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Complex biofuel credits complicate costs for local refinery

These are tough times at Philadelphia Energy Solutions, the joint venture that rescued the South Philadelphia refining complex from threatened closure just four years ago.

These are tough times at Philadelphia Energy Solutions, the joint venture that rescued the South Philadelphia refining complex from threatened closure just four years ago.

Philip L. Rinaldi, the chief executive of PES, told employees last month that the refinery's finances were "significantly stressed" and it must shrink staff, trim pensions, reduce health-care benefits, and delay capital investments.

Low fuel prices are a culprit, but Rinaldi also blamed the soaring costs of government-backed ethanol blending credits called RINs, or Renewable Identification Numbers.

"Our RINs obligation has become really astounding right now," Rinaldi said in an interview last week. He said PES would pay $250 million for ethanol credits this year. Other area refiners, including Monroe Energy in Trainer and PBF Energy in Paulsboro and Delaware City, Del., face comparable costs.

Merchant refiners say the villain is the Renewable Fuel Standard, established in the Energy Independence and Security Act of 2007 to force the industry to blend ever-increasing volumes of biofuel like ethanol into motor fuel.

Merchant refiners say their beef is not with the Renewable Fuel Standard itself, but with the mechanism used to enforce compliance. Each gallon of ethanol consumed is assigned a RIN, which is traded in an unregulated market.

That market is rigged, the refiners say, putting them at the mercy of traders. They are pushing the government to fix the system.

A RIN is generated when a distributor blends ethanol with gasoline at a terminal or "rack" before it is delivered to a retail outlet. Conventional gasoline contains up to 10 percent ethanol.

The Environmental Protection Agency has placed the onus on refiners and importers to obtain RINs to meet government biofuel quotas. Integrated refiners, which blend fuel and distribute it to their own retail outlets, generate their own ethanol credits. But merchant refiners, who sell fuel to blenders, need to buy RINs on the market to meet their obligations.

They say that traders can manipulate the market to create a shortage of RINs, driving up the price.

"A RIN producer has no obligation to put it in the market," Rinaldi said. "He doesn't have to sell it. He could actually burn it in his fireplace and destroy it. If he does that, the market gets squeezed, which is exactly what has happened."

RINs are neither a tax nor a subsidy paid to ethanol producers.

"It is merely a transfer of wealth from the refiner to the blender," Rinaldi said.

Billionaire investor Carl Icahn, who owns a controlling interest in the refiner CVR Energy Inc., recently compared the RINs market to the Colombian cocaine cartel of the 1990s.

Tom Kloza, the global head of energy analysis for the Oil Price Information Service, said the market design had created inequities that benefit fuel blenders, and hurt refiners.

"It's a mess, and it really penalizes merchant refiners, which would include most of the refiners in the Philadelphia area, on the Delaware River," Kloza said.

The cost of renewable blending credits for nine publicly traded independent refiners will increase $1 billion this year, to $2.1 billion, according to a recent Bloomberg Intelligence estimate.

Pressure is building on the EPA to ease next year's mandate for biofuel, which would reduce the RINs shortage. The EPA used that approach in 2013, when RIN prices soared from under a nickel to more than $1.45.

Citibank, in a Sept. 23 report that called the RINs market "a broken program requiring a structural overhaul," said it expected the EPA to relax the mandate after the Nov. 8 election, but not to address the underlying mechanics of the market.

Refiners like PES are lobbying the government to shift the "point of obligation" for buying RINs from refiners to the owners of fuel terminals, where ethanol is blended with petroleum products and the RINs are generated.

But the industry is split over the issue. Some argue that shifting the responsibility to fuel distributors would increase opportunities for fraud.

"I just don't see it," said Kloza, the oil analyst. "It would be so complicated. It would be so difficult to get compliance."

The financial woes at the Philadelphia refinery go beyond the challenges caused by the opaque market in ethanol blending credits.

PES was created in 2012 by the Carlyle Group and Sunoco LP to run Sunoco's ailing refinery, and its financial footing improved after it tapped into discounted oil production from North Dakota, brought in by rail.

But the fall in oil prices has wiped out the competitive advantage of North Dakota crude oil, squeezing margins at Northeast refiners like PES. The rising price of ethanol blending credits has only made matters worse.

PES reported that sales declined 34 percent last year, from $13.3 billion to $8.8 billion, and net income fell 21 percent, from $143.6 million to $113.5 million, according to financial reports included in a recent Sunoco filing.

In a Sept. 7 email, Rinaldi offered buyouts to nonunion employees. The company's unionized workforce, which accounts for about 60 percent of the refinery's 1,140 employees, are subject to a contract that runs through 2019, according to sources.

Rinaldi declined to discuss his company's finances.

Curiously, one company that benefits from the soaring price of RINs is Sunoco, the fuel retailer that owns one-third of Philadelphia Energy Solutions.

Robert W. Owens, Sunoco's chief executive, told investment analysts in August that Sunoco does not disclose its RINs earnings. "My view of the RINs is the bulk of it gets passed through to the end consumer," he said.

Rinaldi said retailers like Sunoco were pocketing the profits from RINs, and refiners were eating the cost. "We're on opposite sides of the story with Sunoco," he said.

The soaring cost of RINs could bankrupt some merchant refiners, Rinaldi warned.

"This program is supposed to be about energy security, but if it puts a couple of big oil refineries out of business, Katy bar the door in regards to the pricing," he said. "You're going to have shortages."