Increased use of renewable fuels is a core element of our country’s quest for energy independence and has also been used to incentivize private efforts to reduce greenhouse gas emissions. Now more than ten years old, the Renewable Fuel Standard (RFS) program has helped make ethanol made from sugarcane and compressed natural gas produced from sludge at municipal wastewater treatment facilities common household concepts. While the vast majority of renewable fuel producers are compliant, the program has suffered from high-profile cases of fraud and abuse requiring federal enforcement, including criminal prosecutions.
What is the RFS program and how does it work?
The RFS program was created under the Energy Policy Act of 2005 and expanded significantly by the Energy Independence and Security Act of 2007. Embedded in Title II of the Clean Air Act, the program requires the sale of an annual minimum volume of renewable fuels that increases over time, from 11 billion gallons in 2009 to 36 billion gallons by 2022, to replace or reduce the quantity of petroleum-based transportation fuel. As part of the Clean Air Act, the RFS program is administered by the U.S. Environmental Protection Agency (EPA) in consultation with the U.S. Department of Agriculture and the U.S. Department of Energy.
The program contains what are called “nested” volume requirements—providing specific volume targets for particular types of biofuel, beyond the corn ethanol that is the basis for the overall RFS volume requirement. Specifically, EPA establishes annual volume requirements for four types of biofuel (cellulosic biofuel, biomass-based diesel, advanced biofuel, and total renewable fuel). Each of these must achieve a reduction in lifecycle greenhouse gas emissions as compared to a 2005 petroleum baseline. The RFS requires renewable fuel producers and importers to generate and assign Renewable Identification Numbers (RINs) in proportion to the amount and type of renewable fuel produced or imported. RINs are credits used for compliance—the “currency” of the RFS program. RFS regulations also require gasoline refiners or importers to either blend renewable fuels into transportation fuel or obtain RINs (credits) by either purchasing renewable fuels with RINs attached or purchasing RINs on the open market. Supply and demand dictates the value of RINs. Some RINs are more valuable than others—for example, a RIN representing a gallon of cellulosic ethanol may sell for much more than a corn ethanol RIN. This logically creates incentives for the creation of higher-value RINs.
EPA monitors compliance by program participants through an online reporting system known as the EPA Moderated Transaction System. RIN transactions (“buying” and “selling”) are required to be reported to EPA through the EPA Moderated Transaction System. Subject to limited exceptions, in theory, the amount of renewable fuel produced in any given year should match (1) the amount of renewable fuel purchased, (2) the amount of RINs purchased or otherwise traded, or (3) a combination of the two.
The need for federal enforcement
Although the vast majority of program participants comply with EPA’s regulations, in recent years, EPA and the U.S. Department of Justice (DOJ) have pursued numerous enforcement actions against renewable fuel producers and importers that generated invalid RINs. For example, in fall 2016, EPA settled with Chemoil Corporation, one of the world’s leading retail energy companies. Chemoil exported about 48.5 million gallons of biodiesel from the United States in 2011–2013, without retiring the approximately 72.7 million biomass-based diesel RINs for that fuel. This created the opportunity for Chemoil to either sell the 72.7 million RINs outright (valued at more than $70 million) or produce a corresponding amount of renewable fuel for a second time, thereby increasing profits and violating the program’s requirement (that a RIN only be used once). Chemoil agreed to retire 72.7 million RINs and paid a $27 million civil penalty, the largest in the history of EPA’s fuel programs.
Also in 2016, a Texas man, Philip Rivkin, was sentenced after pleading guilty to mail fraud and making a false statement under the Clean Air Act. Rivkin operated several Houston-based companies in the fuel and biodiesel industries. He allegedly claimed to produce millions of gallons of biodiesel, thus generating 60 million RINs based upon this claim. In reality, no biodiesel was ever produced at Rivkin’s facility. To cover up his scheme, Rivkin made false statements regarding his biodiesel production, importation, and RIN generation. He was sentenced to more than ten years in prison and three years of supervised release and ordered to pay more than $87 million in restitution and forfeit $51 million in proceeds from the sale of the fraudulent RINs.
The Rivkin case also illustrates EPA’s willingness to pursue, and settle with, buyers of fraudulent RINs—those who may legitimately consider themselves the victims of fraud. Because the Clean Air Act is essentially a strict liability statute, those who have renewable volume obligations need to meet those obligations with valid RINs. EPA takes the position that the reason a RIN was invalid does not mean that there was no violation of the RFS by the obligated party. Rather, EPA has traditionally taken the position that the market for RINs is one of “buyer beware,” in which sophisticated purchasers of this currency are obligated to ensure that it is valid currency or suffer the consequences. Thus, while the Rivkin criminal case was underway, EPA separately resolved civil violations against 16 companies that had purchased RINs from Rivkin and used them to satisfy volume obligations. EPA pursued the companies even if they had a good faith belief that the RINs were valid when purchased and used to meet annual obligations.
Pursuing enforcement in this type of scenario, however, may have resulted in unintended consequences. Although the RFS program is intended to create a flexible, efficient, liquid marketplace and reduce the barriers to entry for small renewable fuel producers, that goal can be undermined by concerns about RIN validity. This could restrict the marketplace to larger or more established renewable fuel producers, consequently artificially increasing RIN prices. To address these concerns, EPA created the Quality Assurance Plan in 2014. Under the Quality Assurance Plan, an independent third party audits and verifies the validity of RIN generation. The Quality Assurance Plan program provides an affirmative defense to buyers of audited RINs if the RINs they purchase are later found to be invalid.
The Quality Assurance Plan is one tool to minimize the risks associated with purchasing RINs from smaller or newer renewable fuel producers. The Quality Assurance Plan does not, however, prevent all costs associated with RIN fraud. An obligated party may still incur additional costs including due diligence, investigating EPA’s claims, asserting an affirmative defense, and defending any residual claims. Further, there are costs associated with replacing invalid RINs to ensure compliance with the RFS program. Obligated parties would be well advised to evaluate what, if any, measures may be appropriate beyond the Quality Assurance Plan based on a number of factors, such as risk tolerance, specific knowledge of the RIN source, any additional quality-assurance programs the renewable fuel producer offers, the value of the RINs, and the potential transaction cost of defending against a civil action.
In his recent testimony to the U.S. House of Representatives, Acting Assistant Attorney General for the DOJ’s Environment and Natural Resources Division Jeffrey Wood highlighted the prosecution of renewable fuels fraud criminal cases as an area of particular success. Mr. Wood stated, “[p]rosecutions in this area help to reassure the industry that the government is serious about attacking criminal conduct that undermines the industry as a whole, hurts law-abiding operators, and defrauds the taxpaying public.” While questions may abound regarding the future of environmental enforcement, Mr. Wood made clear that RFS cases are of the type that EPA and Environment and Natural Resources Division will likely continue to pursue. Given the history of RFS enforcement and these statements, companies may well want to evaluate their RIN portfolios and plans to assess the probability that the Quality Assurance Plan has adequately captured risk of fraudulent RINs and whether additional mitigation steps make sense. The answer will depend on these various factors, but asking the question is the key—as well as knowing why a company is relying on the Quality Assurance Plan or choosing to take additional steps to protect its RIN flank.
©2017. Published in Trends, Vol. 48, No. 6, July/August 2017, by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association or the copyright holder.