Briefing On Rins Renewable Identification Numbers

The Changing RINs Landscape Sponsored by: CompIntelligence RINAlliance RINXchange Sutherland

American renewables policy that directs oil refiners, fuel importers and gasoline reformulators to incorporate biofuels in U.S. motor fuel and the blending credits that serve as the currency for compliance have moved quickly from regulatory challenge to a profit center capable of generating anywhere from 4 to 30 cents per gallon of renewable fuel.

Contents

As of May 2009, corn ethanol is the renewable fuel with the largest volume target and the greatest number of related credits, called Renewable Identification Numbers (RINs). However, it isn’t the only fuel covered by the Renewable Fuel Standard (RFS). Legislation also calls for the future use of advanced biofuels such as cellulosic ethanol and biomass-based diesel.

Steep Learning Curve ............................... 1 RIN and Biofuel Regulation, Compliance .......................................... 3 RFS-2 Rules, Much Awaited, Long Overdue....................................... 4 Economics Behind RINs ........................... 7 RIN Market Dynamics .............................. 9 Changes Ahead For Trading, Reporting Systems ..............................11 Compliance Tool Turned Turn-key Program ...............................13 RINs’ Electronic Trading Exchange .............................................14 Law Firms’ Role in the RINs Marketplace ...............................15 The Role of the CPA ................................17 About the Sponsors ..................................19

Executive Summary The mandated and growing inclusion of biofuels in U.S. motor fuel and trade in the credits (RINs) generated by their use is evolving from compliance burden to profit center for fuel suppliers of all kinds. Regulations and compliance methods are changing; shifts in energy policy could result in even more modifications down the road; ethanol-gasoline price relationships have shown high volatility and supply estimates of both RINs and biofuels themselves have varied greatly. This white paper provides a guide to the new developments, complete with OPIS graphs and pricing data as well as regulatory, financial services and trading expertise, to help fuel professionals navigate the changing landscape.

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Many companies found the first compliance year of the RFS program, 2007, difficult because they were focused on learning the basic principles for the RFS, or attempting to find a means to outsource their RIN compliance management. Marketers who were also renewable fuel blenders did not foresee their role within the RFS. Most blenders simply refused to take on the responsibility, which comes with taking title to the RIN. Others joined a cooperative that assisted with EPA compliance while pooling and marketing their RINs. In the second year, complexities emerged as companies discovered recordkeeping inadequacies and mismatches between their systems and others’ that resulted in invalid RINs, and had to cope with not just changes to regulations but the prospect for new ones in the near future. Issues of duplicated and overlapping RINs were and are problematic but pale in comparison to the issues brought on by bottlenecks in the system created when the RIN was not transferred downstream for months following a product transfer. Now, in 2009, major changes lie ahead in the world of RINs. In early May, the Environmental Protection Agency ended months of uncertainty about the direction of biofuels policy by proposing regulations for the expanded RFS, or RFS-2. Industry representatives and analysts who are parsing the massive Notice of Proposed Rulemaking for specific impacts to their businesses have flagged several issues that have major implications for the country as a whole but more are likely to emerge during the 60-day public comment period. This white paper will explore RINs’ brief history, the current business climate and the developing issues most likely to shape the future of RINs.

Steep Learning Curve When RINs first entered the market in September 2007 their value was measured in fractions of a penny per gallon. They were perceived primarily as a regulatory burden that fuel producers, marketers and importers had to bear. Familiarity with the 38-character numeric codes, which were generated by

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renewable fuel producers and importers and transferred to buyers of physical renewable fuels or separated from it as a credit, was slim at best. With ethanol production surging and the federal mandate for its use in petroleum fuel modest by comparison, petroleum fuel producers (Obligated Parties mandated by the RFS) thought they could best meet regulations by continuing to buy their own ethanol to blend with gasoline. However, passage of the Energy Independence and Security Act (EISA) in December 2007 dramatically raised the ethanol blending requirement and the market kicked into high gear early in 2008. RINs soared to pennies on the gallon. Companies face a choice of either actively stepping up their own purchases of physical renewable fuel product, or purchasing the already separated RIN credits from other parties. With little to no renewable fuel infrastructure on the coasts, many are forced to purchase the credits from those blending in the Midwest.

38 digits of Renewable Identification Number (RIN) Information KYYYYCCCCFFFFFBBBBBRRDSSSSSSSSEEEEEEEE K

RIN assignment code (1=assigned, 2=unassigned)

YYYY

Year batch is produced/imported (leaves facility)

CCCC

Company registration ID

FFFFF

Facility registration ID

BBBBB

Producer assigned batch number

RR

Equivalence value for the renewable fuel

D

Renewable type code

SSSSSSSS

RIN block starting number

EEEEEEEE

RIN block ending number

Source: Environmental Protection Agency

RFS-2 proposes that the D code be expanded to cover the four categories of renewable fuel defined in EISA.

The first quarterly reporting deadline in February 2008 proved to be a powerful motivator for RIN trades as did the EISA’s near doubling of the biofuels requirement to 9 billion gallons. Those market participants who had put RIN accounting, reporting and trading systems in place and had accumulated a number of RINs by blending biofuels into traditional fuels found themselves besieged by refiners and other Obligated Parties for whom it was cheaper or easier to buy the credits from already-blended fuel than to do the blending themselves. Another significant challenge in 2008 was the requirement by RFS that all regulated companies needed to have an attestation performed by an independent certified public accountant (CPA) by May 31, 2008. Confusion was prevalent regarding the requirements and availability of CPAs with requisite knowledge of RFS regulations and attestation requirements. A primary area of confusion was the waiver by EPA for Obligated Parties to be able to defer a portion of their attestation requirements until their 2008 attestation. Some regulated parties misinterpreted this as a complete waiver of attestation requirements. The second year of the attestation required completion by May 31, 2009. Regulated Parties are again facing challenges due to the fact that 2008 included a full year of activity whereas 2007 was only a partial year. Additionally, RFS regulations were modified in late 2008, which increases the scope of testing required for the attestation process. Some Obligated Parties supplying fuel have re-written supply agreements which require the marketer to automatically transfer the valuable RINs over to the supplier if the RIN laden renewable fuels are blended with the supplier’s fuel. Unless individual states require that straight gasoline and diesel be offered at pipeline terminals, most products will likely be offered preblended in the near future.

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The RINs market in 2008 was a wild ride of highs and lows but RIN prices’ ability to skyrocket now has renewable fuel blenders looking to get on the same train that so many were trying to avoid early on in the program.

About the Editors of this White Paper Beth Heinsohn joined OPIS in 2008 after almost 20 years of writing about oil markets for Platts and then Dow Jones Newswires. Her stories have appeared in the Wall Street Journal, Barron’s, the Associated Press, The Moscow Times and web sites including MSNBC, Smart Money, CNNMoney and MarketWatch. She co-authored the 2008 OPIS White Paper, “Gasoline Economics Revisited.” Contributing Editors Greg Staiti (202) 383-0833 [email protected] John Gelbard (212) 841-4439 [email protected] Jeff Hove (515) 224-7545 [email protected] David Bennett (203) 216-1972 [email protected]

Holding many marketers back from either blending renewable fuels or taking possession of RIN credits are issues such as confusion about reporting and compliance requirements, the uncertain economics of blending, uncertainty about the supply of RINs and biofuels themselves, new RFS regulations and the emerging direction of government policy on fuel, biofuel and climate change.

RIN and Biofuel Regulation, Compliance In the eyes of the EPA the purpose of the RIN is, simply put, a means to track the volume of renewable fuels used each year. By reporting and tracking RIN-gallons used in the U.S., the EPA is better able to adjust the following year’s renewable fuel standard that obligated parties must meet to achieve their Renewable Fuel Volume Obligations (RVO) each year. Current law requires two separate obligations for 2009: a standard renewable fuels obligation, which can be comprised of all renewable fuels, and a second obligation that directs the obligated parties to purchase biomass-based diesel. RFS-2 increases the number of fuel categories to four. Refiners, fuel importers and blenders who are obligated parties are to use (or purchase in the form of RINs) 10.5 billion gallons a year of corn ethanol and 600 million gallons a year of advanced biofuels in the fuel they sell. The advanced biofuel volume includes 500 million gal of biomass-based diesel and 100 million gal of undifferentiated advanced biofuel. Ahead of the publication in May 2009 of RFS-2, many obligated parties attempted to stay ahead of the curve by purchasing biodiesel RINs. It’s a strategy that has paid off following EPA’s direction that the 2009 obligation for 500 million gallons of biomass-based diesel will be rolled into 2010’s obligation of 650 million gallons for a total obligation of 1.15 billion gallons to be met in 2010. Biodiesel and renewable diesel RINs from both years (as well as some 2008 RINs) can be used to meet the requirement. The amounts increase every year until 2022 when corn ethanol is capped at 15 billion gal and advanced biofuels account for 21 billion gal (16 billion gallons of cellulosic ethanol and 5 billion gallons of undifferentiated advanced biofuel). Renewable fuel producers are tasked with generating the 38-digit renewable fuel identification number (RIN) and must pass the RIN downstream as attached to the gallon or batch of ethanol or biodiesel. Technically, the RIN must be transferred to the buyer within 24 hours but EPA’s technical amendment of October 2008 suggests that five days may be adequate.

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RIN ownership, obligations Anyone can own RINs, including private citizens. However, those owning or intending to own RINs must register with the EPA and are subject to recordkeeping and reporting requirements related to RIN transactions [http://www.epa.gov/otaq/regs/fuels/ rfsforms.htm]. Obligated Parties under the RFS are suppliers of finished transportation fuel made from non-renewable feedstocks or blendstocks. This includes gasoline and diesel refiners, importers and those blenders whose activities extend beyond the addition of renewable fuels to gasoline. For example, a facility that only blends ethanol into gasoline is not an Obligated Party. Small refineries (defined as refineries for which the average aggregate daily crude oil throughput for the calendar year doesn’t exceed 75,000 bbl) are exempt until 2011 but can opt into the RFS program if they want to. Obligated Parties calculate their Renewable Volume Obligations by applying the RFS percentage issued every year by the EPA (10.21% in 2009, for example) to their annual gasoline and diesel production/import volume. EPA concern about a possible mismatch between blending obligations and access to RINs spurred the agency to invite comments about how to change the definition of an obligated party in its RFS-2 Notice of Proposed Rulemaking.

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Enormous bottlenecks and non-compliance issues arise when RINs are delayed for months due to the producers’ inability to transfer the RINs in a timely fashion. This has resulted in a compliance nightmare for blenders as they are forced to report and resubmit reports whenever late or revised RINs are transferred. Thankfully, new reporting systems will be offered soon, in order to reduce the compliance difficulties. Another technical amendment now allows the producer to not pass RINs down to a customer. The producer still cannot detach the RINs and sell, but they have to attach them to another customer’s gallons (up to 2.5 RINs per gallon). The only time a producer may separate and sell them is when the renewable fuel has been blended with on-road motor vehicle fuel at a rate of 80% or less renewable fuel. Any person or company accepting RINs must first register with the EPA. Those who are accepting RINs must complete the appropriate quarterly reports either as a RIN owner, Obligated Party, exporter of renewable fuel, or producer/RIN generator. All RIN owners must provide to the EPA, a third-party CPA attest engagement which is designed to look for errors in RIN management methods. The RINAlliance program, for example, automatically creates audit accounts while creating the necessary EPA quarterly reports for RIN owners. These accounts are then accessed by its third party CPA firm for the purposes of the audit. Other blenders must provide their quarterly reports (RFS0100, 0200, 0300, and 0400) to a third party CPA who must then complete a representative selection of the information and perform the attestation. All attestations are due to the EPA no later than May 31st of each year. Misreporting of RINs or failing to meet federal renewable blending targets can result in Clean Air Act penalties of as much as $32,500 per day per violation. Numerous issues arise as invalid RINs mistakenly get into the system or are delayed from moving downstream. Many times the invalid RIN is not recognized for months and quarterly reports and RIN sales have already been completed. In these situations, and there are many, each party who took title to and reported that RIN must now correct all reports and notify the company downstream of the error so it can do the same. EPA hopes to resolve these major issues with their proposed Moderated Transaction System (MTS), a development we’ll discuss in greater detail later.

RFS-2 Rules … Much-Awaited, Long Overdue Revisions to the RFS (called for by EISA 2007 and superseding the mandate in the Energy Act of 2005) promise to make compliance much more compli-

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cated, and some say more difficult, than it already is. It will become increasingly important, for those regulated under the RFS, to gain access to software compliance programs either in-house or from a third party.

Source: Environmental Protection Agency

In brief, RFS-2 establishes specific volumes of a broader variety of biofuels that must be used in transportation fuel, a category that now includes nonroad, locomotive and marine diesel. There are new definitions and criteria for both renewable fuels and their feedstocks, including new greenhouse gas (GHG) emission thresholds for biofuels, which, depending on how they’re calculated, may discourage new investment in production of conventional biofuels like corn ethanol and soybean diesel. Because the proposal requires obligated parties to blend their share of each of the four “carve-out” biofuel categories, RINs will have to change in order for the EPA to keep track of who is doing their fair share of blending and who isn’t. Each obligated party will have a RVO for each of the following: renewable fuel, biomass-based diesel, advanced biofuel and cellulosic biofuel. The 22nd digit of the RIN (designated “D” in the RIN form) is currently either a “1” signifying cellulosic biomass ethanol or “2” signifying non-cellulosic biomass ethanol. However, now the EPA is proposing that as of January 2010, the D code will be 1 (cellulosic biofuel), 2 (biomass-based diesel), 3 (advanced biofuel), or 4 (renewable fuel). The new designation scheme incorporates 15 separate “pathways” by which biofuel is produced. All regulated parties under the RFS will have to capture specific RINs and bundle those RINs before they can be sold to an obligated party. Obligated Parties will have to decide which RINs they need for any given compliance year. Each takes feedstock and production process into account, a development which in combination with GHG emission thresholds and the proposed indirect land use change method of calculating lifecycle carbon footprint has

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some wondering whether RFS-2 might curtail expansion of corn ethanol and soybean oil biodiesel production. Conventional biofuels other than those from grandfathered plants will be required to emit 20% fewer lifecycle GHG compared to gasoline or diesel. Advanced biofuels will be required to emit at least 40% fewer lifecycle GHG, biomass-based diesel 50% fewer and cellulosic biofuel 60% fewer. After months of contentious debate over how EPA should calculate carbon dioxide emissions of various biofuels, the agency chose to include emissions from indirect land use change (ILUC) in its lifecycle requirements. Biofuel groups, agricultural academics and some lawmakers have objected to ILUC, claiming there isn’t a generally accepted method of determining it. Some were pleased that EPA is soliciting scientific feedback and peer review on the ILUC proposal but lawmakers have introduced legislation that would have the agency focus only on direct lifecycle GHG emissions in its regulation.

The EPA has given itself several ways to deal with a possible shortfall of cellulosic biofuel, including RIN creation, alteration of the requirement and substitution of advanced biofuels.

The new greenhouse gas rules and policies will directly impact how RFS-2 plays out and will create a number of new issues on how to handle ethanol, biodiesel, advanced renewable fuel, and cellulosic ethanol. All who will own RINs must find a way to systematically distinguish between ethanol RINs and biodiesel RINs as well as future cellulosic ethanol and advanced renewable fuels. That task is all the more vital in the face of new details about the MTS in RFS-2. The EPA’s new transaction system will be a federally run, central database used to collect and validate RINs and to help eliminate the errors, duplication, and generation of “bad” RINs. It’s slated to begin full operations in 2011. Something RFS-2 didn’t provide was a waiver for the 2010 cellulosic ethanol volume, seen as the toughest carve-out to deal with. Many believe it unlikely that the U.S. cellulosic ethanol industry will be able to produce 100 million gal/year by next year. The economic downturn has slowed the progress of the industry, which is trying to move from pilot-scale facilities to commercialscale plants. “The waiver criteria is not ‘plans to build,’ but is ‘projected volumes of cellulosic biofuels production’,” American Petroleum Institute spokeswoman Karen Matusic said, commenting after the release of RFS-2. The EPA is authorized to create RINs or alter or waive biofuel requirements and could resort to such a measure for the cellulosic requirement. EISA 2007 sets the price of waiver gallon-RINs at the greater of 25 cts/gal or $3 minus the wholesale cost of a gallon. RFS-2 also proposes to allow excess advanced biofuels to make up some or all of any shortfall in cellulosic biofuel. Another RFS-2 issue of particular importance to fuel marketers is the EPA’s consideration of changes to its definition of Obligated Parties. Concerned

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about inflation in the cost of RINs, the agency has invited comment about ways to more evenly align companies’ obligation to blend with biofuels with their access to RINs. We’ll discuss the market implications of such a move later.

The Economics Behind RINs RINs are a tradable commodity but primarily represent volumes of biofuel that are blended with petroleum fuel. The economics of fuel blending are no small part of RINs value, as witnessed by their first full year and a half of trade. For most of 2008, the fuel market provided blenders, refiners and other marketers enough financial incentive to blend gasoline with ethanol above and beyond their obligations, creating tradable RINs in the process. Simply put, the net cost of gasoline (when it’s worth more than ethanol) can, at the appropriate differential, be lowered by blending with the alcohol fuel. For vehicles with conventional engines, the maximum ethanol volume allowed by law is 10%, hence the designation E10 for gasoline blended with ethanol. However, the EPA is considering a request by a number of ethanol industry interests and their legislative advocates to allow the use of concentrations up to 15%. The groups have expressed concern that the U.S. may soon reach the so-called “blend wall” posed by the current 10% maximum for vehicles not specially equipped to consume E85, and not meet the expanded RFS volumes. Some think that the EPA is likely to approve the incremental use of E12 or E13 well before the December 1 deadline for a decision on E15 while others note the equally vociferous objections to higher ethanol blends coming from a number of oil refiners, automakers and environmental groups.

Whatever the concentration of ethanol, the graph above illustrates the economic incentives and disincentives made possible by blending ethanol into gasoline.

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The price of spot market conventional gasoline moved decisively higher versus ethanol in Spring-Summer 2007 and again in 2008. The differences were so great that blending allowed marketers to shave 5-10 cents a gallon of costs (including the tax subsidy, then 5.1 cents). Major oil companies introduced E10 blends in a number of non-mandated markets and interest in splash blending took a sharp turn higher. In Chicago, for example, in mid-August ethanol commanded a price of about $2.24/gal. Spot market reformulated blendstock could be had for $3.36/gal and conventional gasoline for $3.10/gal. Blending 10% ethanol with 90% reformulated blendstock resulted in a finished cost for a blended gallon of $3.24, or some 12 cents a gallon less than the initial cost of the refinery-produced fuel. Applying a 5.1 cents a gallon tax deduction (reduced to 4.5 cents as of Jan. 1, 2009) produced a net cost of $3.19 which was some 17 cents under the original price of the gasoline blendstock.

Ethanol-gasoline price relationships in Spring-Fall 2007 and then again in March-September 2008 aligned to produce wide cost savings for petroleum fuel marketers.

There was similar motivation for marketers in areas that use conventional gasoline. In Florida, or example, mid-August spot prices of $3.06/gal for conventional 87 octane gasoline and $2.30/gal ethanol allowed a typical 90%/10% splash blend to result in a finished gross price of $2.98. After accounting for the blending credit, the net cost was $2.929 or 13cts under the spot price of conventional gasoline. In late October 2008, the collapse in oil markets and faltering demand dragged gasoline prices below those for ethanol and all but erased the financial incentive to combine the fuels together. However, by early April, a rise in gasoline prices was making ethanol blending more financially remunerative. Blending economics in 2009 (also influenced by fluctuations in the prices of ethanol and corn) will likely remain subject to change. However, blenders need to remember that just because they are registered under EPA’s RFS program does not mean they have to report during periods when no renewable fuels are purchased. It is best to be registered under the program and be ready to take advantage of renewable fuels once the price structures make economic sense to do so. You must be registered with EPA in order to take title to renewable fuels with RINs attached, as well as to engage in the trading of unassigned RINs.

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RIN Market Dynamics Factors unique to the new market have exerted both upward and downward pressure on RINs. Born of government policy (in the form of the RFS), mandated use of biofuels has interacted with politics and market forces across several commodities to produce something new. As already mentioned, the near-doubling of the required corn ethanol volume between 2007 and 2008 to 9 billion gallons a year was a significant factor in the spike in RINs prices in January 2008, along with the realization of many that compliance for the first reporting period might be more easily met by buying RINs instead of blending ethanol in gasoline themselves. But as of early 2009, the increase was a mere 1.5 billion gallons for the full year and market participants had had several quarters more to comply with their obligations. So what was behind the near-doubling of RIN values in the first month of 2009? Some attribute the rise to concerns about insufficient supply of ethanol and of RINs, due to financial troubles for a number of biofuel producers and a drop-off in discretionary blending in some parts of the country. Similarly, traders attributed the late 2008 price rise to the end-October bankruptcy filing of major ethanol producer VeraSun, spot gasoline prices’ drop below ethanol values and end-year tallying and topping off of RIN inventories ahead of attestations for 2008 obligations. Uncertainty about the course of biofuel regulation and/or policy has had the opposite effect, driving RIN values lower. Texas Governor Rick Perry’s (R) request to the EPA to waive half of the

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biofuels mandate for one year across the country began one such period of uncertainty between April and August of 2008. At the time, the food vs fuel debate was raging and Gov. Perry voiced concerns that soaring commodity prices were sapping the buying power of lower-wage consumers who could least afford a rise in their food and fuel bills. Biofuel critics went so far as to blame rising food prices on increasing ethanol production. Flooding in the Midwest raised concerns that a smaller-than-expected corn crop for ethanol production would prompt a diversion of the harvest to food and away from biofuels. Some thought the situation might constitute enough of a natural disaster that the government might act to temporarily ease the ethanol mandate. RIN values moved lower on the prospect that a waiver would greatly reduce the amount of ethanol that obligated parties would have to blend into fuel in 2008 and 2009.

The EPA’s August 2008 rejection of a governor’s request for a temporary reduction of the RFS signaled that economic concerns were insufficient to warrant a waiver.

However, in early August, the EPA rejected Gov. Perry’s request for a waiver of the RFS and dimmed the prospect of success for future requests. The decision included criteria for new waiver requests that signaled the agency’s position that economic concerns were insufficient in and of themselves to warrant a waiver. RIN values subsequently recovered a few cents and held near those levels until beginning an abrupt climb higher in early November. More recently, uncertainty about the RFS-2 proposal (expected by the end of 2008 but not released until early May 2009) may also have contributed to a slump in RIN values in March and April. Probably the most current and relevant strain on renewable fuel blending comes from downstream handling of the RINs as new fuel supply agreements are re-written in an attempt to capture RINs. Branded marketers/blenders that have brought renewable fuels onboard will begin to see new language in their supply agreements that states that if renewable fuels are blended with the supplier’s fuel, all RINs will be transferred and retained by the supplier. This, in effect, leaves the marketer with a compliance burden that comes with RIN ownership and little to no incentive to continue blending. Some suppliers have already positioned themselves at pipeline terminals as only offering pre-blended fuel leaving the marketer no straight gasoline to blend. Some states have begun requiring straight gasoline and diesel be offered at all pipeline terminals in hopes of keeping the market competitive. Overall, the RIN regulations and markets are new to everyone. Renewable fuel blending practices and economics on the coasts differ dramatically from those in the Midwest. What might be true for some speculators in a geographic area may not be true for others.

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As the rules become better understood throughout the RIN chain, the market will surely become less wild. Large discrepancies between 2008 and 2009 RIN values, for example, will be lessened as more obligated parties begin to realize that 20% of their RIN obligation can come from the preceding year RINs.

Changes Ahead For Trading, Reporting Systems RIN tracking, validating, reporting, and auditing are playing a major role in stopping marketers from accepting RINs and blending renewable fuels during a time when millions of dollars are being generated. Changes in the RFS and in EPA’s administration of it promise to complicate an already extensive reporting system. For example, RFS-2 has introduced greenhouse gas policies. In the case of biodiesel, a producer will have to document that one gallon of B100 is able to reduce GHG emissions by 50%. New technical amendments to the RFS also require industry to submit software applications used in their company’s RIN management process to their third party CPA during the annual attest engagement.

The EPA’s Moderated Transaction System aims to catch errors and monitor RIN quality as well as supply and demand.

The Moderated Transaction System, through which all RIN trades will be channeled, will monitor RINs for quality and weed out duplicate RINs and other errors. The system should also reduce the reporting burden for obligated parties and companies that handle RIN transactions, EPA said. And, if “aggressive” renewable blending obligations lead to tightened RIN markets, the MTS would allow the agency to monitor credit supply and demand. RIN producers, sellers, traders and buyers currently communicate among themselves when deals are done, passing batches of RINs back and forth and creating many opportunities for error. The agency envisions a “node to node” communication network between RIN market players and the EPA. The network would use a secure website, trading batch RIN transactions in the XML format instead of formats commonly used now, including Excel or CSV. Before passing RINs on to the market for trading, EPA would verify their quality. EPA will not be a “matchmaker,” pairing RIN buyers and sellers, however. Annual attestation engagements will still be required. RINAlliance will be working with EPA on testing the new MTS node to node system as early as January 1, 2010, a year before it becomes fully operational. “The new RINAlliance system will disseminate the variable types of RINs and prepare them for downstream sales once blended with standard fuel,” said RINAlliance’s Jeff Hove. “This will accurately and expeditiously deliver specific RINs to obligated parties.”

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Noting changes in demand for RINs and the operation of the RIN market that may be inflating their value, the agency raised the possibility in its RFS-2 proposal that it could, in a future rulemaking, change its definition of Obligated Party to more evenly align companies’ blending obligations with their access to RINs. Increases in the volume of biofuel injected into the U.S. fuel pool have given rise to “significant disparities between obligated parties in terms of opportunities to acquire RINs,” according to EPA, which could be addressed by tweaking the definition. Obligated Parties are currently refiners and importers of finished gasoline, RBOB and CBOB and only the parties downstream of them which use nonrenewable blendstocks to make finished gasoline, RBOB or CBOB. This group excludes splash blenders who don’t have RVOs and can profit from the sale of all the RINs they acquire by blending ethanol into purchased gasoline, RBOB or CBOB.

The definition of Obligated Party could, in a future rulemaking, change to more evenly align companies’ blending obligations with their access to RINs.

One approach would be to shift the obligation to blend ethanol into gasoline from refiners and importers to ethanol blenders (many of whom are refiners). EPA could eliminate RBOB and CBOB from the list of fuels subject to RFS, such that a party’s RVO would be based only on the non-renewable volume of finished gasoline or diesel that he or she produces or imports. For blenders, this means that parties who blend ethanol into RBOB or CBOB to make finished gasoline would be obligated parties and their RVOs would be based on the volume of RBOB and CBOB prior to ethanol blending. Traditional refiners who convert crude oil into fuels would only have an RVO to the degree that they produce finished gasoline or diesel, with all RBOB and CBOB sold to another party being excluded from the calculation of their RVO. A variation that would more evenly distribute the obligations for diesel as well as gasoline is one where the compliance obligation for all gasoline and diesel goes downstream to parties who supply finished fuels to retail outlets or to wholesale purchaser-consumer facilities. EPA took a deliberately tentative approach because a definition change would “result in a significant change in the number of Obligated Parties and the movement of RINs,” and “many parties … would become obligated, and would be forced to implement new systems for determining and reporting compliance,” the agency said in the RFS-2 notice. The advantage however would be to more evenly distribute the cost of meeting the RFS among all parties that blend renewable fuel into gasoline.

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Compliance Tool Turned Turn-key Program The RINAlliance program was born out of necessity to allow marketers the ability to continue blending renewable fuels if they so choose. What began as a compliance tool to help Midwest renewable fuel blenders has grown to a profit center for those blending renewable fuels across the country. Some marketers have created new positions and hired fulltime employees for the sole purpose of managing RIN credits. The RINAlliance removes the need for additional employees and software required to maintain compliance. As of early April 2009, the RINAlliance program had already began separating out RINs as ethanol and biodiesel in preparation for the new RFS-2 program. RINAlliance subscribers are able to batch their RINs based upon RIN type, aggregate their RINs with millions of others and sell based upon the market demand for each type of RIN. The program will separate out RINs by year and fuel type so that millions of RINs can be bundled in respective groups and transferred to obligated parties.

Under the revised RFS it will become increasingly difficult for blenders to avoid taking title to RINs.

As an indication of how important this process is, the price of 2009 biodiesel RINs, made independent from ethanol, have already reached a high of 28 cents. At the current 1.5 RINs per gallon of biodiesel, that price equates to a value of 42 cents per gallon of B100 for the blender who combines biodiesel with petroleum diesel and then sells the RINs. RINs made available by renewable fuel blending marketers are in demand and very necessary for meeting the RFS goals. Unfortunately for those just getting into the blending of renewable fuels or small-volume blenders, the numbers don’t always appear to work out to their advantage. Incapable of dedicating an employee’s time to the compliance requirements, they decide to avoid renewable fuels altogether. In some cases this is the marketer’s best strategy. If the blender can avoid taking ownership of the RIN credits, they can avoid the compliance requirements of the RFS. However, it will become increasingly difficult for these companies to avoid taking title to RINs under the revised RFS as it is currently being suggested. Furthermore, those that pass on accepting RINs, and have subsequently seen their renewable fuels usage grow, have lost out on significant income. Blenders that want to grow their renewable fuel usage either as a profit center or to provide for a booming niche market may find that a web-based compliance tool will relieve many of the compliance pitfalls and generate otherwise lost revenues.

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RINs’ Electronic Trading Exchange In addition to joining cooperatives that assist with EPA compliance while pooling and marketing their RINs, renewable industry players have also incorporated RIN activities such as trading, reporting and tracking into existing systems. While companies trading RINs may rely on already-established connections with other traders and brokers, there is also an online trading platform where deals for tradable RINs can be executed by anyone willing to register with the EPA. RINXchange, launched by New York-based Renewable Trading Services in early 2008, capitalizes on one of the RIN program’s most compelling components – free trade. Expressly permitted by the federal government to buy and sell Type 2 RINs, non-stakeholders such as hedge funds and Wall Street banks have expressed significant interest in trading RINs.

The greatest obstacle confronting exchange-based RIN trading has been the difficulty of settling RIN transactions.

While companies trading RINs may rely on already-established connections with other traders and brokers, there is also an online trading platform where deals for tradable RINs can be executed by anyone willing to register with the EPA. RINXchange, launched by New York-based Renewable Trading Services in early 2008, capitalizes on one of the RIN program’s most compelling components – free trade. Expressly permitted by the federal government to buy and sell Type 2 RINs, non-stakeholders such as hedge funds and Wall Street banks have expressed significant interest in trading RINs. Financial firms, battered by the severe contractions of the housing, mortgage and then banking industries, as well as by a global economic recession, are monitoring the budding RINs market, according to RINXchange CEO John Gelbard, but haven’t yet initiated actual involvement. Apart from the uncertainty about the course of RFS-2 and U.S. biofuel policy in general, financial players have market-based concerns about trading RINs, Gelbard says. The single greatest obstacle confronting exchange-based RIN trading has been the difficulty of settling RIN transactions. The complexity of the 38digit numbers and the bookkeeping involved when transferring ownership greatly complicate the clearing of trades (an essential component of any actively traded product) and have deterred many traders from participating. While still some months away from implementation, the aforementioned RIN Moderated Transaction System run by the EPA should eliminate these concerns.

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The MTS central database would allow all changes of ownership to occur in something close to real time (T+3, similar to security settlement). Each registered RIN participant would have an account at the EPA which is credited or debited for each transaction. With the system in place, RINXchange will be able to confirm long RIN positions of sellers prior to sell orders being entered, and counterparty risk should become insignificant. Currently, the electronic bourse works as follows: If requested, buyers are given a list of all potential RIN sellers on the exchange and can then choose those whom they trust as counterparty, along with per-company volume limits. The exchange compiles an algorithm from the preferences which is then built into the trading program. Orders by that buyer will execute only against those counterparties unless manually overridden.

With the MTS in place, RINXchange will be able to confirm long RIN positions of sellers prior to sell orders being entered, and counter-party risk should become insignificant.

With increased liquidity in RIN trading, especially after the MTS introduction, Gelbard foresees the listing of RIN-related derivatives such as a synthetic RIN product. This would allow hedging by market participants who are currently unable to sell short. Producers who want to pre-sell future production could sell a synthetic RIN to take advantage of high prices, while speculators would be able to place bets on either side of the market. As with all other instruments traded in financial and commodity markets, this will reduce volatility as supply and demand are brought into balance. Producers who want to pre-sell future production could sell a synthetic RIN to take advantage of high prices, while speculators would be able to place bets on either side of the market. As with all other instruments traded in financial and commodity markets, this will reduce volatility as supply and demand are brought into balance. RINXchange’s Gelbard also sees a U.S. environmental policy role for RINs beyond that of a “currency” for complying with the RFS. For example, the purchasing of RINs could be an attractive strategy for corporate public relations campaigns. To demonstrate their commitment to sustainability and the neutralization of their carbon footprints, corporations could purchase RINs and retire them. This gesture would remove a given amount of RINs from circulation, decreasing supply in the market. Since refiners, blenders and importers continue to have to report RINs to comply with the RFS, a greater quantity of renewable fuels would have to be produced to bring supply back into RIN markets.

Law Firms’ Role in the RINs Marketplace For participants in the RIN market, legal advisors may be the best defense against the myriad of current and future challenges posed by the RFS program. The current regulatory framework was ramped up faster than any other EPA fuels program (with less than a year between the proposed rule and effective date), and has experienced considerable growing pains as a result.

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Moreover, just as parties were beginning to adjust to the economic realities of the program, Congress laid out an aggressive and multi-layered quartet of mandates that promised significant near-term changes. A “push-pull” tension began to emerge, with powerful interests arguing for further expansion while co-equal voices lobbied for retraction. EPA has been caught in the middle of this debate, which contributed to the long delay in publication of the RFS-2 proposal and has created substantial commercial and regulatory uncertainty. Against this backdrop, your legal and compliance team can play a critical role in maintaining current compliance while advising on strategies to mitigate investment risks and adopt flexible, long-term plans to participate effectively in the renewable fuel and RINs marketplace. Trading RINs under the current regulatory framework is fraught with ambiguity and risk. At the outset of the RFS program, parties – many of whom had not previously been subject to EPA regulation – were left to their own devices to develop proprietary systems and methods to generate RINs, reconcile volumes, document transfers and manage inventories and other records.

Amid commercial and regulatory uncertainty, your legal team can play a critical role in maintaining current compliance, while advising on investment risk and RIN market participation.

The lack of a standardized procedures contributed to inconsistencies, which in turn spawned problems including invalid RIN codes, transfer delays, and reporting inaccuracies. Even with the emergence of third-party software or data management services, these problems have persisted and have lead to recent calls to revamp the RIN trading system (to which EPA has responded with its proposed MTS). Legal and compliance advisors can help market participants navigate the complex documentation, reporting and recordkeeping requirements to prevent these types of issues from arising, and help companies make informed choices on the available compliance technologies and solutions. Legal advisors can also coordinate self-audits and other internal assessments, which can be extremely useful tools for maintaining compliance and avoiding penalties, particularly since the annual attest audit is currently the primary enforcement mechanism under the RFS program. Conducting an attest audit without even a modest amount of preparatory self-review is ill-advised, especially under EPA’s strict liability system and the possibility for up to $37,500 per day of violation in penalties. Moreover, if a serious problem is discovered, your legal counselors can be a critical ally in devising strategies to minimize exposure to penalties. A self-disclosure can be a powerful asset in framing your non-compliance in the best possible light. Of course, ambiguity in the current regulations is not the only source of uncertainty confronting RIN market participants. There are broader concerns about the direction of the program – particularly the aggressive new advanced biofuel mandates – in light of the current recession and concomitant slowdown in investments in renewable fuel technologies.

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EPA may be faced with multiple state or private party requests to waive some or all volumes under the various mandates in the next few years. Each such request raises the possibility of a mid-course change in regulated parties’ RIN obligations. EPA denied Texas’ 2008 waiver request, but the agency has acknowledged on numerous occasions concerns about the tight RIN market. Other major unresolved issues – such as the “grandfathering” and carry-over of current RINs for RFS2 compliance, the effect of the E10 “blendwall,” and future legislative initiatives (e.g., a low carbon fuel standard) – inject further uncertainty into parties’ RIN investments. Certain aspects of the RFS-2 proposal are raising new areas of concern. For example, it is unclear if renewable fuel producers and importers will be able to certify compliance with the new feedstock restrictions incorporated in the proposed definition of “renewable biomass.” This reluctance may result in RIN shortages, which in turn could lead to price spikes.

Through appropriate hedging strategies, parties can lock in minimum prices for RINs, thereby safe-guarding against programmatic changes.

In this environment, timely information and analysis is crucial, as new developments have a direct, contemporaneous impact on RIN prices. It is equally important to put this information into context and assess the legal and political likelihood of changes in the program. Your advisors can play an important role in crafting the legal and policy arguments that will advance your company’s interests with federal regulators and legislators. Moreover, your advisors can function as an intermediary to unite fellow market participants with shared interests in a common alliance. Strength in numbers is not lost on EPA nor its congressional overseers. It’s not enough, however, to merely react to new developments with advocacy at the administrative and/or legislative levels. Parties must proactively protect their significant investments in RINs, and can most effectively do so by anticipating and addressing the consequences of a programmatic change in their commercial arrangements. Through appropriate hedging strategies (e.g., put/call options), parties can lock in minimum sale/purchase prices for RINs, thereby safeguarding against abrupt programmatic changes such as a regulatory waiver. In addition to counseling on these strategies, your legal counsel can develop contract terms to protect against more “routine” threats to your investments, such as a counterparty’s breach or other material non-compliance affecting the validity or availability of RINs for purchase or sale. Warranties, indemnifications, and prompt delivery terms are all options in your legal advisors’ toolkit that can help you minimize the risks associated with transacting in the complex, evolving RIN market.

The Role of the CPA Companies’ varying levels of knowledge about RFS regulations often dictate

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how they implement processes, systems and people. This can represent significant risk if their knowledge is incomplete or incorrect. The RCO (Responsible Corporate Officer) is ultimately accountable for the information that is submitted to EPA in quarterly reports and annual attestations. However, the process and system may be the responsibility of someone other than the RCO, such as finance, operations, tax, or trading. For example, a company may choose to incorporate their RIN reporting and compliance processes directly into their accounting system. This puts additional burden on those individuals and it represents another element of data and information that must be validated. Oftentimes, regulated parties don’t have the resources to dedicate to day-today management of RINs and ongoing study of EPA regulations and updates to them. For example, companies that have multiple EPA classifications may be using inadequate systems and processes such as Microsoft Excel. In addition, there can be confusion over reporting requirements versus compliance rules.

Companies that have multiple EPA classifications may be using inadequate systems and processes, such as Microsoft Excel. Others confuse reporting requirements for compliance rules.

Even when a company has a dedicated compliance group, the focus on RFS that is necessary to ensure proper compliance can be lacking. The danger is that any misinterpretation, even minor, could potentially result in significant compliance issues. There’s also the issue of invalid, irregular or fraudulent RINs. Regulated parties dealing with RINs need the ability to track and replace them, and then amend and re-file reports. EPA’s issuance of RFS-2 in early May 2009 adds further levels of complexity relating to compliance and annual attestations. Section 80.1464, Subpart M contains new procedures that must be performed as part of the annual attestation process beyond the existing requirements of Section 80.1164, Subpart F, such as Independent Third-Party Engineering Reviews and validation of feedstock purchases and transfers. More importantly, the required procedures incorporate the changes previously mentioned with regards to renewable fuel management, recordkeeping and reporting. In addition, companies will be required to maintain recordkeeping for now four types of renewable fuel, which results in manpower burden beyond that which exists today. Systems will need to be modified or completely changed, processes will need to be modified and staff will need to be adept in their knowledge of the regulations. The key factor is that regulated companies will serve themselves most effectively by making these modifications with the end result, the annual attestation, as a critical factor in design and execution of these changes. Outsourcing of day-to-day RIN management will now become a very favorable option for many companies.

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About the White Paper sponsors

CompIntelligence Service CompIntelligence is a full-service financial solutions company, and specializes in renewable fuels business intelligence and compliance. We provide RFS and other business services, financial software applications, custom design and implementation services, and ongoing support of your operational processes and systems. Our Renewable Energy Group has extensive experience working with companies on Renewable Fuels regulatory compliance, as well as performing attestations mandated by EPA regulations. We work with you to develop a methodology to apply this same information to gain business insight from your RIN and other compliance data. We can provide staff augmentation, as well as design a customized process and ongoing support for regulated companies’ day-to-day program for managing RINs • Annual Attestation – This procedure under RFS regulations requires companies to have their RFS activity tested and signed off by an outside CPA in accordance with standards prescribed by the American Institute of Certified Public Accountants (AICPA) and the Public Client Accounting Oversight Board (PCAOB). • Quarterly RIN Activity Forensics and Reporting • Design, Implementation and Improvement of RIN Processes, Systems and People • Outsourcing of Day-to-Day RIN Management • Compliance Counseling * Irregularities and Potential Fraud * Responding to EPA Correspondence * Tax Implications * RFS2; MTS; Updates to Regulations * RIN Trading for Obligated Parties and Other Regulated Companies To learn more about CompIntelligence’s solutions please visit www.compintelligence.com or contact David Bennett, CPA, CFF at [email protected] or 203.216.1972.

RINAlliance The RINAlliance program was designed by regulatory professionals Jeff Hove and Dawn Carlson to save renewable fuel blenders time and money. The program was developed initially for members of the not-for-profit Petroleum Marketers and Convenience Stores of Iowa but quickly expanded across the nation as a turn-key internet-based program to assist blenders of all sizes and in all states. The program is operated out of the PMCI offices in the heart of renewable fuel country. RINAlliance is a consulting service managed by industry professionals with more than thirty years experience in the renewable fuel marketing industry. Hove also manages the regulatory compliance issues for petroleum marketers and chairs the Iowa Renewable Fuels Infrastructure Board which assists retailers with grant monies to install renewable fuel infrastructure. Carlson manages the overall operations of the association and subsidiary companies, lobbies and focuses on the financial success of RINAlliance clients. The RINAlliance online software allows blenders to upload and validate their RINs for duplication and overlaps and segregate data for submission to the EPA’s CDX system satisfying quarterly report requirements. RINAlliance manages all aspects of RIN management including consulting on proper management of RINs in order to maximize returns and minimize expenses. RINAlliance prepares the EPA reports and the annual attest engagement and also brokers the RINs

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About the White Paper sponsors to obligated parties, returning profits back to the loyal and growing client base. The large volume of RINs managed through the program makes one-stop shopping easy for obligated parties in need of reliable and accurate purchases of any quantity. To learn more about RIN Alliance’s solutions please visit www.RINAlliance.com | email [email protected] | phone the office at 1.866.433.RINS | or phone direct to Jeff Hove at 515.250.2966 or Dawn Carlson at 515.238.9819

RINXChange RINXchange is the only online marketplace for the buying and selling of Renewable Identification Numbers (RINs). RINXchange provides an efficient, fast and neutral trading platform for RIN market participants and is open to all parties registered with the EPA under the Renewable Fuel Standard (RFS) program, including producers, importers, blenders, marketers, petroleum refiners, brokers and investors. RINXchange was founded in 2007 and is based in New York. To learn more about RINXchange please visit www.rinxchange.com or contact John D. Gelbard, CEO at [email protected]; 212-841-4439; Yahoo ID RINSRUS

Sutherland Asbill & Brennan LLP Sutherland Asbill & Brennan LLP provides legal services worldwide to diverse clients in seven major practice areas: corporate, energy and environmental, financial services, intellectual property, litigation, real estate, and tax. Our Energy & Environmental Practice has more than 50 lawyers representing every major sector of the industry in sophisticated matters, including: • • • •

Transactions and Project Development Environmental and Economic Regulations Legislative Tax

• • •

International Trade Finance Litigation

Our clients are independent power producers and electric cooperatives; petroleum, power and natural gas marketers; domestic and multinational traders; hedge funds and financial institutions; refiners and crude oil producers; industrial end-users and end-user groups; leading companies in the nuclear energy business and energy lenders. Sutherland’s environmental practice covering fuels specification and mobile source programs has served refiners, gasoline blenders, renewable fuel producers and importers for over two decades. We routinely assist our clients in every aspect of the development and implementation of policies, plans and procedures to comply with the environmental regulations that govern gasoline and diesel fuel specifications nationwide. In addition, Sutherland attorneys have litigated major cases concerning the state and federal rules governing the manufacture and distribution of clean gasoline and have worked closely with the Environmental Protection Agency to assure that our clients’ interests are reflected in federal and state fuels policies and rulemaking. To learn more about Sutherland and our Energy practice, please visit us at www.sutherland.com, or contact one of our team members: Peter H. Rodgers p. 202.383.0883 e. [email protected] Susan G. Lafferty p. 202.383.0168 e. [email protected] Gregory R. Staiti p. 202.383.0833 e. [email protected]

RINXCHANGE

TM

Where RINs Trade The RINXCHANGE™ serves as a platform for the trading of RINs. The RINXCHANGE is open to all parties registered with EPA under the RFS program, including producers, importers, blenders, marketers, petroleum refiners, and investors.

www.rinxchange.com