In the wake of the political defeat of various measures to improve energy security and to reduce greenhouse gas emissions ("GHGs"), the Renewable Fuel Standard ("RFS") has emerged as the primary federal program to accomplish both U.S. policy goals. Originally established by the Energy Policy Act of 2005 ("EPACT"), the first stage of the RFS, typically referred to as RFS1, focused on ethanol usage. With the passage of the Energy Independence and Security Act of 2007 ("EISA"), the greatly expanded program became known as RFS2 and began to shift focus toward advanced biofuels that meet GHG performance standards. While ethanol continues to fulfill the large majority of the RFS volume mandate, the value of the renewable identification numbers ("RIN") credits under the RFS program is shifting heavily toward advanced biofuels. With the program likely to deliver more than $2 billion in RIN value to the advanced biofuel market in 2012, the Environmental Protection Agency ("EPA" or "Agency") is dedicating increased resources to the policing and enforcement of the RIN market.
Congress established the RFS as a component of the fuel and fuel additive provisions contained in the Clean Air Act ("CAA"). Consistent with other CAA programs, EPA is vested with authority to promulgate regulations and administer and enforce the RFS. During the period of RFS1, the program was one of multiple factors that drove the rapid expansion of the U.S. ethanol market from four billion gallons of production in 2005 to over 10 billion in 2009. Other ethanol attributes that drove the rapid industry expansion included its oxygenating quality (particularly given the demise of methyl tertiary butyl ether or MTBE), octane boost, market price, and a federal tax credit. These factors provided sufficient motivation to refiners to blend ethanol without the need for significant RIN value and so ethanol RINs (known under the RFS program as renewable fuel RINs or EPA D Code 6 RINs) have typically been worth pennies on the gallon. Even without significant RIN value, the U.S. ethanol program has been remarkably successful, with the industry exceeding 13 billion gallons of production in 2011. This production quantity represents 25% of all gasoline fuel produced in the U.S. from domestic sources, and when compared against foreign imports of petroleum, will likely soon exceed the quantity of petroleum annually provided to the U.S. by Saudi Arabia, the largest importer of petroleum to the U.S. after Canada.
Now, with an aggressive mandate from Congress under RFS2, the RFS program is beginning to drive the rapid expansion of advanced biofuel production. Since adoption of RFS2, the market value for advanced biofuel RINs (EPA D Code 5 RINs) and biomass based diesel RINs (D Code 4 RINs) has dramatically increased. With a 1.35 gallon mandate for advanced biofuel production in 2011, the value of advanced biofuel RINs skyrocketed to exceed $1.50 per gallon at the height of the market. With a proposed 2012 mandate of two billion gallons, the value of this category of RINs is likely to remain high. EPA has proposed a one billion gallon requirement for the subcategory of biomass based diesel, and this RIN market traded as high as $2 per gallon RIN in 2011. With the potential sunsetting of tax credits for ethanol and other biofuels at the end of 2011, there is also the possibility that ethanol RINs will begin to attract significant value.
As Congress' mandated quantities increase and the market responds with rapidly increasing RIN values, regulated entities are paying increasing attention to their compliance obligations under RFS2. Not surprisingly, a complex set of EPA regulations underlies this valuable program, and achieving full compliance is challenging. EPA began implementing the RFS2 regulations in July 2010, and already EPA enforcement activities are beginning. Pursuant to the CAA, EPA has substantial investigative and enforcement authority to regulate all aspects of the RFS program, including developing and revising the regulations; interpreting and issuing guidance; and most importantly, investigating, enforcing, and meting out punishment for violations. This article highlights the particular aspects of the RFS2 program where enforcement actions are already underway, describes the nature and scope of EPA's enforcement authority, and recommends a preferred course of action for companies subject to EPA scrutiny.
II. Key Policy Goals Underlying the RFS Program
While a full examination of the RFS program is outside the scope of this article, an examination of the key objectives, participants, and components of the program is necessary in order to provide a context for a discussion of EPA enforcement activities. For readers seeking a detailed review of the RFS program, the white paper, "America Advances to Performance Based Biofuels – the Advanced Renewable Fuel Standard, RFS2," co-authored by Clayton McMartin and Graham Noyes, is recommended as a resource. In addition, EPA has a series of PowerPoint tutorials on its RFS website that are highly valuable for understanding the various components of the program.
The most effective starting point for understanding the RFS program is to consider the underlying policy goals of Congress: energy security and GHG reduction. During the course of offering guidance and pursuing enforcement actions, EPA officials regularly refer to their duty to promote these policies and maintain the integrity of the RFS program. EPA personnel recognize that through adoption of EPACT and EISA, Congress vested EPA with broad authority to pursue and achieve two policy goals that are to some degree distinct from EPA's traditional role of safeguarding the environment. These goals are reemphasized by EPA in the course of implementing and enforcing RFS2 regulation, and the goals inform EPA's compliance responses and enforcement discretion. It is therefore worthwhile to examine each goal in some additional detail as well as the manner in which the RFS regulations seek to fulfill them.
First and foremost, under EPACT, the dominant goal was to improve U.S. energy security. Since the 1970s oil price spike triggered by the decline in American oil production and the oil embargo, successive bodies of Congress have struggled to formulate viable strategies to reduce American dependence on imported oil. Over time, the increased production of U.S. biofuels has emerged as the most viable policy solution to provide some relief to this abiding dependence. EPACT created the RFS program to establish a systematic plan for increasing reliance on biofuels and a corresponding decrease in petroleum imports. With the subsequent adoption of EISA, Congress dramatically expanded the scope and duration of this strategy. Congress established a 15-year framework with specific numerical targets and future deadlines to reduce import dependence. Recognizing the challenge of long range forecasting, Congress also built in a series of pressure relief valves in the event that the biofuel mandates resulted in substantial price increases to consumers, strains on fuel production, or negative environmental impacts. Congress vested the Administrator of the EPA with authority to grant waivers to the mandates based on these factors after consultation with the heads of appropriate Executive Branch agencies. In this manner, a high degree of long-term certainty is achieved by EISA's framework, while maintaining flexibility to respond to unintended consequences.
While the energy security goals of the RFS Program are well recognized, it would be a mistake to overlook the second policy goal underlying EISA and RFS2: the reduction of GHGs that contribute to global warming. Indeed, many of the most complex and demanding aspects of RFS2 arise from the policy imperative that production of RFS-qualified fuels demonstrably reduce GHG emissions. This factor also provides the rationale for the shift in emphasis from corn ethanol fuel in the early years of the program to advanced biofuels in the later years. Under RFS2, cornstarch ethanol is relegated to participate only in the lowest value RIN category, and ethanol reaches a plateau target of 15 million annual gallons in 2015. Meanwhile advanced biofuel targets increase dramatically under RFS2 ultimately reaching 21 million gallons in 2022. In addition, cornstarch ethanol is uniquely restricted in that even if it is produced in such a manner as to achieve a 50% GHG reduction (as required to be included in the advanced biofuels category), the resulting cornstarch-derived fuel is nonetheless precluded from qualifying as an advanced biofuel.
While EPA certainly refers to its detailed regulations in determining whether to pursue investigative and enforcement actions, the Agency is mindful of whether Congress' underlying policy goals are being supported or undermined by the activities of members of the regulated community. Given EPA's authority to serve as quasi-legislator (writing the regulations), prosecutor (identifying who to investigate and how to enforce the regulations), and judge (determining the resolution, at least in settlement negotiations), EPA's perspective on the system is prudently viewed as paramount. In many respects, comprehending the complicated aspects of the program is best supported by frequent reference to these goals. This is illustrated in subsequent sections of this article that examine the particular requirements, the underlying rationale, and the compliance implications.
III. Summary of Compliance Obligations
Under RFS2, most administrative compliance requirements may be broadly separated into four categories: registration, reporting, record-keeping, and attestation. The first set of regulations pertain to registration under the system. Any person (defined to include corporations and other entities) that seeks to generate or own RINs must register and effectively receive approval from EPA for participation in the RFS2 program. The lowest level of registration obligations attaches to owners of RINs. Renewable fuel producers who seek to generate RINs have substantially more demanding registration obligations under the system and undergo a more rigorous review process. Petroleum refiners and importers, referred to as "Obligated Parties" under the system, are the entities required to show compliance with the substantive RFS2 requirements and thus have a distinct set of registration requirements.
Once registered, all persons owning or transferring RINs must comply with complex reporting and record-keeping requirements. Transactions and other activity are reported through the electronic EPA Moderated Transaction System and at regular intervals via other reporting formats. It is essential to note that record-keeping requirements exceed reporting requirements and are particularly arduous, especially for producers utilizing specified feedstocks or in other specified circumstances.
To facilitate compliance and EPA's enforcement of the RFS, certain RFS2 participants are also required to submit annual attestations prepared by certified public accountants. These annual attestations are regarded as third-party compliance reviews and are intended to flag compliance shortfalls for both EPA and the RFS participant.
Various participants in the RFS program play distinct roles in the marketplace and within the regulatory framework, and must typically focus on distinct substantive components of the regulatory scheme. For example, biofuel producers are the RIN generators under the system. These entities produce the fuel and must determine if that fuel conforms to a particular RIN category referred to under the regulations and a corresponding D code. Before generating its first RIN, the biofuel producer must be recognized by EPA as a qualified RIN generator for a specific type of fuel that corresponds to a particular approved manufacturing pathway. In other words, the biofuel producer must retain a third-party engineer to verify that critical aspects of the facility's production process are as prescribed by RFS2. This engineering report is submitted to EPA by the biofuel producer, who must register and receive a facility specific approval from EPA to generate RINs. Once approved, the biofuel producer must adhere to the various requirements of its registration, including adherence to the manufacturing pathway verified by the engineer and relied upon by EPA for approval.
The pathway approval for the particular fuel and the resulting D code represents four distinct and necessary aspects: the feedstock origin, the production process, the process energy utilized, and the resulting fuel type. One of the most profound changes to the RFS wrought by EISA is the emphasis on feedstock. This emphasis relates back to the early political struggles over reliance on cornstarch ethanol and the political compromise whereby corn ethanol mandates are capped in 2015 and all future expansion occurs in advanced biofuel categories. Under RFS2, the feedstock must be qualifying renewable biomass, as determined by EPA. Thus a facility that was approved to produce biofuel from woody biomass must maintain that feedstock source and obtain approval for any changes from the information provided with its registration. Similarly, a facility that was approved to produce biofuel from corn, separated food waste, or woody biomass from a tree plantation on non-federal land, must maintain that specific feedstock source mix and obtain approval for any changes from the information provided with its registration. To the extent that the facility utilizes multiple feedstocks and/or generates multiple types of RINs represented by different D codes, the compliance obligations become more complex and demanding. The details of these regulations must be strictly followed because through implementation and enforcement of the production and documentation requirements prescribed by RFS2 EPA is seeking to ensure that the fuel meets the necessary GHG specification.
RFS2 explicitly authorizes foreign production, but the rigorous requirements for imported fuel present challenges to producers attempting to confirm the four fuel aspects for biofuel produced outside the U.S. Foreign producers must meet demanding requirements for approval to participate in the program and for RIN generation, thereby saddling the fuel supplied by foreign producers with these restrictions in favor of domestic production.
Another segment of the regulated community under the RFS framework is intermediaries—companies that purchase fuel with assigned RINs but that are not regulated as obligated parties. The primary compliance obligations for these companies are to ensure that they receive fuel with valid RINs attached and that they either properly sell the fuel with assigned RINs or separate the RINs properly based upon defensible regulatory analysis. Purchasers of RINs that are separated from the fuel also fall into this regulatory category and share these obligations. This compliance group must be particularly aware of the RIN invalidation provisions and the strict liability enforcement regime of the RFS2 rules, described in more detail below. Participants found holding or trading invalid RINs, even unintentionally, may be subject to investigation by EPA to identify suspect RINs. Despite EPA's enforcement discretion, the agency's broad authority to investigate can force RIN traders to dedicate significant resources to respond and to establish their good faith intent.
The final compliance group covered by the RFS2 requirements is obligated parties. These are the only RFS participants that have a renewable volume obligation ("RVO") and thus must own a sufficient number of RINs in the various D code categories to comply, based on the quantity of fossil fuel that the obligated party imports or refines. Obligated parties have unique flexibility under the system to separate RINs; however, this flexibility is receiving increased scrutiny from the EPA and the proposed 2012 rule revisions could establish new ceilings for some RIN separation transactions that were previously authorized without limit. Obligated parties are most closely regulated by EPA under the RFS program, to ensure that the underlying Congressional policy goals are achieved.
IV. Key Enforcement Provisions
EPA's investigations and enforcement actions are likely to focus on activities that allegedly undercut the integrity of the RFS program. Specifically, EPA is likely to prioritize review of activities that the Agency considers to be interfering with the achievement of the underlying policy goals: (1) to improve energy security by ramping biofuel production to 36 billion gallons annually by 2022; and (2) to reduce GHG emissions by prescribing and tracking preferred feedstock sources for that biofuel. For example, in the case of biofuel producers, the generation of RINs using an unapproved pathway or an incorrect feedstock, or in a quantity that exceeds the qualifying fuel produced, would all be suspect actions. In the case of an intermediary, the activities could involve improperly documenting transactions, selling RINs to unauthorized counterparties, or selling renewable fuel into non-fuel applications outside the scope of the RFS program. Suspect obligated party issues could include failing to meet an RVO for one or more RIN categories, not heeding RIN separation ceilings, or failing to meet reporting obligations thereby limiting EPA's ability to track production volume and compliance accurately.
A small number of key regulatory provisions govern compliance. For the sake of simplicity, all of the requirements summarized in this article pertain to RFS2 and are found in Title 40 of the Code of Federal Regulations, Subchapter M, Section 80.1400, et seq. The corresponding regulations for RFS1 are found in Subchapter K, Section 80.1100, et seq. In most respects, the RFS2 regulations track the previously existing RFS1 regulations. In some areas, however, there are significant distinctions between the RFS1 and RFS2 regulations. Thus, to the extent that an EPA investigation straddles the time period covered by RFS1 and RFS2, it is essential to examine each allegation within the applicable regulatory structure.
The federal regulations establish what acts are prohibited under the RFS program, including improperly generating RINs, creating or transferring an invalid RIN, failing to acquire sufficient RINs to meet an RVO, or meeting an RVO with valid RINs where the corresponding fuel is ultimately used by the person in a non-qualifying use. A regulated entity is prohibited from causing another person to commit a violation or to fail to meet any requirement under the regulatory subpart. These rules are comprehensive, complex, and well worth a close review.
The regulations clearly establish who is liable for violations under the program. Any person who violates the regulations may be liable. In addition, any person who causes another to violate or to fail to meet a requirement may be liable. Parent companies are liable for any violation by any of its subsidiaries, and each partner to a joint venture is jointly and severally liable for any violation committed by the joint venture operation.
Violations are enforced under strict liability, meaning that neither mental state nor intent is required as an element of proving the violation occurred, and the alleged violator is subject to penalties. EPA need only show that the regulation required a certain action or inaction, and that the alleged violator failed to conform to the obligation. There are no reported cases reviewing EPA's authority to impose strict liability under the RFS; however, EPA has been highly successful in court reviews of other CAA enforcement actions where the standard is clearly strict liability. For example, during the period when unleaded gasoline was introduced, there were a series of enforcement actions against retailers who improperly sold fuel with excessive lead concentrations through unleaded pumps. In addition to the retailer, EPA's regulatory regime extended strict liability to the branded wholesale supplier for the station even if the wholesale supplier could prove that it did not supply the contaminating fuel to the retailer. Generally speaking, courts upheld EPA's ability to impose this strict and vicarious liability so long as EPA made available to the wholesale supplier recourse to an affirmative defense.
Any person found liable may be subject to a maximum civil penalty under the CAA in the amount of $37,500 for each day of violation. For example, failure to meet RVO requirements or causing another person to fail to meet an RVO may constitute a separate day of violation for each day in the compliance period. Penalties under the CAA typically include the amount of economic benefit or savings afforded the violator as a result of the non-compliance.
V. EPA Authority
The CAA affords EPA broad powers to investigate non-compliance and to enforce alleged violations. Using the strict liability legal standard, EPA can assert that a person subject to RFS is liable and demand penalties simply by showing that the company did not conform to the regulatory obligations. Neither intent nor knowledge on the part of the alleged violator is required for liability to be imposed and upheld. Proof of a violation is often readily provided to EPA by the regulated entity after being compelled to do so in response to an EPA request for information.
EPA utilizes its broad investigative power to request information from regulated entities in order to evaluate and determine whether a person is in violation of applicable air quality regulations, in this case those implementing the RFS. EPA has explicit authority to enter the premises, review records, require sampling, and request information necessary to determine compliance with the CAA. To assess compliance with RFS, EPA may issue written requests for information to regulated entities seeking paper records required to be kept under the rules. The information requested can be voluminous and difficult to access or assemble. EPA typically provides a short deadline for response.
Receipt of a request for information is serious. The request must be addressed promptly and a response must be prepared carefully. Failure to timely respond to EPA may result in civil penalties. Failure to respond truthfully, accurately, and completely may result in criminal sanctions. A response may simply require the straightforward submission of forms or reports, or a response may require legal analysis of the underlying requirements and of the level of compliance demonstrated by the records. In any case, a response can take time and resources. The high stakes require that the respondent exercise due diligence. Often EPA is willing to extend the time to respond; however, a company should be prepared to demonstrate good faith to conform or good justification for an extension.
In any response to a federal government request for information, and particularly in the case of EPA's enforcement oriented investigative requests, the company must understand the meaning of the information provided in relation to the regulatory requirements, and be aware of the compliance status illustrated by the response. EPA will use the information provided against the company and in support of its allegations. Information submitted to EPA in response to a request for information is also available to the public for review under the CAA and the Freedom of Information Act ("FOIA"). A company may assert that the information is subject to confidential business information exceptions to FOIA; however, certain conditions must be met for the information to be excluded from public disclosure. Review and preparation of any response to EPA to identify trade secrets or other confidential business information is an important step in the due diligence involved in preparing a response to EPA.
Once EPA receives a response the agency may review the material promptly or may postpone review for months or years. Generally, EPA is subject to a five-year statute of limitations, prompting the agency to assert its claim for penalties under the CAA within five years of EPA becoming aware of the violation. This statutory deadline, however, can be overcome in certain instances, such as when a claim is made by EPA for injunctive relief or when EPA alleges that a violation is continuing.
The CAA provides four enforcement responses for EPA to utilize when violations are detected. EPA may issue an administrative penalty order, so long as the total penalty amount does not exceed $295,000 and the violation occurred no more than 12 months prior to initiation of the action. EPA may issue a compliance order requiring the regulated entity to cure the violation. EPA may request that the Department of Justice initiate a civil judicial action in the federal court where the business is located. And finally, EPA may request that the Department of Justice commence a criminal action.
In the first two types of responses, EPA staff and attorneys lead the prosecution and are involved in the inevitable settlement discussions. In the latter two types of responses, lead roles in the enforcement discussions are typically taken by Department of Justice attorneys, who rely upon EPA staff and attorneys for substantive input. In any case, conversations with EPA at this stage can become adversarial quickly. An entity subject to RFS and targeted for enforcement must develop a sound strategy for response, including an internal comprehensive assessment of the current compliance status and prompt attention to cure any deficiencies.
Entities subject to RFS may proactively conduct internal compliance audits to self-detect and self-police any deviations from the regulatory requirements. This voluntary activity extends beyond the attestation requirement set forth in RFS2. A compliance audit could provide more in-depth evaluation of the company's understanding and implementation of the complex rules governing feed stock compliance, RIN generation, RIN tracking, RIN trading, RIN retiring, or record-keeping. In the event that deviations are detected in the course of an RFS compliance audit, a company may be afforded some relief from EPA enforcement, if the violations are properly self-disclosed to EPA. Under EPA's policy, entitled "Incentives for Self-Policing: Discovery, Disclosure, Correction and Prevention of Violations," published on April 11, 2000, environmental violations disclosed properly and cured expeditiously can be afforded certain enforcement relief. Instances of applying this policy to RFS violations are not yet known; however, the policy is certainly broad enough to include RFS violations of CAA requirements that are self-detected, properly disclosed, and promptly corrected.
In situations where enforcement is initiated by EPA (this includes receipt of a request for information under the CAA or issuance of a notice of violation) and formal interactions with EPA commence, our experience is that it is best to over-prepare. EPA's authority is broad and the stakes are high. Preparation begins with an honest internal assessment of the company's current compliance status and a prompt effort to cure any known non-compliance. Preparation also requires a realistic assessment of the scope of the agency's action and the company's ability to respond timely. Preparation includes assembly of a team of resources who are experienced with the regulatory requirements and with the enforcement framework overlaying the government's activities.
EPA typically does its homework before issuing a request for information or a notice of violation. But the EPA is not always accurate in its initial assessment, and the scope of an action may appear unreasonable. The respondent to either a request for information or a notice of violation must review the scope of EPA's action carefully and address any concerns promptly and directly with the federal government. Inaction on the part of the company will inevitably cause more EPA scrutiny and increased adversarial tone from the federal government.
Penalties claimed by the federal government for violations of the CAA, including RFS regulations, are negotiable. Generally, EPA will attempt to recover any economic benefit afforded the violating company, as a result of the non-compliance, in an effort to level the playing field with companies who comply. EPA will also assess "gravity" penalties to capture the real or perceived impacts of the violation on the environment, on public health, and, in the case of RFS2, on the ability of the U.S. to achieve the two underlying goals of EISA.
Responses to requests for information must be filed with a certification by a company officer. This certification attests that, under penalty of law, the officer is familiar with the information in the responsive documents and attachments, and that the information is true, complete, and accurate to the best of the person's knowledge and belief. There are significant penalties for knowingly submitting false statements and information including criminal provisions under 18 U.S.C. Sections 1001 and 1341. The officer making such a certification needs to thoroughly understand the nature of the certification as well as the substance of the response.
It is too early to describe the magnitude of penalties EPA may pursue in RFS2 enforcement matters, but the statutory maximum is severe. EPA typically collects penalties well below the statutory maximum, but five, six, and seven-figure fines for CAA violations are common.
The RFS is quickly becoming a substantial program in terms of expanding American biofuel production, reducing petroleum imports, stimulating innovation in advanced biofuel commercialization and utilizing a market-based incentive structure. Due to the underlying goals of energy security and GHG reduction, the RFS program is complex and the burdens it places on participants are significant. Given the EPA's expansive authorities under the CAA and the RFS, participating companies are well-served to develop a thorough understanding of the program, as well as its constantly evolving compliance obligations. In the event that a company receives a request for information or notice of violation from EPA, it is necessary to revisit compliance status immediately and with a heightened focus on the EPA's area of inquiry to determine the appropriate response and meet the demanding response requirements.