Traversing the RIN QAP Proposal

Dissecting comments to EPA’s proposed rule
By Ron Kotrba | July 10, 2013

By all accounts, the U.S. EPA’s proposed solution to the RIN fraud debacle is far too complex, cumbersome and, ultimately, costly. The RIN quality assurance plan (QAP) proposal, issued early this year, establishes a tiered “voluntary” system, QAP-A and QAP-B, with varying degrees of stringency. EPA’s default stance has been “buyer beware,” meaning if obligated parties retired invalid RINs, they bear replacement costs while being subject to fines and notices of violation. Option A and Option B both provide obligated parties with an affirmative defense against civil liabilities, but under Option A, the proposal requires the QAP auditor to bear the cost of replacement. Under Option B, the obligated party that retired the invalid QAP-B RINs would be responsible.

Option A requires a much more rigorous and comprehensive audit procedure than Option B; the former involves near real-time, ongoing auditing and reporting while quarterly auditing suffices for the latter. QAP-A replacement by the auditor, as the proposed rule exists now, must be backstopped by one or more replacement mechanisms: a RIN escrow account, a RIN bank or a financial instrument. But even less-stringent QAP-Bs exceed the needs of simply assuring invalid RINs are not generated by fly-by-night scammers—the Rodney Haileys and Jeffrey Gunselmans of the world who never produced a drop of biodiesel, making hundreds of millions of dollars on fake RIN credits while nearly destroying this industry.

“They don’t need to be built as bullet-proof plans,” American Petroleum Institute Senior Downstream Policy Advisor Patrick Kelley tells Biodiesel Magazine. “They just need to provide assurance that fraudulent RINs won’t be generated, and I think they go beyond that and built a bullet-proof plan. What the market needs is a cost-effective solution that meets the EPA’s goals while at the same time being cost-effective for the companies that are going to be implementing it. So we really hope they ratchet back the stringency.”

The API and AFPM submitted their comments to EPA on the Notice of Proposed Rule Making jointly. Their comments essentially say that if the final rule exceeds what is actually needed to simply prevent invalid generation of RINs, it would increase the cost of the QAP, lower participation and therefore fail to restore liquidity to the RIN market. For instance, quarterly requirements to review annual reports provide no risk reduction and only add costs. And while fuel quality is important, it’s beyond the scope of a program to reduce generation of invalid RINs. API/AFPM believe all that’s needed in a RIN QAP is an initial site visit to ensure plant operating capacity (and related items) followed by annual visits; and the auditing of a statistically valid sample of receipts for feedstock along with monthly utility bills and bills of lading for fuel compared against feedstock receipts.

The Petroleum Marketers Association of America also supports minimizing costs by allowing third-party electronic monitoring of RIN generation and transfer, feedstock use, and monthly mass-balance calculations, as opposed to quarterly site visits. “Quarterly site visits will place an undue burden on small facilities and disproportionally drive costs up,” PMAA states.

Third-party auditors such as EM Biofuels also state quarterly site visits would cut out small foreign producers who could not absorb the cost to have such frequent overseas onsite audits. EcoEngineers, one of two parties preregistered for both foreign and domestic QAP-A and QAP-B RINs (the other is Genscape), asks EPA to consider reducing onsite visits for QAP-A from quarterly to yearly.

Green Earth Fuels of Houston, which operates a 90 MMgy production facility, states, “While the intent (of the three-tiered structure) is to give the market greater flexibility, we are concerned that the market will move towards one option, QAP-A, which will prove to be an onerous and expensive option forced upon biodiesel producers. It would be much more expeditious to provide a two-tiered structure [that] simply includes business as usual (with no affirmative defense) or a simplified, well-understood QAP plan that affords an affirmative defense.” The National Biodiesel Board also suggests a three-tiered system is fatally flawed.

A big issue for many biodiesel producers is retaining ability to separate RINs at the plant. Most comments support this, some with caveats. Genscape states RIN separation for small producers is necessary to increase greater liquidity in the market to reestablish the capabilities of smaller producers to sell RINs. “RIN separation is core to the business model of producers who serve local and regional markets and who have retail and community-based business models. Separation activities need to continue for the livelihood of these producers.” However, while the QAP program has been proposed as voluntary, Genscape recommends that, in order to mitigate risk, EPA mandates a QAP program for RIN generators who separate.

Jennifer Case, CEO of New Leaf Biofuels, believes QAP-B should be eliminated entirely since small producers will be forced to produce QAP-A RINs—and like GEFH, she also states there should only be status quo and a simpler nontiered RIN audit program. She, like all producers, says the ability to separate RINs is vital. “We have several jobbers that do not want to participate in the RIN program, but they blend more than 125,000 gallons per year,” she comments. “As such, we are often forced to transfer extra RINs to our other blenders in order to stay in compliance with the RIN-hoarding rules, and those RINs rarely fetch more than 75 percent of the RIN’s value.”

API/AFPM state this “loophole” allowing producers to separate at the plant must be closed. “It’s still a big concern of ours,” Kelley tells Biodiesel Magazine. “The EPA acknowledged in their development of RFS2 rules that there is a potential for playing games in the marketplace. There was a limited rationale as to why a biodiesel producer could, that’s where a producer is selling directly to an end user, and while that is still the exception in the marketplace, the practice is often the rule and widespread in the marketplace.”

There is also a replacement cap for auditors under Option A and a limited exemption for obligated parties under Option B. Option A limits the replacement obligation of the auditor to 2 percent of RINs they audit over a five-year period. Under Option B, there is a limited exemption for obligated parties (for years 2013-’14 only) to not have to replace up to 2 percent of their total renewable volume obligation (RVO) if they retire invalid QAP-B RINs. API/AFPM support the 2 percent limited threshold exemption (LTE), and although EPA says this is only good for the first two years of the program, API/AFPM comments this should be for every year beginning in 2013 indefinitely. On the 2 percent LTE, Genscape comments that in today’s market, Genscape A-RIN assurance can be obtained for about 2 cents per RIN. “This also shows that the 2 percent replacement volume for a QAP provider creates a very manageable cost structure for the producers who need it. The 2 percent threshold also strikes a good balance between the QAP provider having enough ‘skin in the game’ and having a financial obligation that is manageable for the QAP provider.”

Louis Dreyfus comments that the QAP-A 2 percent cap and five-year period “is not a big enough liability on the third-party auditor to assure the accuracy of the validation of the RINs. Of course, imposing a higher level of liability on the third-party auditor would require [them] to increase and improve audit procedures to reduce the risk that fraudulent RINs could’ve been issued. … Our view is the concept of a QAP-A is unworkable because to impose a level of liability on the third-party auditor necessary to be nearly certain no fraudulent RINs could have been issued would make the plan so expensive biofuels producers could not afford to use it. In fact, with the low level of liability placed on the third-party auditor proposed in this rule, it is conceivable … that fraudulent RINs could be generated under a QAP-A.”

Regarding the five-year look-back period, API/AFPM states, “It is not possible to go back in time and induce additional production; we question the rationale behind requiring a 2013 RIN be replaced when found to be invalid in 2017. EPA should limit the requirement to replace RINs to the current and previous year only. The financial burden for a RIN auditor to hold this liability on a balance sheet for five years potentially adds significant cost to the program. This two-year limitation should also apply to obligated parties under QAP-B. EPA should be able to conclude enforcement investigations within this time frame.”

While API/AFPM do not support the proposed requirement for verified RINs to be replaced by an obligated party, the alternative replacement mechanisms discussed in the NPRM could have significant market liquidity consequences. “EPA discusses several mechanisms that rely upon documented financial assets to procure RINs, or the requirement to hold actual RINs in inventory for potential use if invalid RINs are discovered,” API/AFPM state. “Any mechanism employed that holds RINs (such as a RIN bank) is an artificial restriction on the supply of RINs that could lead to a shortage of RINs and potential RIN price volatility. … EPA should promote RIN supplies for compliance [and] not promote RIN banking, hoarding, or other market supply constraints.” GEFH suggests obligated parties should be required to replace RINs under any circumstance. “Obligated parties can significantly de-risk their RIN purchases by simply purchasing and blending biodiesel themselves,” GEFH comments. Genscape recommends prohibition of liability insurance as a financial mechanism for A-RIN assurance for several reasons, including the fact that premiums would have to be paid five years in advance to avoid instability in the RIN replacement mechanism.

Other important, specific aspects of the NPRM include a 24-hour reporting period for errors, downstream RIN tracking, and the issue of exports, to mention a few. Most comments suggest 24 hours is far too little time to investigate potential problems. While EcoEngineers believes 24 hours is not enough, Genscape says it’s “reasonable.” API/AFPM state that 10 business days rather than one should be given to report problems with suspect RINs. Also, since errors in RIN reporting are somewhat common and don’t rise to the level of “invalid” RINs, EcoEngineers suggests replacing the NPRM’s language of “potential problems” with “confirmed problems.”

Murex states that requiring exporters to retire RINs at any higher frequency than annually is an unbalanced approach. VicNRG comments that it would like to see the window for retirement of RINs upon export to shrink to 90 days with appropriate quarterly documentation. Independent Terminal Operators suggest retaining the current export compliance obligation (annual compliance with an exporter’s RVO). API/AFPM say it’s EPA’s responsibility to investigate and enforce export violations and this obligation shouldn’t be transferred to RIN auditors. They also highly disagree with downstream tracking of RINs. “No part of the proposed rule demonstrates the problems of expanding the scope of the verification program beyond production more than the discussion of downstream activities that could violate other RFS requirements,” API/AFPM state. “We think EPA is foisting some of their obligations to enforce the rules onto the QAP provider, the RIN generators, and ultimately the obligated parties at the end of the day,” Kelley says. “The scope of the rule, this whole tracking RINs through the system, really needs to be pulled back, and have the QAP provider really focus on proper RIN generation and have EPA enforcement work on having people meet their obligation.”

Author: Ron Kotrba
Editor, Biodiesel Magazine
[email protected]

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