The Energy Policy Act of 2005 created a Renewable Fuel Standard (RFS) requiring 7.5 billion gallons of renewable fuel — primarily corn ethanol — to be blended into the fuel supply by 2012. But the ethanol industry overbuilt capacity, so the US government expanded the ethanol mandate with the Energy Independence and Security Act (EISA) of 2007.

The new Renewable Fuel Standard — the RFS2 — accelerated the renewable fuel adoption schedule. Instead of 7.5 billion gallons by 2012, the new law required 9 billion gallons by 2008, soaring to 36 billion gallons by 2022.

The structure of the RFS2 set up some future problems. If gasoline blenders failed to comply with the mandated volumes (based on the volume of gasoline they sell in the US) they were required to buy credits called Renewable Identification Numbers (RINs) to make up the shortfall.

But Americans are burning less gasoline than we used to, so meeting the EPA’s ethanol mandate would require a higher ethanol content than the current allowable maximum of 10 percent in regular unleaded.

This created a so-called “blend wall” that forces refiners to blend amounts of ethanol that would only be possible if the 10 percent limit were exceeded. Difficulty in complying with the mandate caused the cost of RINs to soar by 3,500 percent during the first six months of 2013, costing refiners a bundle and hurting their share prices.

Valero recently pegged its cost of complying with the mandate at $800 million this year — equal to 20 percent of 2012 operating income.

Source: Zerohedge

Prior speculation had refiners buying up as many RINs as possible to ensure they met their mandates, and this had driven up the price of the RINs. The idea that the EPA is willing to bend on the mandated volumes was enough to cause the price of RINs to fall by 20 percent shortly after the announcement was made.

Valero will fare better than most because it owns ethanol plants with a capacity of 1.2 billion gallons. This will cover the majority of ethanol Valero needs to blend into its estimated 17 billion gallons of annual gasoline production. Still, even Valero considers the current RFS to be problematic, and has expressed their desire to see it repealed. A total repeal is unlikely, in my opinion, and refiners will continue to see profits dragged down as a result, although some (like Valero) are somewhat hedged thanks to their own ethanol production.