I. LCFS Readoption

On February 19, 2015, the California Air Resources Board (ARB) will take feedback on proposed regulations implementing the readoption and updating of California’s Low Carbon Fuel Standard (LCFS), with formal readoption targeted for the Summer of 2015.  Triggered by legal defects during the original adoption of the LCFS Program, ARB initiated the rulemaking after the U.S. Supreme Court denied certiorari regarding the constitutionality of the program.  ARB is building on a series of workshops held last year to institute a variety of major changes to the LCFS, going far beyond the largely procedural defects that catalyzed the rulemaking.

The LCFS, which was adopted pursuant to the Global Warming Solutions Act of 2006 (commonly known as “AB 32”), requires fuel suppliers to reduce the carbon intensity of transportation fuels to 10% below 2010 levels by 2020.  Those who over-comply generate credits that can be sold to those who miss their targets (and thus have deficits).  While the 10% target has not changed, a number of regulations pertaining to how that target is achieved, including the schedule of annual reduction requirements between 2016 and 2020 would be modified under ARB’s proposal.

II. Carbon Reduction Schedule

The current LCFS regulations contain a schedule of carbon intensity reductions to achieve the mandated 10% total reduction by 2020.  This “compliance curve” is frozen at its 2013 level by court order until ARB completes the readoption process.  As such, the original compliance curve has been disrupted and requires a more rapid acceleration through the final five years in order to achieve the desired reductions by 2020.  A summary of ARB’s proposed acceleration is below:

Click here to view table.

This accelerated schedule flattens interim reduction targets, but places a considerably higher burden on the final three years of compliance, potentially creating a tight credit market during those years.  ARB has employed aggressive assumptions about technological innovations and the mix of available fuels during this period.  For example, ARB assumes that electric vehicles will generate 10x as many credits in 2020 as in 2013 and renewable CNG 32x as many credits.

III.       Cost-Containment Provisions

In an attempt to alleviate concerns about the ability of the market to produce enough credits in coming years, ARB is proposing to establish a “credit clearance market” whereby regulated parties can purchase credits from other market participants to make up credit shortfalls.  In the event of a credit shortfall, an inflation-adjusted credit price ceiling of $200 would apply.  The “credit clearance market” would function somewhat similarly to the consignment auction process in ARB’s Cap-and-Trade Program, with several key differences, including that ARB would publish the names of entities participating in the credit clearance market, including the number of credits that each participating entity must buy or sell.

Entities that are unable to obtain credits needed for compliance during the credit clearance event would be able to “carry over” deficits per a “5×5” rule:  5% interest on carried-over deficits with total debt due within 5 years.  Market participants previously expressed concern about the credit clearance proposal during ARB workshops, noting its potential to distort the market in ways not envisioned by ARB.

IV. Enforcement Mechanisms

The proposed rules would include a robust invalidation regime for LCFS credits, deficits, and carbon intensity determinations (an “Approved CI”), similar to the current ARB rules for emission offset credits in the Cap-and-Trade Program.  The new rules would allow ARB to delete an Approved CI or invalidate LCFS credits for a variety of reasons, including noncompliance with laws during credit generation.  This expansion of the invalidation regime could open the door to the kind of uncertainty that market participants have experienced in the Cap-and-Trade Program offset market.  ARB also proposes changing the definition of a violation to encompass each separate net deficit, which will allow for differentiation among small- and large-scale offenders.  However, the penalty for a single violation would shrink from a presumption of $35,000 to a maximum of $1,000.

V. Indirect Land-Use Change

ARB calculates carbon intensity using the CA-GREET model, which measures direct life-cycle emissions from “well to wheel,” including a fuel’s production, transport, storage, and use.  The Board also supplements this calculation with a calculation of indirect impacts on emissions due to land-use change (iLUC).  For example, carbon sequestered in soil and organic matter can be released when non-agricultural land is converted to agricultural use for growing biofuel crops.  Going forward, ARB proposes to modify its iLUC values for certain biofuels, including ethanol refined from corn, sugarcane, and sorghum and biodiesel from soy and palm.  These changes are based on new research regarding land-use changes and are lower than previous iLUC values, providing a benefit to ethanol producers.

Additionally, ARB will update the CA-GREET model, as well as the OPGEE model, which estimates carbon intensity for crude oil production and transport to petroleum refineries.

VI. Miscellaneous Further Changes

In addition to these major modifications to LCFS regulations, ARB has proposed a number of other important changes.

First, ARB would simplify the process for certifying certain established, compliant fuels and the procedures for generating them.  Under a new two-tiered system, stakeholders proposing to register pathways for established fuels (e.g., starch- and sugar-based ethanols) generated in a conventional manner would receive expedited approval.  Those seeking pathway approval for more novel fuels (e.g., cellulosic alcohols) or technologies to generate them would receive elevated scrutiny from ARB.

Second, certain innovative technologies for producing crude oil would offer the potential to generate additional credits.  Since 2011, producers that employ carbon capture and sequestration or solar steam generation have been eligible for credits, but no one has yet attempted to apply.  To facilitate such projects, ARB now proposes to:  (a) reduce the minimum threshold for carbon intensity reduction from such technologies from 1.0 gCO2e/MJ to 0.1 gCO2e/MJ or even lower in some cases; (b) simplify calculations of credits generated; (c) allow crude producers, in addition to refineries, to earn credits; and (d) add solar and wind electricity generation and solar thermal generation to the list of technologies that can yield credits.  Similarly, refineries would become eligible for credits if they invest in modifications that produce fuel derived in part from renewable feedstocks.

Third, petroleum refineries also would become eligible for credits if they employ low-energy-use refining processes, although these credits would not be available for sale.  Some smaller refineries could further benefit from a proposal to allow them to opt out of ARB’s statewide calculation of baseline average carbon intensity for all crude fuels produced in the state.  Instead of being judged against the 2010 baseline for the entire state, small, low-energy-use refineries could set their own baselines.  They would receive this opportunity only once and it would be irreversible, making the calculation a potentially risky one.  For those refineries subject to the statewide baseline, calculations of volume contributions would now come from government data, rather than reporting by the refineries themselves.

Fourth, additional transportation credits also would become available for electricity used not only by roadway vehicles (as is now the case), but also by trains and electric forklifts.

Finally, recordkeeping and reporting requirements for stakeholders also would change in important ways.  Minimum record retention would increase from three to five years. Quarterly reporting requirements would shift from a 60-day period in which parties can compile their data and reconcile it with that of their business partners to a “45/45 Schedule,” allowing 45 days to report data and an additional 45 days to reconcile it.

VII.     2030 Extension

While ARB proposes to institute many changes to the LCFS via the readoption process, one thing that has not changed is the fundamental target of a 10% reduction in carbon intensity by 2020; both the target reduction and the final date remain the same.  Nevertheless, ARB asserts that it intends, in a subsequent rulemaking, to extend the LCFS program through 2030 and apply aggressive new CI reduction targets for the 2020-2030 period.