The Hidden Costs of the Renewable Fuels Standard

By Clayton McMartin | January 10, 2008
Millions of dollars in operating capital are being wasted as the ethanol industry struggles to comply with the renewable fuels standard. A survey conducted during an Oct. 30 web conference attended by 234 industry stakeholders indicates that as many as 61 percent of renewable fuel suppliers are out of compliance.

Each of these facts are directly attributable to the requirements set forth in the RFS regulations requiring new documentation for product transfers throughout the renewable fuel supply chain. Many players have attempted to satisfy these requirements by modifying their existing production account systems, resulting in a short-term solution with long-term consequences.

Although the threat of $32,500-per-day fines for Clean Air Act violations is significant, even greater daily costs have come to bear upon the entire industry by those mixing business systems with regulatory compliance systems. Millions of dollars in extra operating capital are required for those who have adopted this ill-advised operating practice, which comes at a time when most in the biofuels business are experiencing painfully low profit margins.

The root of the problem stems from the U.S. EPA requiring the use of a product transfer document to signify transfer of title to both renewable fuel and any associated renewable identification numbers. RINs are the serial numbers assigned to each gallon of fuel under the RFS program and tracked throughout their life in the supply chain. The product transfer document serves to record the transfer of title from one party to the next and must be kept on record for five years. The document is analogous to a warranty deed received when purchasing a house or other piece of real estate.

Regulations Result in More Paperwork
Prior to Sept. 1, 2007the effective date of the RFSthe industry had no product transfer document. In practice, the closest legal document satisfying this purpose would have been a written contract between buyer and seller stating all terms and conditions, including title transfers. Of course, this type of contract served more as a static document, where numerous individual sales could be executed over weeks, months or even years.

Faced with the impending deadline, two schools of thought formed. One developed new documents called the product transfer document and associated RIN certificate. The other modified existing invoicing systems in an attempt to satisfy the new requirements.

The product transfer document and RIN certificate approach, like that used by those on the renewable fuel registry, allows for documents to be generated independent of any corporate financial function. This approach avoids costly delays in payment for product.

On the other hand, the use of invoices almost always results in delays, which can be attributed to the inherent nature of the process itself. Invoices always have some time delay after shipping, and make a company dependent on its supplier to send RINs before they can complete their own invoicing. These delays are further compounded whenever product is traded multiple times before finally reaching its end user.

Inherent Costs of Delayed Paperwork
To illustrate the impact of these delays, consider a railcar of product that is produced at an ethanol manufacturing facility. The title is transferred to a marketing company that sells it to a trader that turns around the same day and trades it to yet another marketer before it is ultimately shipped to a petroleum refiner, which is the end user. This series constitutes four transfers of title to the product and the associated RINs. If each party attempts to handle the product transfer document requirements with its existing invoicing processes, and considering a minimal two-day lag time for each of the invoicing steps, the RINs will lag the product by at least eight days. The example is a real-life case seen every day throughout the industry.

Let's look at the dollars and cents. Let's assume the railcar holds 28,500 gallons of ethanol at $2 per gallon, or $57,000 in working capital. Also assume a cost of capital at 10 percent, 250 working days per year and a two-day lag costing each company just over $45. Applying that to everyone in the supply chain in the example means more than $180 was wasted as a result of inefficient compliance management systems.

Conservatively, the time delays resulting from the invoicing methodology results in a cost of $1.50 per 1,000 gallons transferred. This does not count any additional cost for increased personnel or computing systems. With renewable fuel production levels at approximately 7 billion gallons per year, and assuming an average of three title transfers during the life of each gallon, the industry is tying up $31.5 million annually by handling the product transfer documentation through modifications to invoicing systems. Again, this is a conservative estimate, as experience has shown many companies experience as many as four- or five-day delays in their invoicing, as well as the need to increase staff levels.
Many companies simply can not afford to wait for their RINs before invoicing. However, the regulations clearly state that RINs must be transmitted on the same day as the product transfer documentthe invoice in this instance. To not abide by this requirement places these companies out of compliance with the RFS and subject to hefty fines. It's possible that two-thirds of the industry is still out of compliance with the basic product transfer document requirements of the regulation. This is supported by polling conducted during a late October webinar that showed that only 39 percent of participants receive RINs on the same day they receive their invoices.

A New Approach Offers a Better Way
The regulations do not force companies to transmit RIN information on invoices. The regulations only state what information must be transmitted and that it must be done on the same day as title to the product is transferred. Title-to-product transfers occur well before any invoices are prepared. Early on in the program, and at the request of many throughout the industry, EPA loosened up on its interpretation to allow for invoices to serve the product transfer document requirements. However, EPA still maintains that RINs be transmitted no later than the same day as the invoice, so transferring RINs seven to 10 days after the invoice is clearly not permissible.

Another proven approach to handling the product documentation requirements of the rule is to prepare a separate product transfer document and accompanying RIN certificate. This is the approach utilized by participants on the renewable fuel registry. Regulatory compliance documents are generated independent of any corporate invoicing processes. The registry approach to product transfer documents minimizes costly delays in payment for product and saves the industry millions of dollars in working capital.
Counterparties are notified immediately of RIN transfers, allowing members to operate their accounts receivable and compliance programs independently and in parallel. This approach allows for minimal disruption to commercial operations while avoiding regulatory violations. With registry participants now accounting for more than 1 billion gallons per year of biofuel transfers, millions of dollars are being saved across the industry with a simple change in operational procedures.

Dangerous Precedence Forming
Some within the industry are now developing payment policies that require RINs be transmitted on the invoice before payment is made. The regulations do not mention the word "invoice" at all, and certainly do not require that RIN information be transmitted on invoices. However, the law requires that RINs be transferred on the same day title to the product is transferred so it is reasonable for a customer to expect RINs no later than their supplier's invoice. In the case of the product transfer document/RIN certificate approach, however, RINs can show up well in advance of any invoice. Denying payment in this scenario would have no regulatory support.

Formal recognition of this issue will almost definitely come as a result of attestation engagements as required by the RFS regulation. The first of these independent outside audits are not due until May 2008, with many already qualifying to delay until May 2009. Proactive companies will certainly not want to wait until an outside auditor brings this to EPA's attention before taking action. Fines for such willful violations are tallied on a daily basis, so the sooner a company acts to correct this issue the better. Companies finding themselves in this situation should seriously consider taking proactive measures by notifying EPA's Office of Transportation Air Quality Enforcement Division and implementing corrective solutions as soon as possible.

Clayton McMartin is the president of the Clean Fuels Clearinghouse, a company formed in 2001 for the sole purpose of cost effective implementation of clean fuel regulations. Reach him at (575) 377-3369 or www.rinregister.com.