Practical steps to mitigate RIN market fraud risk in light of EPA's Inspector General RFS audit report

On September 19, 2023, the US Environmental Protection Agency (EPA) Office of Inspector General (OIG) issued its conclusions after conducting an audit of EPA’s Renewable Fuel Standard (RFS) Moderated Transaction System (EMTS) and Quality Assurance Program (QAP) (the Report). Specifically, the audit sought to determine whether the EMTS and QAP include controls to identify and reduce the generation and trading of invalid Renewable Identification Numbers (RINs)—which are used by certain parties to demonstrate compliance under the RFS.

In short, while EPA has strengthened RFS controls over the years, the Report confirms additional controls are necessary and makes a number of recommendations to ensure the integrity of the RIN market. However, the Report serves as a reminder that RIN fraud risk remains, and while EPA can take and has taken measures to provide assurance of reliability in the RIN market, responsibility ultimately falls to the RIN purchaser to ensure that the RINs are valid. This article discusses the OIG’s conclusions and steps that RIN market participants can take to help mitigate RIN fraud risk to the best extent possible.

Brief Overview of the RFS and RIN Market

The RFS requires that transportation fuel sold each year in the United States contain certain volumes of “renewable fuel” (i.e. renewable fuel volume mandates). The RFS outlines four such renewable fuel volume mandates: (1) Total Renewable Fuel, (2) Advanced Biofuel, (3) Biomass-Based Diesel, and (4) Cellulosic Biofuel. Renewable fuel producers manufacture a variety of different renewable fuels (ethanol, biodiesel, renewable diesel, biogas, etc.) and generate credits, or RINs, for each gallon (or gallon equivalent) of renewable fuel they produce. There are different RIN types corresponding to the particular mandate, and each RIN type is designated by a particular “D-Code” as follows:

1. Total Renewable Fuel = “D6”
2. Advanced Biofuel = “D5”
3. Biomass-Based Diesel = “D4”
4. Cellulosic Biofuel = “D3” or “D7”

Typically, the renewable fuel and RIN are sold together into the market, but when the renewable fuel is blended to create a finished transportation fuel or is used as a transportation fuel itself, the RIN may be separated from the renewable fuel. After separation, RINs may be freely traded between parties that register for the RFS program.

As alluded to above, parties that are refiners or importers of gasoline and diesel fuel (Obligated Parties) must acquire and retire RINs on an annual basis corresponding to a percentage standard set by EPA via rulemaking. The percentage standards are calculated by dividing the renewable fuel volume mandates by anticipated gasoline and diesel use in the United States for the particular upcoming year. The percentage standard is then applied against the amount of gasoline and diesel produced and imported by an individual Obligated Party to determine the number of RINs that the Obligated Party must retire in a year.

RIN Fraud and RFS Controls

The RFS has experienced a number of fraud cases since the program’s inception. As the Report points out, EPA has initiated 15 enforcement actions against companies from 2013 through 2021, 13 of which (approximately 81%) related to the generation and sale of fraudulent RINs. One of the most significant EPA actions against RIN fraud was the Genscape case,where Gen-X Energy Group fraudulently generated and sold over 71 million RINs, and Genscape, a QAP auditor, verified the RINs knowing they were fraudulently generated.

In response to such cases, EPA has implemented a number of controls to help improve the tracking of RINs and mitigate RIN fraud, including (1) engineering reviews, (2) attest engagements, and (3) the EMTS. Engineering reviews are independent third-party reviews, written reports, and site visits to renewable fuel producers completed at the time of registration and every three years thereafter. The attest engagements are annual third-party audits of company records and information submitted in RFS reports to EPA, and EPA implemented the EMTS to make RIN transactions and reporting more efficient and less prone to errors.

In addition to the above, in 2014, EPA also implemented a more significant control by promulgated rules that established the QAP, which is a voluntary program that allows independent third parties to audit and verify that RINs have been properly generated and are valid (Q-RINs). Generally, the RFS is a “buyer beware” regime, meaning if RINs are determined to be invalid, the Obligated Party that purchased the RINs must purchase new RINs to replace the invalid RINs. However, Obligated Parties that purchase RINs verified through the QAP have an affirmative defense for the transfer or use of any invalid RINs that had been verified under an approved QAP.

The QAP was a step in the right direction, but as the Report emphasized—and even EPA identified this as a top concern during the QAP rulemaking—the QAP necessarily involves conflicts of interest because RIN generators (i.e. renewable fuel producers) must pay for third-party auditing services.

OIG Conclusions and Recommendations

Overall, the OIG found deficiencies in the EMTS and the QAP that limit RFS rules intended to prevent the generation and trading of invalid RINs. Specifically, the OIG concluded that EPA:

• does not require timely submission of RIN transactions, allowing companies to submit such transactions to the EMTS up to 30 business days after the date of the transaction (when RFS regulations require reporting within five or 10 business days, depending on the type of transaction)
• does not prevent companies from generating RINs in excess of their registered renewable fuel production capacity
• does not verify RIN transactions entered in the EMTS despite RFS rules prohibiting any party from creating or transferring invalid RINs and the RFS’ history of fraudulent RIN transactions, and
• does not ensure independence between QAP audit providers and renewable fuel producers (e.g. QAP audit providers who perform paid consulting services in addition to QAP services are required to review and verify services they performed previously and may have incentives to ignore potential issues).

Additionally, the OIG found that EPA lacks an integrated information system with the automated reporting functions needed to efficiently manage the RFS program, instead relying on four separate applications: the Data Analysis Reporting Tool (DART), DC FUEL, EMTS, and the Office of Transportation and Air Quality (OTAQ) Fuels Registration.The Report concludes that the lack of an integrated information system and the limitations of DART:

• hinder EPA oversight of RINs and the RFS program
• place a significant burden on EPA staff to address information requests, and
• result in data quality problems, including missing data and incomplete reports.

Overall, while the Report concedes that EPA has taken a number of actions to provide reasonable assurance relating to RIN generation and market integrity, the OIG concludes that EPA must implement additional controls. Specifically, the OIG made the following recommendations:

• improve adherence to the five- and 10-business-day reporting requirements for RIN transactions in the RFS regulations
• develop a process to identify and review instances in which RIN generation exceeds registered or reported renewable fuel production capacity
• develop a risk-based selection process to verify RIN transactions entered in the EMTS
• develop a process to reduce the likelihood of QAP auditor conflicts of interest during QAP reviews
• communicate relevant requirements, expectations, and consequences from RFS regulations to QAP auditors to minimize the likelihood that they verify invalid RINs
• annually review the scope of consulting services that QAP auditors are performing for renewable fuel producers to identify prohibited relationships
• integrate key applications to reduce staff burden and to allow better oversight of RIN and RFS requirements and engage the Office of Enforcement and Compliance Assurance in the integration process to ensure all inspection and enforcement data needs are addressed in the integrated system, and
• enhance or replace DART to facilitate external information requests and Office of Enforcement and Compliance Assurance inspections.

Takeaways and Mitigating Risk

As the Report emphasizes, EPA has previously taken steps to improve controls under the RFS to help ensure RIN market integrity. Indeed, EPA stressed more recent such efforts in its Final RFS “Set” Rule—which, in part, established renewable fuel volume mandates and percentage standards for the years 2023, 2024, and 2025. Specifically, EPA highlighted its memoranda of understanding with the US Commodity Futures Trading Commission and California Air Resources Board and its intent to continue such partnerships to “assess what new improvements and modifications could reasonably be made that would further strengthen [RIN] market oversight and [RFS] program implementation.”

Notwithstanding EPA’s efforts to date, fraud risks within the RIN market exist, and the RFS remains a “buyer beware” regime. Purchasers of invalid RINs would not only be responsible for the costs of purchasing new RINs to replace the invalid RINs but may also be subject to an EPA enforcement action and penalties. Nevertheless, there are reasonable steps that RIN market participants can take that, in conjunction with measures implemented by EPA, can help mitigate such RIN fraud risks to the best extent possible.

Know Your Counterparty. RIN transactions with a known and reputable entity with established and reliable trading relationships can provide some certainty and assurance. RIN market participants should also develop and maintain a process for vetting and approving counterparties or other intermediaries and remember the counterparties with whom they have had repeated successful transactions.

Conduct Careful Due Diligence. The RFS’ “buyer beware” marketplace necessarily means RIN market participants should conduct careful due diligence before entering into RIN transactions. Developing and conducting “know your customer” as well as “know your product” procedures can help confirm the counterparty is reputable and the RIN generation is legitimate.

Contractual Provisions. Certain provisions may be incorporated into a RIN purchase or transfer agreement that outline procedures and the purchaser’s remedies for RINs that are ultimately deemed invalid for compliance.

Internal Auditing Processes. RIN market participants may also opt to develop and implement their own internal RIN auditing processes. Such an internal function could be considered “elevated due diligence,” and while it could be effective, it likely would require commitment of considerable internal resources, which is not ideal for smaller companies.

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