risk this scenario rather than seeking immediate comment on a structural design flaw – the point of obligation – that could actually help this program.
To this point, the EPA has chosen to close its eyes to the crisis in the refinery business laid out above, indeed going so far as to even deny that any problems exist! Based on the views of an internal EPA “economist” (who is in fact not an economist at all, but rather a chemical engineer!), the EPA has bizarrely concluded that refineries are passing through the higher RINs compliance costs: “EPA notes that after further review…it has been found that a refinery does not experience disproportionate economic hardship simply because it may need to purchase a significant percentage of its RINs for compliance from other parties, even though RIN prices have increased…because the RIN prices lead to higher sales prices obtained for the refineries’ blendstock, resulting in little or no net cost of compliance for the refinery.” But the facts are the facts, and they belie the EPA’s ridiculous position.
When a merchant refiner, a large integrated refiner and “Big Oil” or exempt blenders compete at a rack, they all get the same price for their fuel – the merchant refiner doesn’t get more simply because it has a cost that the others do not. What happens at the rack is that the exempt blenders and “Big Oil” reap a windfall because they can blend without a compliance obligation – the exempt blender on all its volume and “Big Oil” on retail volume that exceeds its fuel production. The integrated refiner earns a windfall or captures the RIN it needs for compliance without incurring a cost. The merchant or small refiner incurs a cost that others do not have – the price of purchasing a RIN. The EPA’s theory of “RINs cost pass through” is a red herring because two of the three parties at the rack have no cost to recover.
The result of this disparity in treatment of competitors by the EPA will be extremely deleterious to the merchant or small refiner, and many will ultimately be driven into bankruptcy. In addition to being penalized vis-à-vis their competitors in this manner, the merchant or small refiner is then forced by the EPA to take on even more risk by having to purchase RINs in an unregulated market where fraudulent activity is rampant and there is no way to verify whether purchased RINs are counterfeit. The active and ongoing manipulations and illegal collusion in the RINs market are unconscionable, known to the EPA, and, as Thomas D. O’Malley, the former Executive Chairman of PBF Energy Company, LLC advised the EPA in August, will “ultimately lead to a serious government scandal” and will badly damage merchant refiners as well as other unwary purchasers of fraudulent RINs, just as the purchasers of mortgage-backed securities and derivatives were damaged during the 2008 crisis.
Every investment bank has spotted this issue as plain as day and has advised its investors to sell their shares in refiners that have RINs exposure, but the EPA’s chemical engineer continues to tilt at windmills and ignores facts.
Facts are facts. The financial results at many of the refineries most affected by skyrocketing RINs costs have gotten pummeled. Net income from 2012 to 2015 dropped from $1.7 billion to $740 million at HollyFrontier, and from $595 million to $291 million at CVR Refining. This dismal trajectory has, for the most part, continued in 2016.
The EPA’s argument that the carryover “RIN bank” will be available to satisfy the RINs needed for 2017 is as ludicrous as it is fallacious. In the proposed 2017 rule, the EPA stated: “We believe that carryover RINs are extremely important in providing obligated parties compliance flexibility in the face of substantial uncertainties in the transportation fuel marketplace, and in providing a liquid and well-functioning RIN market upon which success of the entire program depends.” The EPA failed to mention, however, that there are two major flaws in its logic. First, a large portion of this so-called “bank” may be comprised of counterfeit RINs due to the fraudulent activities described by Doug Parker, the former Chief of Criminal Investigations of the EPA – and thus the “bank” may be much smaller than anticipated, or may not even exist at all. Second, even if there is a supply of legitimate carryover RINs, they may never find their way into the hands of the small and medium-sized merchant refineries that are suffering under the EPA’s oppressive regime (absent the payment of extortionate rent) – because they are held by “Big Oil” and exempt big fuel retailers who do not need them for compliance and are more than able to absorb a small loss over the short term by letting excess RINs expire worthless in order to put their smaller competitors out of business and thus strengthen their oligopoly power over the longer term. Furthermore exempt blenders are not required to meet EPA’s RVO targets and have no incentive to “break through” the blend wall. Thus they will blend at lower levels forcing a net shortage of RINs.
The EPA now has an opportunity to avert this disaster by finally addressing the major structural flaw in the program—the point of obligation—before it’s too late. The precipice we are now facing is alarmingly similar to the situation that preceded the 2008 financial crisis. Just as the EPA has been warned repeatedly about the consequences of failing to fix the RINs program, regulators were warned back in ‘08 of the great dangers being posed to the economy due to Wall Street’s shenanigans in the housing market. Nothing was done then and the whole economic system almost collapsed. Similarly, if the EPA fails to take this opportunity to remedy the RINs crisis, a number of small and medium-sized refineries will be driven into bankruptcy, which will do for “Big Oil” what the Federal Trade Commission would never allow them to do for themselves – destroy all of their competitors in the refining business. This will allow them to strengthen their oligopoly power, giving them the ability to cause gasoline prices to spike and squeeze consumers at will, which will start a domino effect, crippling the transportation industry and causing many businesses to suffer and even fail.
One lesson learned from the ‘08 crisis is that when the smoke clears, everybody will be looking for somebody to blame. The difference between 2008 and the coming RINs scandal is that in 2008 it did not become clear until much later why exactly the crisis had occurred. In this case, however, we already know now who will be to blame when the refining industry comes crashing down and national security is jeopardized – the EPA. The sad fact is that the EPA’s reputation and many laudable accomplishments will be overshadowed by a scandal that could have been so easily avoided by making a few relatively minor changes. Hopefully, action will be taken before it is too late to save the refining industry – and our economy.