An uptick in recent federal enforcement actions involving renewable fuel credits is signaling that market participants can expect more fraud investigations and prosecutions as federal regulators strive to maintain control over the renewable fuel credit program. The enforcement actions involve the trading of Renewable Identification Numbers (RINs) under the Renewable Fuels Standard (RFS) program.

The RFS program was originally enacted under the Energy Policy Act of 2005 and expanded under the Energy Independence and Security Act of 2007. The RFS program is market-based and mandates certain levels of biofuels that must be blended into gasoline. Under the RFS, RINs are generated when a discreet volume of renewable fuel is manufactured in the United States. A RIN is attached to the volume of renewable fuel produced but may be “separated” from the fuel once the fuel has been blended with fossil fuels to produce gasoline. The separated RIN may then be traded to refiners and importers of gasoline and diesel to allow them to meet their Renewable Volume Obligation (RVO).

Starting in 2011, the Environmental Protection Agency (EPA) launched a series of investigations into fraudulent RIN transactions. The EPA prosecuted millions of dollars’ worth of fraudulent RIN transactions after finding that so-called producers of renewable fuels had not actually produced the amount of renewable fuel claimed in RIN transactions. As a result, EPA sought to address the potential for fraudulent RIN transactions by requiring third-party verification of the generation of RINs. The EPA later enacted a Quality Assurance Program (QAP) under which third-party auditors evaluate producers of renewable fuel to certify they were in fact producing the required product in compliance with RFS regulations.

Despite the QAP, fraudulent RIN transactions continue to be a concern both for federal regulators and market participants. On October 12, 2016, the co-owners of two biofuels processing plants in Waterloo, Ind., pleaded guilty to conspiracy, fraud and false statements in connection with a scheme that generated more than $60 million in fraudulent tax credits and renewable fuel credits (see United States v. Witmer, N.D. Ind., No. 16-CR-64). The co-owners of Triton Energy LLC and Gen2 Renewable Diesel LLC admitted in a plea agreement that they claimed tax and RIN credits for fuel sales that didn’t qualify for either. The credits can only be claimed when renewable fuel is sold for domestic transportation purposes. One of the co-owners admitted that he sold the two plants’ fuels for uses that included production of fire starter logs and power generation.

On October 4, 2016, the EPA and Department of Justice (DOJ) announced a settlement with Iowa-based Western Dubuque Biodiesel, LLC, resolving allegations that the company entered into a series of transactions in 2011 that resulted in the generation of more than 36 million invalid renewable fuel credits. Western Dubuque owns and operates a 30 million gallon biodiesel plant in Farley, Iowa. EPA alleged that another company, NGL Crude Logistics, LLC purchased RINs from other companies, separated and sold the RINs to third parties, and then sold the biodiesel to Western Dubuque as a methyl ester feedstock, a component of biodiesel. According to the EPA, Western Dubuque then reprocessed the feedstock, classified it as biodiesel and generated a second set of RINs for the reprocessed fuel which it then sold along with the RINs back to NGL. The EPA alleged that Western Dubuque violated a number of other RFS requirements because the RINs generated were not produced using a qualifying feedstock or process. The company agreed to pay a civil penalty of $6 million.

These and other recent multi-million dollar fraudulent RIN cases raise new questions about the ability of officials at the EPA, DOJ and the Internal Revenue Service (IRS) to maintain control over the markets for renewable fuel credits. In a white paper published last month, Doug Parker, the former director of EPA’s Criminal Investigation Division (CID) who led EPA’s efforts to investigate fraudulent RIN transactions, called into question the ability of the existing RFS program to guard against fraud in the renewable fuel credit market. According to Parker, the complex structure of the RINs market combined with limited federal enforcement resources and an expanding market have created incentives for fraudulent conduct. Parker noted that the RINs market has increased from less than $1 billion in 2010 to around $5 billion today. At the same time, the complex structure of the RINs market has created an extended chain of custody for RINs from the point where renewable fuel is created, though the point where it is blended, and extending to petroleum refiners and importers, the obligated parties ultimately responsible for RVO compliance.

“This extended chain of responsibility mandates that obligated parties, refiners and importers (that have essentially no influence on the purchase and blending of renewable fuel) make large-scale, and often unverifiable, purchases of these credits to meet their regulatory mandates. In practical terms, those with no leverage to influence the blending of renewable fuel or to ensure its validity, are required to purchase vast quantities of RINs from entities who bear no responsibility to ensure the validity of the product and can profit from the process by separating RINs for later sale at the blending point,” Parker said in the white paper.

In March of this year, the EPA and the Commodity Futures Trading Commissions (CFTC) entered into a Memorandum of Understanding under which the CFTC will advise EPA on conducting investigations into fraudulent RIN transactions, which some take as tantamount to an EPA admission that it doesn’t have the resources to exercise proper oversight over the RINs market.

Parker is calling for a number of changes to the RFS program to shore up the RINs market. First,Parker believes that the regulatory obligation should be moved from petroleum refiners and importers to those parties who actually blend renewable fuel with convention fuel and thus would be in the best position to conduct due diligence as to the validity of RINs created and maintained. “Altering the RFS regulations – so that the obligated party moves from refiners and importers to those making decisions on who to purchase and blend fuel from – will much better align risk and incentivize due diligence at the appropriate points across the renewable fuels sectors.” Parker said. Second, the federal government should add resources – analysts, enforcement attorneys, inspectors, special agents – to investigate and prosecute fraud in the RINs market. Lastly, according to Parker, moving the point of obligation to blenders would substantially reduce the size of the RINs market, which would in turn provide a smaller playing field for those seeking to conduct fraudulent RIN transactions.

In the meantime, petroleum refiners and importers –currently the obligated parties under the RFS program – remain stuck in a difficult position when conducting due diligence on the RINs they purchase to satisfy their RVOs. Often, it can be difficult or nearly impossible to confirm the validity of RINs purchased on the market. As Parker noted in his white paper, “it is nearly impossible for the currently designated obligated parties to conduct appropriate oversight, and they simply do not have the investigative expertise or leverage to conduct such oversight based on where they sit in the production chain.”

Nevertheless, until changes are made to the RFS program, RIN purchasers should take whatever measures possible to protect against buying invalid RINs. Such measures should include conducting robust due diligence – when possible – on the renewable fuel producers who generated the RINs being purchased. Petroleum refiners and importers should also ensure that they have strong contractual protections addressing any liability that may arise as a result of being sold fraudulent RINs. Lastly, refiners and importers should consider implementing an audit program to evaluate compliance with RFS requirements, including the use of third-party auditors to verify RINs pursuant to EPA’s QAP. Under the QAP, RIN purchasers have an affirmative defense to civil liability for the transfer and use of invalid RINs that were verified by an independent auditor as properly generated and valid under an audit program that meets the minimum standards of the QAP. Obligated parties may also want to consider taking steps to prepare for potential government investigations of their RIN transactions in light of the recent spate of enforcement actions.