The latest in a series of thoughtful analyses by the folks at the University of Illinois Ag and Consumer Economics is out and shows the relationship between the biodiesel supply and demand curves and Renewable Identification Number (RIN) pricing. This article from Scott Irwin shows how RIN prices are made of two components – intrinsic and time value.
[T]he model in Figure 1 actually predicts the “intrinsic” value of biodiesel RINs. In options market parlance, this refers to the immediate value of exercising an option. This is equivalent to the loss blenders incur today by blending biodiesel, and it is represented by the blending margin. There is a second component of option value that is also relevant. This value is called “extrinsic,” or “time,” value and it reflects the value to an option owner of waiting until later to exercise the option when the intrinsic value may be even higher than it is today.
From a conceptual standpoint, RINs prices can be thought of as consisting of two components – intrinsic and time value. The intrinsic value should track current blending margins, and it was shown that this is generally true for D4 biodiesel RINS. The time value of RINs reflects the chance that blending margins will be even larger (bigger losses) in the future and it has typically represented about one-third of RINs prices. A particularly interesting dimension to RINs pricing right now is that time values have been driven basically to zero, precisely when there is great uncertainty about the outcome of EPA rulemaking and the status of the blenders tax credit. Variation in soybean oil prices adds to the uncertainty. Estimated supply and demand curves can be used to generate plausible D4 biodiesel RINs values for 2014 anywhere from $0.16 to $2.07 per gallon (in ethanol equivalents).
The piece goes on to show how it’s tough to evaluate the RINs market in relation to high vs. low blending margin scenarios, central to determining the time value of a RIN.