REFILE-REPEAT-Surging ethanol credits bring little joy to Wall Street

Thu Nov 7, 2013 12:05pm EST

By Cezary Podkul

NEW YORK Nov 7 (Reuters) - As the tiny niche market for ethanol credits turned into this year's hottest commodity, the spike in prices didn't do much for the so-called Wall Street refiners.

The biggest commodity traders in the financial world have either steered clear of the opaque market for the credits or ended up on the wrong side of a rally that saw prices surge as much as 2,900 percent in recent months, according to other market participants and bank officials.

Despite attracting public scrutiny over their role trading the renewable identification numbers (RINs) that were blamed this summer for adding extra pennies to U.S. gasoline prices, the banks have mostly played only a small part in the market, the sources said.

Morgan Stanley Inc, the biggest physical gasoline and diesel trader on Wall Street due to its import and terminal business, has ended up short of the credits this year, forcing it to buy extra to meet its obligations, a spokesman said.

JPMorgan Chase & Co needs to collect the credits to cover a small gasoline-component blending contract in Texas. It is also responsible for making up any shortfall in RINs at a large Philadelphia refinery as part of a supply deal.

Goldman Sachs Inc, which is not a major oil products trader, doesn't trade the credits at all, according to sources familiar with the matter.

The banks' limited engagement with a seemingly attractive market highlights the pullback in riskier dealing because of new U.S. regulations. It also shows wariness on Wall Street of anything that may draw further scrutiny from Washington, where banks have been blamed for spikes in food or fuel prices.

In recent months, members of the House and Senate have called on U.S. derivatives regulators to look into potential manipulation of the market for the credits. And refiners have pegged high gasoline prices to the surging price of the credits, which they say have added nearly $2 billion to their costs this year.

Federal rules require refiners and importers of fuel products to collect RINs to show compliance with a 2007 law mandating the blending of biofuels like ethanol into the nation's gasoline supply. The 38-digit number tracks each gallon of biofuel from the factory to the gas tank. If a refiner doesn't buy and blend enough ethanol, the company must buy RIN credits in the open market to make up the shortfall.

To gauge the banks' foothold in the RIN market, Reuters analyzed gasoline import data, refinery contracts and compliance data, and interviewed traders active in the market. None of the three banks own refineries, and with the exception of Morgan Stanley - a sizeable importer and blender of gasoline - none have had much of a reason to be active players in the market.

EPA rules allow anyone to register to buy RINs purely for speculative purposes, not for compliance. Some proprietary traders, such as Chicago-based DRW Trading, show up on a compliance registry kept by the U.S. Environmental Protection Agency. A spokesman for DRW would neither confirm nor deny that it is still active in the market.

But outfits that have done the best trading in credits have had a reason to be actively involved in the market.

Oil major BP Plc said it found itself with credits to spare and traded them for a profit earlier in the year. Swiss trading house Vitol SA, a major gasoline importer, is also said to have done well trading the credits, which spiked from about 5 cents in December to almost $1.45 in mid-July. They traded for about 30 cents each on Wednesday.

MORGAN'S TERMINALS

Traders say Morgan Stanley has been a regular participant in the RIN market this year. The firm owns a fuel marketing subsidiary, Denver-based TransMontaigne Inc, which can blend ethanol and gasoline together at five or more terminals. That gives Morgan Stanley a steady supply of the credits.

However, Morgan Stanley is also a heavy importer of gasoline, data from the U.S. Energy Information Administration (EIA) show. The bank has imported more than one billion gallons of gasoline in each of the last three years and is on target to come close to that amount in 2013, according to the data. That puts Morgan on the hook to collect at least 100 million RIN credits a year to show compliance with the 2007 fuel blending law.

Until June, Morgan Stanley also managed supply and gasoline marketing for a large East Coast refiner, PBF Energy. Morgan Stanley blended gasoline from two of PBF's refineries with ethanol for resale. Morgan Stanley said it passed all RINs it collected from the wholesaling of gasoline at PBF's terminals back to PBF. For the gasoline bought in bulk and sold in bulk it collected no RINs.

Asked about its net position last month, a spokesman for Morgan Stanley said the bank has come up short of the credits this year and has been in the market buying more to satisfy its compliance obligations.

As a result, "Morgan Stanley has not benefited from the increase in price," the spokesman said.

GOLDMAN'S HANDS-OFF APPROACH

Rival bank Goldman Sachs says it has not bought the credits at all, either for its own book or for clients.

In July, the bank took over the PBF contract formerly run by Morgan Stanley and has similar arrangements in place with four refineries run by Dallas-based Alon USA Energy Inc. A Goldman spokesman said the bank is not obliged to collect RINs as part of the contracts or to cover PBF or Alon in case the refiners fall short on their obligations.

The EPA compliance database also shows 31 fuel blending and other facilities registered in the name of Goldman's commodities trading arm, J. Aron & Co. Goldman said it has not used the facilities since at least 2008, when it became a bank holding company in the midst of the financial crisis.

Nor does J. Aron import any gasoline, EIA data show, which leaves it free of the compliance obligations Morgan Stanley faces because of its hefty import tab.

JPMORGAN'S CUSTODIAL ACCOUNT

JPMorgan also appears to have little in the way of physical gasoline import activities that would give it a meaningful role in the RIN markets.

The last time the bank imported gasoline was in 2012, when it brought about 22 million gallons into the United States, versus about 8 million in 2011, EIA data show.

The bank does have a contract to blend gasoline components into finished gasoline at a terminal near Houston, according to people familiar with the matter. Similar to a refiner that manufactures finished fuel products, the gasoline blending forces JPMorgan to collect RIN credits to show compliance with the EPA's biofuel blending rules.

It is not known how many credits that is. JPMorgan spokesman Brian Marchiony said the bank's ethanol RIN inventory was less than 0.001 percent of an estimated 14 billion market for the credits, which means it would need to collect less than 14 million RINs.

In September, the New York Times reported that the bank had stockpiled the credits ahead of their spike in prices. Marchiony said in response to the article that "we simply do not trade RINs, nor do we carry an inventory other than a marginal amount for compliance purposes."

JPMorgan does, however, finance the oil supply for a large U.S. refiner, Philadelphia Energy Solutions. The bank buys the oil for the company's 350,000 barrels-per-day Philadelphia plants and gets repaid by selling the gasoline output - an "activity we could not survive without," PES Chief Executive Philip Rinaldi previously told Reuters.

JPMorgan bought RINs for PES for several weeks in September and October of 2012 when it first picked up the refinery contract, according to a person familiar with the bank. Since then the refinery has managed its own RIN purchases.

As part of its arrangement with the refinery, JPMorgan acts as a custodian for the RIN credits. That means the bank oversees the purchases to make sure PES doesn't fall short of its obligations, according to the source.

Were it to do so, JPMorgan would have to make up the difference.

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