RINs Show Not All Refiners Are Equal

It was not too long ago that refiners were up in arms over renewable identification number (RIN) prices. The EPA mandates a certain level of biofuel use. If refiners cannot blend enough biofuels into fuels like gasoline, then they are forced to buy RIN credits on the open market. 

As RIN prices skyrocketed to $1.40, refiners were crying foul. Marathon Petroleum (NYSE: MPC  ) was faced with a $107 million RIN bill in the first half of 2013, compared to a $66 million bill in the first half of 2012.  Phillips 66 (NYSE: PSX  ) did not want to give away how much its RIN bill increased, but its overall RIN obligation for Q2 2013 was around $248.5 million.

The RIN market a few months later
In September, The New York Times published a piece about potential RIN market abuse by the trading arms of big Wall Street banks. This inspired a number of calls for the Commodity Futures Trading Commission to look into the RIN market. Given JPMorgan's recent $100 million fine over unrelated London Whale Trade swaps, a CTFC investigation and possible settlement in the RIN market is realistic.

Apart from the accusations of market manipulation, leaked documents from the EPA show that the agency may require only 13 billion gallons of corn ethanol be used in 2014, just 9.77% of EIA's estimated gasoline consumption for 2014. This means that it will be easy for refiners to blend the required levels of biofuels into their products, decreasing the number of ethanol RINs they need to buy. Ethanol RINs could easily fall back down toward their previous $0.01 to $0.05 range.

Security through diversity
The whole RIN situation shows how important it is to look at a potential investment's risk mitigation strategy. Valero Energy (NYSE: VLO  )  is a big ethanol refiner with a 1.1 billion gallons per year nameplate capacity. Year to date, the segment has posted EBITDA around $125 million. Its ethanol refineries work together with its traditional petroleum refineries to decrease earnings volatility when biofuel prices spike.

Falling spreads between U.S. and international crudes will hurt Valero's margins, but it is looking to grow by upgrading cheap natural gas into methanol.  With a reasonable total debt to equity ratio of 0.37, it offers a world class refinery operation with limited risk and an attractive 2.5% yield. 

The other players
Marathon Petroleum does have some ethanol capacity through a joint venture in Ohio, but it has nowhere near the capacity of Valero. The fall in RINs will give Marathon more cash and help keep its payout ratio low in light of its recent quarterly dividend increase to $0.19.

Marathon's debt load is around industry averages with a total debt-to-equity ratio of 0.29. It could easily buy more ethanol assets, but Valero gained a big advantage by buying up plants in 2009 at bankruptcy prices. 

In the second quarter of 2013 Tesoro (NYSE: TSO  ) estimated that its total RIN bill for the year would be less than $100 million. The recent RIN price decline to $0.32 per gallon should push this bill down significantly, as RINs were trading as high as $1.44 in July 2013.

In the medium term Tesoro hopes to boost its earnings with its recent purchase of the Chevron Northwest Products Pipeline to help move more refined products from its Salt Lake City refinery. Refinery upgrades under construction are expected to add $100 million to its annual EBITDA by Q4 2014.

Tesoro has more debt than its competitors with a total debt to equity ratio of 0.76, but the company is improving its bottom line by moving more of its feedstock to cheap North American crude. 

Even with falling RIN prices, Phillips 66's refinery operations have a number of challenges. It is hoping to wean itself off of expensive Brent crude, but the company is very large, and falling crude spreads will still hurt its bottom line.

Management recognizes these challenges and is planning to grow by focusing on its midstream and chemicals operations. The reality is that such a fundamental reweighting of the company's operations toward midstream and chemicals will not happen overnight. Investors can expect pressure on Phillips 66's 2.7% profit margin for the time being. 

Bottom line
Falling EPA requirements, coupled with calls for investigations into the RIN market, have sent RIN prices plummeting. The whole situations shows that if you are looking for secure dividends, putting your money in Valero can help you sleep better at night. Its complementary ethanol and crude refining operations stabilize earnings, while its latest expansion projects will provide growth in the wake of sustained low natural gas prices.

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