The Environmental Protection Agency’s (EPA) Gasoline Sulfur program sets limits on the sulfur content of gasoline sold in the United States, with the aim of reducing a variety of vehicle emissions.
The program relies on tradable credits that allow U.S. refiners and gasoline importers to reach compliance with sulfur specifications. For the second year in a row, in 2023, gasoline suppliers obtained and retired more sulfur credits than they generated, a trend that could increase supplier compliance costs and the price of octane in gasoline if it continues.
What are gasoline sulfur credits, and how do they work?
Data source: U.S. Environmental Protection Agency (EPA), Fuels Averaging, Banking, and Trading (ABT) Credit Data
Sulfur is a natural component in crude oil that is present in gasoline, diesel, and other petroleum fuels unless it is removed. The presence of sulfur makes vehicle emission control systems less effective and contributes to air pollution. Reducing the sulfur content in fuels enables advanced emission controls in vehicles, reducing air pollution.
The EPA’s Gasoline Sulfur program
In 2014, the EPA finalized a rulemaking that reduced the federal gasoline sulfur emissions standard from 30 parts per million (ppm) to 10 ppm, which would apply to refiners and importers beginning in 2017. Expecting that some suppliers might struggle to meet this standard, the rulemaking allowed refiners and importers to use the EPA’s Sulfur Averaging, Banking, and Trading (ABT) program to come into compliance by trading sulfur credits.
The ABT program measures the volume-weighted average sulfur content of the gasoline that a particular refiner produces or gasoline importer supplies. Market participants generate credits equal to 10 ppm minus the volume-weighted average sulfur content of the gasoline they supply (in ppm), and then they multiply that difference by the overall annual gasoline volume they supply in gallons. Suppliers whose volume-weighted average sulfur level is above the 10 ppm standard must instead acquire and retire credits to become compliant.
The more gasoline a supplier sells within the United States, the more credits they produce (if below the 10 ppm standard) or obligations they incur (if above the 10 ppm standard).
The Tier 3 transition
The reduction in the emissions standard from 30 ppm to 10 ppm in 2017 marked the transition from the Tier 2 sulfur standard to the Tier 3 sulfur specification. To facilitate this change, the EPA made allowances for a transitional period in which refiners could continue to retire credits that were generated under the previous Tier 2 (30 ppm) standard to achieve compliance under the new Tier 3 (10 ppm) standard. This transitional period ended in 2020.
From 2017 to 2019, most retired credits were generated between 2014 and 2016—before the new 10 ppm standard was implemented. From 2017 to 2019, certain small-volume refineries were also allowed to produce transitional sulfur credits under the old 30 ppm standard, but transitional credits could only be used by other exempted small refineries to comply with the sulfur reduction targets.
What are gasoline sulfur credits, and how do they work?
Data source: U.S. Environmental Protection Agency (EPA), Fuels Averaging, Banking, and Trading (ABT) Credit Data
From 2017 to 2019, some refiners were able to produce gasoline under the 10 ppm specification, thereby generating surplus Tier 3 credits. This approach allowed those suppliers to begin building a surplus bank of credits under the new standard that could be used to come into compliance when the standard came into full force.
In 2020, all retired sulfur credits needed to be produced under the Tier 3 standard for the first time. The small-volume refiner exemption expired, and banked credits produced under the Tier 2 standard could no longer be used.
Sulfur specifications since 2020
Significantly less gasoline consumption during the COVID-19 pandemic reduced gasoline sales, so fewer sulfur credits were retired in 2020. At the same time, credit generation surged as low-sulfur gasoline producers continued operations to meet market needs. By analyzing EPA data, we estimate the total number of banked sulfur credits—credits that have been generated but not retired—was about 440 billion in 2020. We also estimate the number of banked credits remained at a similar volume through 2021.
In 2022, the post-pandemic gasoline demand recovery and wider refinery crack spreads—a proxy for a refinery’s profit margin—encouraged refiners to increase production of gasoline. Wider crack spreads also meant more refiners would be able to recoup the cost of purchasing ABT credits. As a result, credit retirements increased while credit generation decreased, causing the total credit bank to decrease by 185 billion credits, or about 40%.
In 2023, gasoline suppliers continued to draw down the total bank of ABT credits by an additional 70 billion credits, reducing it by about 27%. Based on the EPA’s most recent data, we estimate the total credit bank is about 186 billion credits.
Challenges for gasoline production
The EPA’s sulfur target is one of several parameters that gasoline suppliers must meet when producing motor gasoline blendstock. Finished motor gasoline is a mixture of fuel ethanol and multiple petroleum-based blend components that are all produced as part of the petroleum refining process. Pre-ethanol gasoline blends are often called blendstock for oxygenate blending, usually in conventional (CBOB) and reformulated (RBOB) varieties. CBOB and RBOB are marketed as a separate commodity from ethanol in spot and futures markets, and different types of blendstock can meet different specifications for the fuel’s final octane rating, Reid vapor pressure, and emissions of sulfur and other air pollutants.
Refiners remove sulfur from motor fuels through a process called hydrotreating and can achieve a lower sulfur content by intensifying their hydrotreating process. However, intense hydrotreating can decrease octane rating in fuels, requiring producers to increase the share of high-octane, low-sulfur blend components in their gasoline blend to meet all the required parameters. These blend components, such as alkylate, are more expensive to produce.
One way to observe this expense is to look at the price difference, or spread, between regular grade and premium grade gasoline blendstock. In 2022, this octane spread climbed to record highs and remained similarly elevated in 2023.
What are gasoline sulfur credits, and how do they work?
Data source: Bloomberg L.P.
Note: CBOB stands for conventional blendstock for oxygenate blending, premium refers to blendstock for 93 octane gasoline, and regular refers to blendstock for 85 octane gasoline.
So far in 2024, the octane spread has decreased considerably. This decrease primarily reflects lower refinery margins for gasoline production overall and unchanged domestic gasoline consumption growth. When the EPA releases its 2024 sulfur credit data in 2025, we can better determine whether the low gasoline margins in the second half of this year helped to increase the availability of sulfur credits, as the lower octane spreads could imply.
