The EPA is not the Federal Reserve of oil markets

Energy market pricing behavior seems contrary to the relationship between supply and demand. The oddly behaving RIN market is an intermediate factor that influences gasoline prices for automobiles. RIN (Renewable Identification Numbers) should be decreasing. Instead, they are too high.

Bio-fuel pricing anomaly

RIN establish compliance with standards for non-fossil fuel usage, specifically, for corn-based ethanol as a blend in gasoline. In 2007, legislation was passed to encourage greater use of ethanol. The percentage requirement of ethanol is set by the EPA. It increases annually, and is calculated at an aggregate level, measured volumetrically, over all U.S. domestic consumption.

My favorite energy blog, Platt’s Oil Barrel, featured a guest post* by former Special Assistant to President Obama and Senior Director for Energy and Climate Change of the National Security Council Jason Bordoff, explaining anomalous RIN price behavior, and what the EPA is doing about it. He noted two reasons for the seemingly anomalous pricing.

Hitting the blend wall

Renewable Fuel Standards (RFS) were revised in 2007, based on the assumption that gasoline usage would increase over time. In fact, it has not done so, not consistently. Instead, it decreased during 2011-2013, yet the schedule of increasing amounts of ethanol has remained, as legislated. As a result, according to Bordoff, we are now hitting the “blend wall”, when blenders physically cannot put enough ethanol into the gas supply to comply with RFS law.

Bordoff identified a second reason:

broad-based skepticism in the market that EPA will use its waiver authority to avoid the blend wall—even though EPA just went to unusual lengths to signal precisely that it will.

Federal Reserve v. EPA: Powers and purpose

The bio-fuel situation bears an odd resemblance to the rational expectations based logic of monetary policy. It is difficult for the Federal Reserve to effectively signal to markets, e.g. the anticipated (and appropriate!) end of quantitative easing. The Federal Reserve System has taken measures to increase transparency. Fed Governors Bernanke and Yellen hold scheduled press conferences. Bernanke was the first Federal Reserve governor to do so. The Fed was audited by the GAO in 2012. Federal Open Markets Committee (FOMC) meeting notes are published and posted online.

wow.. just wow.. Citi talking of QE4 now with inflation expectations collapsing pic.twitter.com/ZzH2u7nrA8

— Chris (@lebullmarche) October 8, 2014

The Fed also has the necessary tools to carry out monetary policy e.g. quantitative easing known as QE.

@lebullmarche @LadyFOHF OMG | QEn s.t. n = 1 ~> ? It is unnatural. Fed wasn’t intended for this; is worse than a centrally planned economy

— Ellie Kesselman (@EllieAsksWhy) October 8, 2014

Despite all of the above, the “job creators” aren’t investing, and the Fed is now contemplating QE4.

Let’s get back to bio-fuels!

RIN prices were intended to incentivize the build-out of ethanol-blended fuel infrastructure. I tried, but still can’t quite figure out how RINs work. Are RINs a levy on petroleum refiners? Go have a look at this post about RINsanity from Ethanol Producers. I do understand enough to believe that it is inappropriate to expect the EPA to function like the fuel market version of the Federal Reserve. The Environmental Protection Agency is a regulatory authority. It does not have a fuel market oversight mandate, nor does it have the means to effectively influence fuel markets.

Economic Model of Consumer Behavior In the Time of Tranquility

Behavioral economics is NOT the solution to everything. It seems arrogant to expect it to be. Building out biofuel infrastructure will only happen if manufacturers and consumers want it. The EPA is good for enforcement of specific criminal acts of environmental waste and endangerment. The EPA is good for setting standards that provide guidance as part of normal day-to-day life and business. The EPA shouldn’t be responsible for implementing massive, sweeping public policy that spans manufacturing, transportation and consumer necessities!

Externalities are the bane of economic models

Microeconomics is well-suited to mathematical modeling, but can be problematic when trying to run an entire economy with huge, many-variable general-equilibrium models of the macroeconomic variety.  I believe that re-purposing productive U.S. farmland to grow corn for ethanol results in higher food prices,

More than one-third of our corn crop is used to feed livestock. Another 13% is exported, much of it to feed livestock as well. Another 40% is used to produce ethanol. The remainder goes toward food and beverage production.

There isn’t as much corn for animal feed. Next, it becomes uneconomic for farmers to grow organic crops, or anything with higher risk, instead of corn.

The EPA signaled but without any effect. That’s due to a lack of trust, which makes sense, as the EPA is not a market participant. The EPA establishes standards and enforces compliance. They shouldn’t force blends of E10 to E15 if manufacturers say it will damage engines though! If manufacturers, consumers and fuel stations aren’t convinced that the EPA is acting in the public and industry’s best interests, then no amount of so-called incentivizing through RIN prices will be effective.

For newer Porsches only

The EPA can’t force the public to behave irrationally. Irrationally? Yes. Everyone except the ultra wealthy ruling class (say, greater than $1 million average yearly income or greater than $10 mil net worth) is worried about money. Of course no one will want to use E15 fuel if it could ruin his car engine (American Automobile Association, November 2012):

The only vehicles currently approved by automakers to use E15 are flex-fuel models, 2001 model-year and newer Porsches, 2012 model-year and newer GM vehicles and 2013 model-year Ford vehicles.

The 1939 Ford pick-up truck will not use bio-fuel although Ford vehicles from 2013 onward will

People won’t worry about the environment if they are afraid of losing their jobs, due to needing a new engine for the vehicle used to get to work. Without that engine, vehicle and job, families will be hungry and homeless. Public transportation is an excellent alternative, but it isn’t available for most of us.

Auto companies should have developed more bio-fuel accommodating automobile engines a long time ago.  Most recently, the government has been obsessed with the JOBS Act (general solicitation for hedge funds), gutting Dodd-Frank while adding bulk,  the America Invents Act (opaque euphemism for more patents, less invention) and funding not-so-high-tech, so-called social media entrepreneurs and cloud computing, instead of chemistry, physics and engineering research by Midwestern auto companies and big land grant universities of the states of Iowa, Michigan, Texas, New Mexico etc.

Don’t blame Big Oil either, not for this! Oil company stock prices are plummeting although there is no obvious causal linkage to RIN activity.

Does the EPA classify information too?

Unless one has spent the past year in a sensory deprivation tank, it would be impossible NOT to be aware of the disclosures of former defense contractor Edward Snowden, and a slew of revelations about surveillance. The concept of classified or restricted information is applied in few government contexts. Most U.S. federal, state, county and municipal documents are available for public review, as they are funded with our tax dollars. Thus, I was rather surprised to learn that the EPA issued its 2013 version of bio-fuel related updates, but redacted a key item and resisted Wall Street Journal requests for disclosure.

* I drafted most of this on 13 Oct 2013, so there may have been changes in the interim.