Easwaran Kanason

Co - founder of NrgEdge
Last Updated: July 7, 2021
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Business Trends

In a ruling that could have interesting implications going forward, the US Supreme Court has ruled that the Environmental Protection Agency (EPA) has significant latitude in providing exemptions to federal biofuels mandates. The ruling will provide the current Biden administration with the power to compel more American refineries to meet annual biofuel quotas by withholding waivers. But, crucially, it will also provide future administrations with the power to do the opposite- increase waivers to reduce biofuel blending, which sets the country up for a push-pull battle between political affiliations and the oil/farm lobbies.

Why is this important? Under the Renewable Fuel Standard law, the EPA issues an annual biofuel mandate that compels oil refiners to blend a certain amount of renewable fuel into the American fuel mix. For 2020, that amount was 20.09 billion gallons of renewable fuel, including a sub-mandate of 15 billion gallons from conventional biofuels (like ethanol) and the rest including other forms of biofuels. Typically, the mandated amount increases each year, but recent levels were kept steady as the EPA accounted for weaker fuel demand due to the Covid-19 pandemic. Refiners that do not satisfy these annual biofuel quotas will be required to buy compliance credits from refiners that do. Given that US fuels consumption has retreated into slow growth, the evolution of EPA biofuel mandates has had the effect of reducing the amount of pure gasoline and diesel required in the American market. The original intent of the mandates was to reduce US dependence on oil imports while simultaneously boosting demand for American agriculture in the Midwest. For a long while, it was a win-win situation. Refiners got to claim that they were ‘Buying American’ by reducing crude supplies coming from countries like Saudi Arabia, Venezuela and Iran, while US farmers got a major boost in captive demand. Given that both industries were staunch Republican supporters also played a role.

But those dynamics have changed. The advent of the shale revolution flipped the equation, allowing the US to reduce its net import position. From a peak of 12.9 mmb/d in June 2006, the US net crude import position fell precipitously to 40 kb/d in September 2019. Since then, the US has during most months actually been a net exporter of crude, with US shale oil making inroads into markets as varied as Poland, India and Vietnam. For refiners, this means the issue of importing crude is now secondary, since there is plenty of supply both domestic and across the border from Canada. The capitalist impetus is therefore then to increase the profit position. Which flies in the face of the EPA biofuels mandates, since that is an enforced cost on a refiner that actively replaced its own products (gasoline and diesel) that is oftentimes expensive. Because the price of corn and soybeans – the principal sources of American ethanol for biofuels – is also driven by food demand. In China, for example, US soy is a major source of vegetable oil and soymeal for the meat industry. Soybean prices recently hit its all-time high in the Chicago Board of Trade, as recovering demand in China and adverse weather in the Midwest created a perfect storm of speculative trade. For American refiners that were already devastated by Covid-19, that added cost could be the difference between solvency and bankruptcy.

And so the EPA – under the Trump administration – used a tool in the law that allowed it to provide exemptions for refineries that face an ‘economic hardship’ from mandate compliance. These waivers surged under Trump’s tenure, bringing cheer to the oil industry but drawing backlash from biofuel manufacturers and, particularly, US farmers that were facing demand hurdles as a result of Trump’s trade wars with China and other major trading partners. This triggered lawsuits from biofuel advocates, which argued that the waivers were only intended to be short-term relief, not long-term arrangements. Refiners, of course, argued the opposite.

In a 6-3 ruling split across non-partisan lines, the US Supreme Court has now affirmed that the EPA’s power on the matter is broad, not limited. Under the Biden administration, this will like lead to fewer waivers to compel more refineries to meet mandates, but allow some flexibility and option to provide relief for independent refiners that are still struggling from Covid-19. Increased environmental scrutiny under Biden has already caused the Limetree Bay refinery in the US Virgin Islands to shutter. To allow a refinery operating in a swing-state like Monroe Energy’s Trainer site in Pennsylvania or Husky Energy’s Superior plant in Wisconsin to shutter over strict adherence could be politically dire. Especially in a hyper-partisan political climate.

But more crucially, the ruling might be a long-term win for American refiners. Since the EPA, under a different administration, could use its position as affirmed by the Supreme Court to reduce mandates instead. It certainly sets up an interesting dynamic for the biofuels industry that has many shades of political influence. The focus at the moment is to ensure that US refineries in critical condition have their burdens eased, with the American Fuel and Petrochemical Manufacturers Association president stating that he hoped the EPA would ‘move swiftly to provide critical relief to those small refineries that have demonstrated disproportionate economic harm resulting from the Renewable Fuel Standard’. In response to the ruling, the EPA is now also re-analysing its slate of proposals for 2021/2022 mandates.

Why does this matter? Refineries in the US are currently operating at near-maximum levels as economic recovery gathers pace, especially with the summer driving season coming up. With US crude output still far below pre-Covid levels, due to shale discipline and investment shyness in the face of climate change conversations, that has bid WTI prices up to its highest level in nearly 3 years. In fact, the WTI-Bent spread has narrowed so much because American fuels demand is far outstripping its supply. Continued exemptions from biofuels waivers would increase that demand, since corn-based ethanol would be displacing less volumes of gasoline, potentially driving prices even higher. The spillover effects on US grain prices and associated impact on food prices may also see a change. But all that could be reversed by a future administration with a different direction, potentially upending price dynamics again. The US Supreme Court has handed the EPA a potent weapon. May it be used wisely.

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