The power to smooth out the boom and bust cycles in the nascent U.S. renewable fuels market is locked in 38 letters and numbers.

If only ethanol producers and consumers had the key.

These strings of code, designed by the U.S. Environmental Protection Agency, and known as Renewable Identification Numbers, or RINs, are part of a system so complex that few players use them as they plan their day-to-day ethanol needs.

"It's not a very well-understood market at the moment," said John Gelbard, chief executive of New York-based Renewable Fuels Trading LLC, which runs the only exchange upon which RINs are currently traded.

Each gallon of renewable fuel, such as ethanol, biodiesel, is assigned a RIN that travels with it from the production plant, through the transportation system, to the refiner or blender who purchases the fuel to add to its gasoline or diesel. Beyond serving as a tracking device, RINs can also be traded. Refiners must each blend a certain amount of ethanol, and can use the RINs to prove that they have met their obligations. Excess RINs serve as credits that can be traded, either to refiners who need to make up for a shortfall or to those who want to use RINs as a financial instrument.

Each RIN tells an embedded tale of the alternative fuel it represents: the manufacturer, production facility location and where it was made. Using these codes, producers and ethanol buyers could better track the volume of U.S. demand for renewable fuels, whether stockpiles of the fuel are robust and whether refiners have complied with their obligations to use alternatives to fossil fuels.

But most aren't using RINs in these ways yet, due to the system's shortcomings. For one, unlike other instruments such as credits for cutting carbon-dioxide emissions, RINs often aren't standardized. They can be grouped to represent up to 99 million gallons of fuel, so varying amounts are being put on the market, collectively.

Additionally, some refiners don't know how many excess RINs they will have at the end of the year, so they continue to sit on the sidelines. The EPA has still not finalized its rules for RINs and RIN trading, which makes it even more difficult for refiners to know exactly how these instruments will work.

Tracking RINS

The EPA created RINS in 2005 as a means for tracking how refiners and blenders were complying with the renewable fuels standard promulgated by the Energy Policy Act. Each refiner must blend a certain number of gallons of renewable fuels with its slate of fossil fuels. By allowing RINs to serve as a trading mechanism, as well, the EPA left room for refiners to meet their obligations even if they operated in areas where biofuels weren't widely available.

When Congress expanded the standard in the Energy Independence and Security Act late last year and mandated a quadrupling of renewable fuels over the next 15 years, RINs took on newfound prominence.

As producers manufacture increasingly large volumes of fuels like ethanol and biodiesel, the RIN system could be used to track demand nationally, and by regions, and could send clear market signals as to whether the biofuel supply was sufficient.

'Drips And Drabs'

Even those who are already trading the credits don't fully understand their powers and limitations, said Gelbard, of Renewable Fuels Trading. In December, for instance, some Midwestern ethanol blenders rushed to trade their RINs by the end of 2007, thinking that they expired. Rather, RINS are tradable for two years, though refiners may only rollover a limited number of credits each year.

And trading volumes on Gelbard's RINXCHANGE aren't steady, but flow in "drips and drabs," he said. Some blenders aggregate the credits on a monthly basis, selling them only once a month, or once every two weeks. Last week, he said, Wednesday was a particularly active day, with several offers made. Even then, though, no deals were actually completed on the exchange.

Deals can be difficult to strike, because buyers often seek large volumes of RINs aggregated together to meet their requirements, while sellers tend to offer smaller amounts of the credits, Gelbard said.

When RINs do trade, they're valued at about 6-7 cents a gallon, Gelbard said.

Because blenders and refiners are required to use renewable fuels to account for a certain percent of their fuel production, they must choose between buying that amount of RINs or blending the actual fuel. Right now, it may be more economical for some refiners to blend ethanol, the most widely available renewable fuel, than to blend additional gasoline and buy RINs.

One gallon of ethanol costs about $2.51, and refiners then get a 51-cent tax-credit for each gallon they use. Gasoline blendstock, on the other hand, costs about $2.92, on top of which the refiner would need to buy a RIN.

However, for refiners and blenders who have difficulty getting sufficient access to ethanol, RINs are an alternative.

Trading may be light because the system is new and hasn't been completed, said Lynn Westfall, chief economist of Tesoro Corp. (TSO), a San Antonio, Texas-based refiner that blends ethanol. Refiners are still waiting for the EPA to publish rules for the new, expanded system, which are due by the end of this calendar year.

And refiners have to develop complicated accounting systems to comply with these rules, and track their credits.

"The industry just needs to get its act together," Westfall said. "I would suspect that by mid-year, you'll start seeing a more active, more transparent market."

(Jessica Resnick-Ault covers ethanol and biofuels in addition to traditional crude-oil refining for Dow Jones Newswires.)

Copyright (c) 2008 Dow Jones & Company, Inc.