Pricing renewable identification numbers under uncertainty

Abstract

We offer a stochastic control framework for understanding the prices dynamics of renewable identification numbers (RINs)—a market-based mechanism for enforcing renewable energy standards. Using a continuous-time formulation, we explicitly model the option value embedded in the RINs prices. We derive a closed-form solution of the RINs prices when underlying commodity prices are geometric Brownian motion (GBM). We also characterize the solution for setups with mean-reverting and jump specifications for the underlying prices, which need to be solved numerically using duality methods. Among other results, we show that the price of RINs has a U-shape relationship with the volatility of ethanol and gasoline prices and a negative relationship with the correlation between the two price processes. Our paper demonstrates a case for using quantitative finance techniques in environmental and sustainability topics.