Landlocked U.S. oil refiners short on capacity to blend ethanol are bracing for a spike in costs, unable to export their way out of a sudden rise in the price of renewable energy credits needed to comply with government requirements.
CVR Energy Inc and HollyFrontier Corp, inland refiners with limited capacity to blend biofuels into the pipeline, are suffering from a jolt to investor confidence while stocks of their coastal peers continue a two-year upward march.
Along with some East Coast refiners like PBF Energy Inc , they are at the sharp end of the uneven distribution of pain resulting from a hundred-fold surge in the cost of ethanol credits.
Refiners are caught between the U.S. ethanol mandate, which requires ever-higher volumes of ethanol to be blended into the domestic gasoline pool, and the limited amount of the corn-based fuel that some cars can safely run.
To offset the difference, refiners must either export gasoline to markets not requiring the blend or buy up ethanol credits that can satisfy government requirements without forcing higher volumes of ethanol into gasoline.
The price of these credits, or Renewable Identification Numbers (RINs), has spiked to more than $1 in recent weeks from 1 cent in December due to concerns of a looming shortfall.
That price rise may prove a serious drag on the bottom line of CVR Energy, for example, whose refineries in Oklahoma and Kansas have neither easy access to foreign markets nor integrated systems to blend ethanol into gasoline themselves.
"If you are in the middle of the country with no access to waterborne markets, and don't own any blending component of the value chain, it could be a disadvantage," said John Williams, investment analyst at T. Rowe Price in Baltimore, Maryland.
The ethanol mandate was conceived during the administration of President George W. Bush, when domestic gasoline demand was projected to grow steadily, increasing the need for foreign oil.
Since then, however, the U.S. shale boom has seen domestic production boom, while gasoline demand has been in decline.
Refiners are therefore obliged to blend more ethanol into a smaller gasoline pool. Older cars face possible engine damage if fuel contains more than 10 percent ethanol, creating a "blend wall" that refiners are loath to exceed for fear of incurring liabilities.
The ethanol requirement is set to grow every year until 2022. Many oil companies have complained about the mandate, and warned that more costly RINs will drive up prices at the pump.
"This failed federal program is already costing consumers and taxpayers dearly," said Tina Barbee, spokeswoman for Tesoro Corp, the largest independent refiner on the West Coast.
West Coast refiners are better placed to export than their East Coast peers, which typically refine imported oil. Tesoro's strong retail presence has also helped shield it from higher RIN costs, said Raymond James & Associates analyst Stacey Hudson.
"(East Coast refiner) PBF, on the other hand, does not have a retail presence and that could be seen as a disadvantage for generating RINs," she said. "If you produce more fuel for domestic consumption than you blend, you will be short on RINs."
PBF declined to comment.
Its shares have fallen 11 percent in the past month. Tesoro's stock has fallen less - 3 percent - but is still underperforming shares in companies with refineries on the Gulf Coast, which export more gasoline.
The Thomson Reuters U.S. Oil & Gas Refining and Marketing index, which includes shares of almost all U.S. refining companies, has risen 28 percent over the past two years as cheap shale crude has propped up margins.
Refiners in the U.S. heartland have seen the benefits of easy access to rising volumes of relatively cheap domestic crude. But CVR and HollyFrontier have started to buck this trend; both stocks are down 10 percent in the last month.
Macquarie Research cut its ratings last month on both companies. RIN pricing, it said, was a big enough issue to warrant longer-term concerns.
"The refiner stocks have performed exceptionally well for two years running, thus we recommend taking profits on those with the greatest RIN risks," Macquarie analysts said in a note.
Refiners with blending facilities to help offset RINs risk, or which can export more gasoline, are seen as better protected. Marathon Petroleum Corp's stock has risen 6 percent and Phillips 66 is up 9 percent in the last month.
"They have a natural hedge through that (blending), and they also have access to export markets through their Gulf Coast operations," said Williams, whose firm owns Phillips 66 shares.
Though the company has not explicitly linked its expansion to RINs, Phillips 66, the refining company spun out from ConocoPhillips, has said it will have the infrastructure needed to raise exports by about 40 percent within three years.
Leading independent refiner Valero Energy Corp -- also in the T. Rowe Price portfolio -- says it expects its RIN-related costs to jump to as much as $750 million this year from $250 million in 2012.
Unlike CVR and HollyFrontier, Valero has the option of raising exports from its Gulf Coast refineries. But the company is also a significant spot seller of unblended gasoline in the United States; its stock is down 7 percent in the last month.
Macquarie said the large volumes of unblended gasoline in the company's Gulf Coast system, which it estimated at 2.2 billion to 2.3 billion gallons in fiscal 2013-14, threatened to overshadow its exports.
Further inland, meanwhile, CVR Energy is limited in what it can export. The company, controlled by billionaire investor Carl Icahn, said in a regulatory filing last month that its RIN costs were likely to be "material".
"There's no way that the RINs cost will not get passed on," Chief Executive Jack Lipinski said on a post-earnings conference call. "Eventually somebody has to pay it."
At $1 per gallon, RIN credits adds 10 cents per gallon to gasoline prices, which cost about $3.68 per gallon on an average for March, compared with $3.39 in January, according to the U.S. Energy Administration.
Ultimately, much is likely to depend on how successful those refiners short on RINs will be in passing on costs to consumers. Valero spokesman Bill Day said: "We expect to see prices of gasoline go up across the country."
Bradley Olsen, analyst at investment bank Tudor Pickering & Co, said comparatively high gasoline prices on the East Coast were at least helping refiners there to balance their RIN costs.
"The U.S. market still needs close to 9 million barrels a day of gasoline. The short-term solution is to export to avoid the RIN obligation but, ultimately, increased exports reduce the supply domestically," he said.
"You are going to see prices rally."