On May 29, 2015, the US Environmental Protection Agency (“EPA” or the “Agency”) released its long-awaited roadmap for cleaning up the regulatory mess that has characterized the Agency’s Renewable Fuel Standard (“RFS”) over the past several years and for setting a course for the immediate future of the program.  The roadmap takes the form of a proposed rule (the “Proposed Rule”) that proposes, among other things, (i) a compliance obligation for the already-completed 2014 compliance year (based only on actual production); (ii) new targets for use of renewable fuels in the US transportation fuel supply in 2015 and 2016, including nested targets for biomass-based diesel production; and, finally, (iii) a biomass-based diesel target for 2017. 

As with all prior EPA action on this program, the Proposed Rule is likely to draw criticism and potential legal challenge from many of the program’s key stakeholders.  Nevertheless, the proposal represents a clear attempt by the Agency to move forward with the RFS.  The Proposed Rule acknowledges that recent regulatory delays have created uncertainty in the market, but firmly reasserts the power of the RFS standards to drive growth in the market for renewable fuels, even despite current, perceived infrastructural constraints, e.g. the ethanol “blendwall”, which the Agency now characterizes as temporary limitations that Congress intended the statutory mandates of the RFS program to help overcome.

Background

The current RFS program was mandated by Congress under the Energy Independence and Security Act of 2007 (“EISA”) and initiated by EPA in 2010.  Under EISA, Congress established specific, annual volumes for required renewable fuel use by obligated parties (transportation fuel producers) out to 2022.  The statute requires EPA to translate these volumes into annual percentage standards, but also provides EPA with waiver authorities to reduce the volumes of renewable fuel required to be used in a given year in certain specific circumstances.

Compliance with the program is generally demonstrated on an annual basis through retirement of Renewable Identification Numbers (“RINs”)1 by obligated parties. However, the program has been in regulatory limbo since 2014, when the Agency delayed the compliance obligation for the 2013 program year because it had not yet finalized standards for 2014.  EPA stated at the time that obligated parties, preparing to retire a quantity of RINs to comply with the program for the prior year, must have an understanding of their RFS obligations for the next compliance year.2  Now, in mid-2015, EPA still has yet to finalize 2014 standards and thus has not yet required obligated parties to demonstrate compliance for 2013. 

Among other things, the long delay in issuing standards for 2014 has been caused by two separate, but related challenges to RFS implementation.  First, slow development of advanced, cellulosic fuels, which Congress intended to have an increasing—and in later years of the program, dominant—role in the country’s renewable fuel mix, has caused actual production of cellulosic fuels to lag well behind EISA targets.  Second, there is increasing pressure on EPA from obligated parties to address perceived constraints imposed on the renewable fuel market by the E10 ethanol “blendwall”.3 Obligated parties have argued, and EPA largely agrees, that these issues are creating an increasing gap between the amount of renewable fuel that can be produced (in the case of cellulosics) and used (in the case of conventional and advanced ethanol fuels) in the US market, on the one hand, and the statutory RFS targets, on the other.

It was in this context that EPA initially proposed standards for the 2014 RFS compliance year in November of 2013 (the “Initial Proposal”).  The Initial Proposal generated over 340,000 public comments and was criticized by obligated parties and renewable fuel producers alike.  The latter category of stakeholders, in particular, took issue with (i) the Agency’s characterization of the ethanol blendwall as a constraint on the “supply” of renewable fuels—a key designation for use of the Agency’s general waiver authority under EISA to reduce the statutory volumes—as well as its broad use of the cellulosic waiver authority; and (ii) the Agency’s perceived failure to account for the ability of the RFS standards themselves to drive new production of renewable fuels.

Key Takeaways from the Proposed Rule

Proposed Standards Based on “Maximum Achievable Volumes”

In the Proposed Rule, which retracts and replaces the Initial Proposal in its entirety, EPA has dug in its heels on its waiver authorities, but fundamentally shifted course from the Initial Proposal on the role of the standards to drive new production.  EPA now states that Congress intended the RFS to provide appropriate incentives to overcome infrastructural and other market constraints like the ethanol blendwall.  While EPA continues to interpret infrastructural/market constraints on ethanol consumption as a “supply” issue for purposes of the EISA waiver authorities (and has used these authorities to propose reductions from the statutory volumes), the Agency believes that the “ambitious” standards it has proposed will nonetheless require the market to begin to overcome these challenges.  EPA goes as far as to acknowledge that its standard-setting approach in the Initial Proposal was “more suited to taking a neutral aim at accuracy of supply, rather than estimating the maximum volumes that can be achieved from a responsive market as implicitly required by the statute.”  

It is clear EPA believes the standards in the Proposed Rule will be technology forcing to a degree and will, for example, require ethanol use at levels “significantly beyond the level of the E10 blendwall or significantly greater use of non-ethanol renewable fuels than has occurred to date.”  EPA describes the new proposed standards as equivalent to the “maximum” volumes that the market can achieve during the relevant compliance periods, factoring in the technology forcing effects of ambitious RFS standards. 

Waiver Authorities

While EPA believes its proposed volumetric standards represent the maximum potential of the market, it also concedes that its calculation of this potential, even after factoring in the impact of its “ambitious” RFS targets, remains well below the volumes required by EISA.  As such, the Proposed Rule also includes an extended explanation and defense of the Agency’s interpretation of its authority to reduce the statutory volumes for the relevant program years.

General Waiver Authority.  Under its statutory “general waiver” authority, EPA may waive the annual EISA volumes in whole or in part based on a determination by the Agency that (i) implementation of the requirements would severely harm the economy or the environment; or (ii) there is an inadequate domestic supply.  As in the Initial Proposal, EPA argues that the E10 ethanol blendwall, described as a constraint on the amount of ethanol the market is able to consume, can be characterized as an “inadequate domestic supply” issue, such that the Agency is justified in using its general waiver authority to reduce the statutory volumes to give the market more time to overcome this apparent constraint. 

In prior rulemakings, program stakeholders have argued that the term “inadequate domestic supply” should be read to encompass production limitations only and not market limitations on distribution or consumption.  These stakeholders point to several other fuel-related waiver provisions of the Clean Air Act (“CAA” or the “Act”) where Congress included express references not only to inadequate “domestic supply”, but also to inadequate “distribution capacity”. There is evidence even that earlier versions of the general waiver provision in EISA contained the supplementary reference to “distribution capacity”, but Congress removed this language before the provision was enacted.  For its part, EPA points to yet another fuel-related waiver provision in the Act that distinguishes between “capacity to produce” and “capacity to supply”.  In EPA’s view, this distinction in another section of the CAA suggests that the concept of fuel supply can be understood to refer to something broader than fuel production alone.

Ultimately, EPA argues in the Proposed Rule, as it has in prior rulemakings, that the RFS general waiver provision is ambiguous on this point and therefore the Agency can reasonably interpret the reference to “inadequate domestic supply” to encompass both inadequate production and inadequate distribution capacity.  As such, EPA believes that the ethanol blendwall (or what it describes as the legal, infrastructural and market constraints on increased consumption of ethanol) provide a valid basis for reduction of the statutory volumes using the general waiver. 

Cellulosic Waiver Authority.  Separate from the general waiver authority, EPA’s statutory “cellulosic waiver” authority provides that if the volume of cellulosic biofuel projected to be produced during an RFS program year is less than the volume mandated by statute, EPA must reduce the cellulosic mandate to match the projected volume.  In the event of such a reduction, EPA “may also reduce the applicable volume of renewable fuel and advanced biofuels” required for that year “by the same or a lesser amount” (referred to here as a “corresponding waiver”).  EPA has used the cellulosic authority to waive entirely or to significantly reduce the mandated volume of cellulosic fuel in the RFS in every program year to date. Now, for the first time, in both the Initial Proposal and the Proposed Rule, EPA has proposed to use its corresponding waiver authority to make related reductions to the two broader fuel categories (advanced biofuels and total renewable fuels). 

EPA’s articulation of its authority to make a corresponding waiver in the Initial Proposal was extremely broad.  EPA stated that the statute does not provide “any explicit criteria that must be met or factors that must be considered when making a determination as to whether and to what degree” the Agency may make a corresponding waiver.  In the interim between the Initial Proposal and the Proposed Rule, the DC Circuit appeared to agree with this interpretation in litigation related to the 2013 RFS standards, stating that in the absence of an “express or implied statutory directive to consider particular factors, EPA reasonably concluded that it enjoys broad discretion” regarding when to exercise its corresponding waiver authority.  Monroe v. EPA, 750 F.3d 909, 915 (DC Cir. 2014). 

Importantly, the holding in Monroe concerned action by EPA to maintain the other statutory volumes despite a reduction in the cellulosic volume, i.e. the court was upholding EPA’s decision not to exercise its corresponding waiver authority.  The Monroe court found that EPA’s decision to maintain the volumes was not arbitrary because the action served the statutory purpose of “ensur[ing]” that U.S. transportation fuel “contains at least the applicable volume[s]” prescribed in the statute.  Id., at 917.  Thus, despite the court’s suggestion that there is no “implied statutory directive” the Agency must consider when it exercises the corresponding waiver authority, the court may read the scope of EPA’s authority in this provision more narrowly if the Monroe fact pattern is reversed.

Perhaps in recognition of the link between the corresponding waiver authority and the broader goals of the statute, EPA has proposed a slightly narrower interpretation of its waiver authority in the Proposed Rule.  EPA now proposes to base its exercise of the corresponding waiver authority on the same general considerations it uses to justify its use of the general waiver authority: availability of renewable fuel and the legal and practical constraints on their supply to vehicles and other qualifying uses.4  For purposes of the Proposed Rule, EPA believes these considerations justify a corresponding waiver of the statutory volumes for advanced biofuels and total renewable fuels, again, based on the legal, infrastructural and market constraints on increased consumption of ethanol.

Legality of Retroactive Action

For many market participants, there is reasonable confusion about how the Agency can propose standards in mid-2015 that are binding with respect to the 2014 compliance year, as well as the first half of the 2015 compliance year.  However, a relatively clear body of case law has developed in the DC Circuit that indicates EPA can take action on the RFS standards after the statutory deadlines and can do so with retroactive effect as long as the Agency’s action is reasonable and balances competing concerns. 

In this case, in an effort to propose a retroactive standard for 2014 that is reasonable and balances competing concerns, EPA has simply set the 2014 standard based on actual production and use during that compliance year.5

In pre-emptive response to arguments that EPA inaction alone—rather than inadequate domestic supply—has led to a de facto waiver of the statutory volumes, EPA argues that several factors other than the weak market signal created by the Initial Proposal and the Agency’s failure to finalize any standards at all before the end of that year were responsible for the failure of the market to meet the statutory volumes in 2014.  Specifically, EPA believes “insufficient production and import of non-ethanol renewable fuels, and constraints on the supply of ethanol to vehicles that can consume it” were responsible for the gap between actual production and the EISA targets for 2014. 

EPA has also proposed alternative compliance deadlines that are intended to provide obligated parties a reasonable amount of time to comply with both the 2013 standards (based on what the regulated community now knows about the 2014 compliance period and beyond), as well as the standards proposed in the Proposed Rule. A summary of the key dates under the Proposed Rule, including the proposed compliance deadlines is included at the end of this Client Alert.

Proposed Standards By Year

2014

EPA acknowledges that, at this point, the Proposed Rule can have no “real world impact” on renewable fuel use in 2014.  As such, as mentioned above, EPA has proposed RFS standards for the 2014 compliance year that match the volumes of renewable fuel that were actually produced and used as transportation fuel during that year.

Table 1.  Proposed Standards for 2014 (in billions of gallons, except as noted)

Click here to view table.

In calculating the number of RINs available to the market in 2014, EPA decided not to factor in the availability of RINs carried over from prior compliance years.  While EPA acknowledges that it will not have a complete understanding of the number of “carryover” RINs currently available in the market until it reviews the compliance reports submitted for 2013, it estimates that up to 1.8 billion carryover RINs may be available for compliance with the 2014 standards.  The role of carryover RINs in the market over the next several years is likely to be a key issue in public comments on the Proposed Rule.

2015

Given the timing of the release of the Proposed Rule (in the middle of 2015), EPA’s proposed standards for the 2015 compliance period are intended to represent a hybrid of the actual production approach (used to set the retroactive 2014 standards) and the “maximum achievable volume” approach  (used to set the 2016 standards).

Table 2.  Proposed Standards for 2015 (in billions of gallons, except as noted)

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EPA acknowledges that the proposed volume for advanced biofuel in 2015 represents a “substantial reduction” from the statutory target.  The Agency believes a reduction from the statutory target is necessary given the “limitations on production and import capabilities and constraints imposed by the ability of vehicles and engines to use renewable fuels, particularly ethanol,” but notes that the 220 million gallon increased required by the Proposed Rule from 2014 to 2015 would require the market to supply “more advanced biofuel than would be expected absent the RFS program, and to do so in substantially less than a full calendar year.”

2016

If the proposed 2016 standards are finalized by November 30 of this year, as EPA anticipates, they would be the first annual RFS standards finalized in accordance with the statutory deadlines since the start of the program.  EPA expects the full statutory lead time will afford market participants greater opportunity to prepare for and respond to the standards and therefore the increase in the proposed standards is more pronounced in 2015.  For example, the increase in advanced biofuels in 2016 is more than double the increase in this fuel category from 2014 to 2015.

Table 3.  Proposed Standards for 2016 (in billions of gallons, except as noted)

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Because the 2014 and 2015 standards are limited by their inability to impact market behavior in the past—a fact that EPA acknowledges and takes into account in the proposed volumes for these years—the 2016 standards are the first real example of what EPA considers to be a “maximum achievable volume” for the market.  Debate on the Proposed Rule will likely focus on whether stakeholders believe the numbers above represent the amount of fuel the market can actually produce and consume after factoring in (theoretically maximized) RFS incentives.  For its part, EPA believes that the 2016 standards will necessarily drive changes in production and consumption infrastructure for renewable fuels, but these changes will not occur fast enough for the market to attain volumes larger than the Agency proposing for 2016. 

Biomass-Based Diesel Numbers Increase, but Emphasis Remains on Competition

Although biomass-based diesel (“BBD”) production contributes to both the broader advanced biofuel and total renewable fuel categories, EISA requires a separate, specific annual standard for BBD.  However, because the statute does not provide a specific volumetric mandate for biomass-based diesel after 2012, but only specifies at least 1 billion gallons of biomass-based diesel must be used  on an annual basis, EPA must decide what portion of the annual advanced biofuel pool should be dedicated to BBD each year.6

EPA’s proposed 2014 standard for biomass-based diesel in the Initial Proposal (1.28 billion gallons) met with significant criticism from the US biodiesel industry, an industry that EPA acknowledges has more than 3.6 billion gallons of production capacity.  Despite the weak market signal from the Initial Proposal and EPA’s failure to finalize any numbers for 2014 during the compliance period, the amount of BBD produced and imported in the US in 2014 still exceeded EPA’s initially proposed target by nearly 4 million gallons. In the Proposed Rule, EPA has tried to credit this increase for 2014 by proposing a target equivalent to actual production and use. Although the 2014 target is notionally based on actual production, proponents of the program will likely argue that the large store of carryover RINs available in the market could mean that many of the RINs generated from 2014 production will not actually be used to meet the standard for that compliance period, but will be banked for use in future years.  In this case, EPA’s stated intent to credit to actual production during 2014 could be undercut somewhat.  The Agency nonetheless believes it is important to leave the entire current store of carryover RINs in the market to create greater “compliance flexibility” over the next several years of the program.   

EPA has also proposed modest incremental increases from the 2014 biomass-based diesel volume in 2015 and 2016.

EPA’s explanation of why it has not proposed higher BBD targets despite the acknowledged production capacity of the industry is that it wants to encourage competition among different types of advanced biofuels without dedicating the entire advanced biofuel category to BBD production.  In fact, EPA states that it believes that it is the advanced biofuel target that drives BBD production entirely, regardless of the specific nested target for BBD within advanced biofuels.

Finally, the statute requires the biomass-based diesel standard for a given year to be set 14 months in advance of the start of the relevant compliance period.  While this timing has never been achieved in practice, the stated intent of the Proposed Rule is to put the program back on its statutorily defined schedule.  To this end, EPA has also proposed a 2017 standard for biomass based diesel, 1.9 billion gallons, that it plans to finalize in November of this year. 

Conclusion

The Proposed Rule indicates EPA has emerged from its long period of delay and self-reflection on the RFS program re-convinced of the role of the EISA mandates and the RFS program to drive the renewable fuels market and to create incentives that allow renewable fuels to overcome existing market constraints.  The clearest articulation of this position is in the Agency’s declaratory statements at the end of almost every forward-looking section of the Proposed Rule stressing that EPA has proposed what it believes are the “maximum achievable” volumes for the market after factoring in the technology-forcing effects of the RFS.  Without question, however, renewable fuel producers will argue that the numbers proposed are still too conservative and obligated parties can be expected to argue that the numbers are unrealistic and unachievable. 

There are several important legal issues at the center of this debate, each of which relate to the extent of EPA’s authority to determine (separate from the annual volumes required by the statute) what constitutes the “maximum achievable” volumes for the market and the appropriate statutory bases for making this determination. 

These issues include:

  • the extent of EPA’s authority under the RFS waiver provisions;
  • EPA’s ability to retroactively reduce the statutory volumes;
  • the appropriate standard of review for EPA’s calculation of “maximum achievable” (in particular, where the calculated volumes are significantly lower than the EISA mandates);
  • the appropriate role of carryover RINs; and
  • EPA’s authority to encourage competition among different types of renewable fuels while also reducing the statutory targets.

These issues, among others are likely to be the subject of considerable public comment over the next two months, as well as litigation that could stretch well into the future compliance periods that the Proposed Rule seeks to regulate. 

All RFS market participants should consider filing comments on the Proposed Rule, as EPA final action on this rulemaking will shape the program for at least the next several years.

Schedule of Key Dates and Proposed Compliance Deadlines in the Proposed Rule

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