Thursday, February 28, 2013

The Renewable Fuel Standard, Fraud and Misuse

Last Friday, Rodney R. Hailey, of Perry Hall, Md., was sentenced to 12 years and six months in prison, for selling $9 million in phony renewable fuel credits from his company, Clean Green Fuel, LLC.  Mr. Hailey registered Clean Green Fuel, a company that only existed on paper, with the U.S. Environmental Protection Agency under the Renewable Fuel Standard, RFS, program as a producer of bio-diesel fuel, a motor vehicle fuel derived from waste restaurant grease and diesel fuel. Though he manufactured no fuel, Mr. Hailey sold the fuel credits and pocketed all the money. Mr. Hailey was also ordered to pay restitution of approximately $ 42.2 million to over 20 companies and forfeit the $9.1 million in proceeds from the fraud, including cars, jewelry, his home and bank accounts, which had already been seized by the government. Mr. Hailey shows no signs of having any other money to pay the restitution.

To encourage the production of renewable fuel and lessen the nation’s dependence on foreign oil, oil companies in the U.S. are required to produce a given quantity of renewable fuel or to purchase credits, called renewable identification numbers (RINs) from producers of renewable fuels to satisfy their renewable fuel requirements. The Energy Policy Act of 2005 established the first renewable fuel volume mandate for the United States. The original RFS program required 7.5 billion gallons of renewable fuel (primarily ethanol) to be blended into gasoline by 2012. Under the Energy Independence and Security Act (EISA) of 2007, the RFS program was expanded to include diesel, in addition to gasoline; increase the volume of renewable fuel required to be blended from 9 billion gallons in 2008 to 36 billion gallons by 2022; and established new categories of renewable fuel, and set separate volume requirements for each one.

Between March 2009 and December 2010, Mr. Hailey engaged in a fraud scheme, selling over 35 million RINs (representing 23 million gallons of bio-diesel fuel) to brokers and oil companies, when in fact Clean Green Fuel had produced no fuel at all and Mr. Hailey did not even have a facility capable of producing bio-diesel fuel. Apparently, there was no requirement to verify production of renewable fuel to register the facility. Federal law enforcement agents investigated the scheme after a tip about the large number of luxury cars parked in front of Hailey’s house. Hailey took in more than $9.1 million from selling the false RINs and used the money to purchase an extraordinary number of fancy cars, including BMWs, Mercedes Benz, a Rolls Royce Phantom, a Lamborghini, Ferrari, Maserati and others, as well as real estate and more than $80,000 in diamond jewelry.

The traders and major energy companies who purchased Hailey’s false RINs are reported to have lost more than $40 million, but the loss also extends to small bio-diesel companies, who had real costs of production and, as a result of Hailey’s scheme, were unable to sell their RINs to recoup any of their real costs and were forced out of business.  “When invalid renewable fuel credits are ‘produced’ and sold, it undermines the integrity of an important program designed by Congress to reduce the nation’s dependence on foreign oil and to grow the nation’s renewable energy industry,” said Cynthia Giles, assistant administrator for EPA’s Office of Enforcement and Compliance Assurance.

Verification of securities is not a new problem, but how EPA chose to operate this market left it open to this kind of fraud. After this fraud came to light, EPA proposed a voluntary quality assurance program to verify that RINs generated under the RFS program have been validly generated. EPA hopes that this will make the RFS program more efficient and effective.  This blatant fraud is unlikely to be the only unintended consequence of the RFS program and how EPA chose register producers of renewable fuel and have RINs generated. The environmental attributes and the federal government created markets may be the wrong tool for achieving their stated environmental or energy independence goals.

While changes the EPA proposes may remedy some of the problems with the sale and marketing of RINs, putting ethanol into gasoline and vegetable oil into diesel is neither cost effective nor does it make the environment a cleaner. Its impact on the U.S. less dependence on foreign oil was never measured. The energy expended in growing and processing the corn or collecting and processing the vegetable oil is an environmental cost that is hidden by various subsidies.  

The RFS is not only subject to fraud (the cheapest RIN is always the fraudulent one), but the RFS’ demand for Biofuels has the ability to change the demand and price of food. The RFS diverts half of the U.S. corn crop into fuel leading to diminished supplies for livestock and food. The RFS determines the crop mix in the U.S. by distorting price and still we might end up importing corn to feed our nation either directly or feed livestock while we pay to convert corn into subsidized ethanol. In 2011, approximately 40% of the corn crop was used for making ethanol to meet the RFS; in 2012 it looks like it will take almost 50% of the corn crop, or 5.05 billion bushels. The USDA has estimated total corn production for 2012 at 10.7 billion bushels, down 13% from 2011. This was the lowest U.S. production of corn since 2006 yet the RFS demand continues to grow. 

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