9/14/13, "Wall St. Exploits Ethanol Credits, and Prices Spike," NY Times, by Gretchen Morgenson and Robert Gebeloff
"It was supposed to help clean the air, reduce dependence on foreign oil
and bolster agriculture. But a little known market in ethanol credits
has also become a hot new game on Wall Street.
The federal government created the market in special credits tied to
ethanol eight years ago when it required refiners to mix ethanol into
gasoline or buy credits from companies that do so. The idea was to push
refiners to use the cleaner, renewable fuel, or force them to buy the
credits.
A few worried that Wall Street would set out to exploit this young market, fears the government dismissed. But many people believe that is what happened this year when the price of the ethanol credits skyrocketed 20-fold in just six months, according to an analysis of regulatory documents and interviews with more than 40 people involved in the market, including industry executives, brokers, traders and analysts.
A few worried that Wall Street would set out to exploit this young market, fears the government dismissed. But many people believe that is what happened this year when the price of the ethanol credits skyrocketed 20-fold in just six months, according to an analysis of regulatory documents and interviews with more than 40 people involved in the market, including industry executives, brokers, traders and analysts.
Traders for big banks and other financial institutions, these people say, amassed millions of the credits just as refiners were looking to buy more of them to meet an expanding federal requirement. Industry executives familiar with JPMorgan Chase’s activities, for example, told The Times that the bank offered to sell them hundreds of millions of the credits earlier this summer. When asked how the bank had amassed such a stake, the executives said they were told by the bank that it had stockpiled the credits.
A spokesman for JPMorgan, when asked about the exchange with the
executives, disputed the account, saying the bank does not trade ethanol
credits for a profit in the way it trades other securities, but is
registered to deal in credits through its energy business. From time to
time, the spokesman, Brian J. Marchiony, said in a statement that the
bank also purchased credits “on behalf of clients who need to fulfill
their E.P.A.-mandated obligations,” though it had not done so in the
past year.
But other market participants, including Thomas D. O’Malley, chairman of
PBF Energy in Parsippany, N.J., identified JPMorgan Chase and other
financial institutions as being active sellers of the credits this year.
He said the institutions had helped transform an environmental program
into a profit machine, contributing to the market frenzy this year.
“These things were designed to monitor the inclusion of ethanol in the gasoline
pool,” Mr. O’Malley said. “They weren’t designed to become a
speculative item. For the life of me I can’t see the justification for
it.”
While banks are by no means the largest player in ethanol credits, Wall
Street’s activity in this market reflects a larger effort by financial
institutions to exert their influence over loosely regulated markets for
basic commodities, from aluminum to oil. The opacity of the ethanol
credit market makes it difficult to determine the extent to which large
financial actors have profited.
The banks say they have far less influence in the market than others are
suggesting, and are doing nothing wrong. But the activities, while
legal, could have consequences for consumers. In the end, energy
analysts say, the outcome will be felt at the gas pump — as the higher
cost of the ethanol credits gets tacked onto the price of a gallon of
gasoline. (The credits, which cost 7 cents each in January, peaked at
$1.43 in July, and now are trading for 60 cents.)
The Valero Energy Corporation, a refiner that owns thousands of gas
stations, says the squeeze in ethanol credits might cost it $800
million. PBF Energy, also a refiner, puts its bill at about $200
million. A review by The Times of a federal registry of nearly 1,500
businesses and individuals in the renewable fuel market found big Wall
Street banks as well as a handful of people with troubled legal
histories among the participants. Several high-profile cases of fraud
have emerged.
Scott Mixon, the acting chief economist of the Commodity Futures Trading Commission,
said in an interview Friday that the issue of banks’ involvement in
this market was something the agency was tracking and might look into
more deeply because of the ethanol component. The commission regulates
the commodities futures market, including trading in ethanol and
gasoline.
Though the ethanol credits are traded by many major investment houses,
they were created not on Wall Street but in Washington, on Capitol Hill
and at the Environmental Protection Agency.
At its inception, the so-called Renewable Fuel Standard was promoted as
a means to reduce the nation’s reliance on foreign oil, fight global
warming and provide a boost to farmers. The rules call for a set amount
of ethanol, most of which is made from corn, and other renewable fuels
to be blended with fossil fuels each year, with quotas assigned to
individual refiners and importers.
Every time they mix ethanol into gas, or import fuel already blended
with ethanol, energy companies get a credit from the government, and
that credit can be sold to other companies that don’t blend ethanol to
help them meet federal requirements. If refiners fall short of their
obligation, they can face fines of $32,500 a day. To monitor compliance,
each gallon of ethanol is assigned a 38-digit Renewable Identification
Number, or RIN. Six billion of them were generated in the first six
months of this year.
The E.P.A. makes sure participants comply with the fuel standard. But
rules that apply to almost every other market — on transparency,
disclosure and position limits, for example — are not imposed on the
trade of RINs, making Wall Street’s role harder to gauge.
If Wall Street traders take a 5 percent stake in a public company’s
stock, for instance, they are required by law to flag that they have
acquired a sizable stake in a filing with the Securities and Exchange Commission. There is no such obligation for traders buying RINs.
Until 1999, regulations barred banks from owning nonfinancial companies
like commodities operations. This was meant to keep banks from
self-dealing or pursuing monopolistic practices in their financial
operations that could benefit their nonfinancial affiliates. Separating
these operations, regulators believed, would also protect a bank’s core
lending and deposit-taking businesses from risky trading by nonfinancial
units. Those restrictions fell by the wayside with the passage of the
Gramm-Leach-Bliley Act, which struck down Depression-era banking laws.
Now, however, the Federal Reserve is reviewing commodities ownership by
banks.
In the case of JPMorgan, the industry executives familiar with its
activities in the RINs market said they were told by a top banker in its
commodities operation about the stockpiling. The executives said the
banker maintained that one of JPMorgan’s traders had urged the bank to
buy up every available credit. The executives spoke on the condition of
anonymity for fear of harming business relationships.
Through a spokesman, the banker denied that the conversation took place. Mr. Marchiony, the JPMorgan
spokesman, characterized the report as a misunderstanding. He denied
the bank had stockpiled the credits. He added that the bank mainly dealt
in RINs as a byproduct of its joint venture with a refiner in
Philadelphia. “The fact of the matter is, we simply don’t trade RINs,
nor do we carry an inventory other than a marginal amount for compliance
purposes,” the statement said.
Morgan Stanley also generates RINs through TransMontaigne, a subsidiary
with 21 blending facilities, and it trades the credits via the Morgan
Stanley Capital Group. According to regulatory filings, TransMontaigne’s
biggest customer for its energy products is the commodities unit of the
Morgan Stanley Capital Group, a trading operation that runs out of the
former Texaco headquarters in Purchase, N.Y.
Mark Lake, a spokesman for Morgan Stanley, said that the firm had not
benefited from the increase in RIN prices in 2013. “The firm’s
obligation to purchase RINs as part of our importing and blending of
gasoline exceeded the RINs we have received from our wholesale
business,” he said.
Mr. Lake declined to discuss Morgan Stanley’s holdings of RINs or to say
whether the bank’s traders used market information received from
TransMontaigne.
Trading on information gleaned from a subsidiary like TransMontaigne
would be illegal in the stock market, but there are no rules against it
in commodities. (Morgan Stanley also holds a stake Heidmar Holdings, of Norwalk, Conn., which owns a fleet of oil tankers.)
Saule T. Omarova, an associate professor of law at the University of
North Carolina at Chapel Hill, said Morgan Stanley’s overlapping
activities illustrate how large financial institutions have become
deeply entwined in every aspect of the commodities markets.
“In the trading chain between the oil well and the gas station,” Ms.
Omarova said, “Morgan Stanley is clearly accumulating as many stakes
along the way as possible because that is what gives them the most
flexibility of control.”
Seizing an Opportunity
The market in ethanol credits is exactly the kind Wall Street loves:
opaque, lightly regulated and potentially very lucrative.
Officials at the E.P.A., which oversees the market, say they have seen
no evidence of improper trading, like hoarding, in the market. But they
do not police the RIN market as a financial regulator would.
“If there were any evidence now or in the future that that was
happening, we have the ability to amend the regulation to constrain
that,” said Christopher Grundler, director of E.P.A.’s office of
transportation and air quality, which oversees the renewable fuels
program.
It is difficult for outside groups, or even other regulators and law
enforcement agencies, to keep tabs on the market, because the E.P.A.
declines to disclose who actively trades the credits, or how much they
trade, citing the confidentiality of refiners and other participants.
Trading is a private affair, usually conducted by phone, and just about
anyone can participate. In creating the market, the E.P.A. says it did
not limit the market for RINs to refiners and other energy companies
because it wanted to encourage a free market.
Price movements on other commodities futures are limited by the
exchanges on which they trade as a check on speculation. But the biofuel
credits are not traded on an exchange: their prices are unbridled. And,
unlike in the broader financial industry, no formal qualification or
license is required before a broker can start trading.
“There is a RINs trading desk at any major brokerage now,” said Paul
Niznik, bio-fuels manager for Hart Energy, based in Houston. “There are
people who are not refiners that are buying and selling RINs like a
commodity. They treat it like something to be traded, to be day-traded.”
The RINs story began in 2005, when the Bush administration joined
Democrats in Congress to pass an energy bill mandating renewable fuel
standards. That law was broadened in 2007 to establish requirements for
the amount of biofuel to be blended into gasoline annually through 2022.
This year, refiners and importers are required to blend 13.8 billion
gallons of ethanol, up from 13.2 billion last year. For 2014, the figure
is 14.4 billion.
But the estimates Congress used about how much gas Americans would keep
buying were wrong. When the biofuel credits were created, gasoline
consumption was projected to grow 6 percent by 2013. But thanks in large
part to the recession and more fuel-efficient cars, consumption has
actually fallen.
As a result, refiners this year began hitting what is known as “the
blend wall,” meaning that the amount of ethanol the government is
requiring them to use is close to the maximum amount that can be blended
into gasoline without creating problems for gas stations and motorists.
Distributing gasoline with greater levels of ethanol is more costly and
corrodes gas station pumps and tanks. Raising the ethanol level in
gasoline, therefore, would require gas stations across America to
install new systems. Therefore, refiners have turned to RINs to meet
their government obligations rather than blend more ethanol into
gasoline.
Some say financial players saw it coming, and jumped into the market.
“When you see something change as rapidly as this, somebody’s hoarding
them, somebody’s buying them, somebody’s making big bucks,” said Senator
Thomas A. Coburn, Republican of Oklahoma, a big oil state. After his
staff examined the run-up in prices this summer, he said he was
concerned that “big moneyed interests” were gaming the credits.
For now, companies like Valero say that they are eating the cost of high
RIN prices, which are still eight times more expensive than they were
in January. But industry analysts, executives and even researchers at
the investment banks predict the cost of the RINs’ surge will be passed
along to consumers by increasing the price of gasoline, if not later
this year then next year.
Mr. O’Malley, the chairman of PBF Energy, likens the outcome to a hidden
tax on the public. Unlike other taxes, which go to the government, this
one goes to the speculators.
Double-Dipping on Credits
Every day, RINs are born in places like Fort Lauderdale, Fla.,
Chesapeake, Va., and Bainbridge, Ga. Across a network of 45 fuel
terminals in the Southeast, and along the Mississippi and Ohio rivers,
Morgan Stanley’s TransMontaigne stores, blends and distributes gasoline
and other fuels.
Even though it is based in Denver, TransMontaigne sits at the center of a
powerful Wall Street energy operation. It delivers 200,000 barrels of
refined petroleum products each day, just under 2.5 percent of the total
market, and plays a role in the RINs market in addition to any trading
its parent, Morgan Stanley, might do. Morgan Stanley bought
TransMontaigne in 2006.
For banks, trading RINs for clients can be lucrative. A big reason is
that the credits are far more difficult to buy and sell because they are
not traded on exchanges like stocks. As a result, the difference
between the price at which one party is willing to sell and another is
willing to buy is unusually wide. Those fat spreads mean big money for
anyone serving as a middleman.
At a hearing in late July at the Commodity Futures Trading Commission,
Mr. Mixon, the commission’s acting chief economist, estimated that RIN
spreads were 4 percent of a transaction’s value. That is far more than
the average stock commission.
Edward Westlake, an analyst at Credit Suisse, said many big financial
firms have gone beyond RINs trading and pushed into blending fuel to
create them as well. “Building a tank and blending doesn’t cost a lot of
money,” Mr. Westlake said, “and there are folks on Wall Street who own
tanks who are benefiting from the RINs.”
Bank research departments are also trying to pique investor interest in
this market. Goldman Sachs and Bank of America Merrill Lynch recently
published bullish reports on the market. In July, Morgan Stanley
published a report predicting that RIN prices would keep rising —
Officials at the E.P.A. do not see excessive influence by financial
speculators. They suggest the price spikes in RINs this year reflect the
expectation of a shortage of the credits because rising renewable fuel
mandates are occurring as consumer demand for gasoline is falling. “The
market is expecting this future scarcity as the statutory mandates
continue to increase,” Mr. Grundler said.
Others say that prices are up mostly because the oil industry has
refused to invest in renewable energy. For example, Jeremy Martin, a
clean energy expert for the Union of Concerned Scientists, said many of
the complaints about the credits come from industry players who want to
see the renewable fuels program killed.
“It was meant to change behavior, and it was understood that if it was
to be binding, RIN prices would not be close to zero,” Mr. Martin said.
In fact even before RINs took off, they had become a contentious issue
within the energy industry. Ethanol producers like the renewable fuel
standards because they essentially guarantee a market for their product.
But refiners — particularly those without operations to blend the fuel —
regard the standards as an onerous and unnecessary business cost.
The Impact at the Pump
Margo T. Oge, who oversaw the creation of the ethanol credit program at
the E.P.A., says that the rising price of RINs — no matter the cause —
is good news and an indication that the program’s goals are being met.
As the credits get more expensive, she says, oil and gas companies have a
financial incentive to add more ethanol to fuel rather than buy
credits. That, in turn, reduces oil imports and emissions — which was
the point of creating the system in the first place.
Ms. Oge, who retired from the E.P.A. last year and is now a visiting
scholar at the International Council on Clean Transportation, a research
group in Washington, said RINs were never supposed to affect the price
of gasoline at the pump. If that is the result of the price run-up this
year, as many energy analysts predict, it would be an unwelcome outcome,
she said. “The last thing we wanted in implementing this program is to get price increases for the consumer,” she said.
Even beyond the likely rise in gasoline prices, critics of the RINs
market say it is deeply flawed, and they do not share Ms. Oge’s
optimistic takeaway of this year’s market frenzy.
First, by allowing anyone to trade, including those with no real
interest in energy, the E.P.A. encouraged speculation,
the critics say.
Second, the market operates largely in the dark, leaving it vulnerable
to manipulation. Third, and perhaps most significant, the federal
requirement for ethanol in gasoline means oil companies are captive
buyers — meaning they are required to buy the credits when they do not
or cannot blend their own fuel — a fact that savvy traders use to their
advantage.
“The problem the E.P.A. had is they opened up the market on the trading
side, but restricted it on the obligated side to refiners and
importers,” said Lawrence J. Goldstein, the former president of the
Petroleum Industry Research Foundation, a nonprofit bipartisan group.
Analysts and others say the market is vulnerable to questionable
practices like short squeezes, where prices are pushed up by holders of
the credits to benefit their positions.
“Anybody who’s participating in these markets has the opportunity to
throw their weight around,” said David J. Hackett, president of
Stillwater Associates, a transportation energy consulting firm.
“Whether
it’s a hedge fund or a refiner or ethanol producer, they would tend to
drive the market in directions that are beneficial for whatever their
goals.”
An examination by The Times of participants registered with the E.P.A.
found several people with troubled pasts, including one who was accused
of helping run a Ponzi scheme, and another who pleaded guilty to illegal storage of hazardous waste.
The RINs market has come off the boil recently, but at 60 cents apiece
the credits still cost far more than they did at the beginning of the
year. While the E.P.A. says the market is sound, W. David Montgomery, an
economist at Nera Economic Consulting, a unit of Marsh & McLennan,
said the agency should install an overseer.
The E.P.A. disagrees, but said it was considering providing more data on
who trades and holds RINs and had instituted a voluntary certification
system for participants.
“We are exploring things like increasing the regularity of updating the
transactional data system and providing more information about
production volumes,” Mr. Grundler, the E.P.A. official, said. “All are
aimed at increasing confidence in this market and increasing compliance,
which is our major concern.”
But Tom Kloza, an analyst at the Oil Price Information Service, a
leading source of petroleum pricing, said the potential for abuse will
not disappear on its own.
“You could conceivably have a company in the middle holding millions of
RINs,” Mr. Kloza said.
“Any entity could have a 1, 2 or 5 percent market
share in RINs and is waiting to sell them at some explosive gain. I
wonder, who’s got the score card?”" via Junk Science
.
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