Ethanol credits are squeezing refiners

Shares of San Antonio-based refiners Valero Energy Corp. and Tesoro Corp. took a beating last week because of a cost that had been of little concern — until now.

Refiners are paying more for credits that help them meet a federal mandate requiring corn-based ethanol to be blended into gasoline.

That could mean refiners’ margins will be squeezed, and they may pass along the higher cost of the credits to consumers through higher prices for gasoline, industry analysts say.

Analysts point to federal renewable fuel standards as the culprit. This year, the government is requiring refiners and importers to blend 13.8 billion gallons of ethanol into gasoline, a total that may rise to more than 14 billion gallons next year.

To ensure the mandate is met, each gallon of ethanol is tagged with a Renewable Identification Number, or RIN — simply put, an ethanol credit.

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If refiners can’t get sufficient ethanol to meet the mandate, they can purchase credits.

The cost of the credits has soared, rising from about 5 cents at the first of the year to more than $1 now.

The rapid increase indicates there’s a shortage of the credits now or a perhaps concerns by refiners that there may be a shortage next year.

There are several reasons why the cost of the credits is soaring, Roger Read, senior analyst at Wells Fargo Securities’ Houston office wrote in a note to clients on Monday.

Ethanol production began to decline in the second half of last year because of drought, followed by a spike in corn prices, Read said. Also, the gasoline market is almost saturated with ethanol.

About 95 percent of the gasoline sold in the nation is blended with ethanol up to its 10 percent limit, he told clients.

Analysts at Macquarie called the credits “a hidden cost” for refiners, putting pressure on their shares. Shares of Valero and Tesoro dipped 5 percent and 3 percent, respectively, in Wednesday’s trading before bouncing back a day later. Valero closed at $43.84 a share on Thursday, and Tesoro, $56.95.

The 10 largest independent refiners lost a total market value of $5 billion in the five trading days through Monday, Barclays calculated.

At Tesoro, the company “has approached the recent price fluctuations in the corn ethanol RIN market with an appropriate level of concern,” spokeswoman Tina Barbee said in an email, “just as the company would with any variable cost that has the potential to impact the cost of providing transportation fuels to consumers.”

Tesoro repeatedly has called for the repeal of the federal renewable fuel standard, she added. “Coupled with fraud in the biodiesel market and the failure of cellulosic (biofuel) to reach production goals, the recent price increases are just another of the problems that emanate from this federal program.”

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She declined to speculate on how the higher price for credits would affect the price of fuel.

At Valero, the situation “is definitely impacting” the company because it’s a net buyer of the credits, spokesman Bill Day said. “We are responsible for ensuring that ethanol gets blended into the gasoline that we produce. We can either buy ethanol or where it’s not readily available, we can buy the RINs.”

Although Valero owns 10 ethanol plants in the Midwest, it doesn’t blend ethanol into gasoline “and that’s part of the problem,” Day said. Every gallon of ethanol has a RIN attached to it, but it doesn’t become a credit until the ethanol is blended into gasoline.

“So whoever blends the ethanol has control of the RIN, not the maker of the gasoline,” Day said.

The key problem is that the renewable fuel standard “isn’t matched to gasoline usage,” Day said. “It’s a completely made up number.”

The best way to address the situation, he added, is to link the renewable fuels standard to gasoline consumption. “That way it can move up and down with gasoline usage. That’s not the way things are working now.”

The Renewable Fuels Association said that it supports blending 15 percent ethanol in gasoline, saying that mix is “fine for 75 percent of today’s vehicles that constitute 85 percent of all miles traveled.”

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But some older cars can be damaged by filling up with gasoline containing 15 percent ethanol, analysts said.

For Valero, as long as the credits remain expensive, there are just three options, Day said.

“We can stop making gasoline, which isn’t an attractive option. We can export more of the gasoline we do make to markets without a renewable fuel standard — that would be very attractive to us.”

Or the third option “is to bear the cost and pass that along to customers.”

Barclays’ analysts were a bit more sanguine, saying the spike in the price of credits is a “transitory issue.”

But the firm said that if the prices for credits should stay high, “at least part of the cost will ultimately pass through to consumers.”