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Policy Uncertainty under Market-Based Regulations: Evidence from the Renewable Fuel Standard

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  • Lade, Gabriel
  • Lin, C.-Y. Cynthia
  • Smith, Aaron

Abstract

Tradeable credits are a central component of many market-based regulations. Whenever the market for compliance credits is efficient and policies are enforced over time, credit prices should reflect both current and expected future discounted marginal compliance costs, which are a function of both expected future market conditions and policy environments. We study credit prices for a relatively recent policy, the market for Renewable Identification Numbers (RINs) under the Renewable Fuel Standard (RFS2). We provide a comprehensive study of RIN markets. Due to the dynamic nature of the program and the feature that credits can be banked and borrowed over time, we specify the first dynamic model of an industry facing a RFS2 to highlight the importance of expectations in driving current RIN prices. We then provide a test of market efficiency, and study historical cost drivers of prices. We find encouraging signs of a maturing over-the-counter market for RINs. Historically, the largest drivers of prices in the program has been policy announcements. We estimate that one particular announcement, the 2013 final rule, was responsible for between a \$10.3 and \$20.7 billion reduction in support the RFS2 provides for the US biofuel industry. The findings call into question the efficacy of using quantity based mechanisms such as the RFS2 to drive innovation and investments in new production technologies, particularly when the regulator faces a classical problem of dynamically inconsistent responses to increases in compliance costs.

Suggested Citation

  • Lade, Gabriel & Lin, C.-Y. Cynthia & Smith, Aaron, 2014. "Policy Uncertainty under Market-Based Regulations: Evidence from the Renewable Fuel Standard," 2014 Annual Meeting, July 27-29, 2014, Minneapolis, Minnesota 170673, Agricultural and Applied Economics Association.
    • Handle: RePEc:ags:aaea14:170673
    DOI: 10.22004/ag.econ.170673
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    2. Li, Jing & Stock, James H., 2019. "Cost pass-through to higher ethanol blends at the pump: Evidence from Minnesota gas station data," Journal of Environmental Economics and Management, Elsevier, vol. 93(C), pages 1-19.

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