Big changes appear to be imminent for California’s Low Carbon Fuel Standard (LCFS).

As discussed in greater detail in our recent post, the LCFS currently is the subject of two interrelated legal challenges commonly known as POET I and POET II. Here we provide an update on recent proceedings before the California Court of Appeal for the Fifth Appellate District (Court of Appeal) in POET I. These proceedings concern the California Air Resources Board’s (ARB) attempts to comply with a peremptory writ of mandate (the Writ) that primarily required ARB to remedy violations of the California Environmental Quality Act (CEQA) that occurred during promulgation of the original LCFS regulation.

On March 20, 2017, three days before oral argument occurred, the Court of Appeal issued a tentative ruling in the POET I Writ appeal. The tentative ruling alerted the parties that the Court of Appeal intended to overturn the Superior Court’s discharge of the Writ and suggested that some or all of the existing LCFS regulatory regime was in jeopardy. The tentative ruling found that ARB failed to comply with the Writ by excluding from its CEQA analysis information relating to nitrogen oxide (NOx) emissions from biodiesel, resulting in the utilization of an improper baseline for measuring NOx emissions. The tentative ruling also found that ARB’s treatment of NOx emissions was not a “good faith” attempt at corrective action because it relied on an objectively unreasonable interpretation of the CEQA term “project.” The Court of Appeal then further underscored its dim view of ARB’s response to the Writ: “ARB’s actions do not appear to be a sincere attempt to provide the public and decision makers with the information required by CEQA and omitted from the earlier documents.”

While the Court of Appeal believes the factual question of whether increased biodiesel usage causes an increase in NOx emissions has been resolved by ARB in the affirmative, the Court did not believe that the evidence in the record was sufficient to assess whether the LCFS has caused, is causing, or will cause an increase in biodiesel fuel usage in California.[1] Based on its tentative ruling, the Court of Appeal appears poised to remand this causation issue to the Superior Court.

The decisive tenor of the tentative ruling suggested that the Court of Appeal would be unlikely to be swayed from these conclusions at oral argument. Looking solely to the tentative ruling, there is little doubt that the Court of Appeal intends to reverse the Superior Court’s order discharging of the Writ, tailor the Writ to reflect the current situation and appropriate relief, and direct ARB to comply with the modified writ and CEQA. Indeed, the tentative ruling directed the parties to be prepared to address at oral argument what modifications the Court of Appeal should make to the Writ. Specifically, the Court of Appeal was focused on whether or not it is possible to sever the biodiesel provisions of the LCFS regulations from the rest of the regulatory regime. The Court seems to prefer to preserve those portions of the LCFS regulations that are “untainted” by ARB’s CEQA violations. Similarly, the Court of Appeal expressed its intent to use oral argument to determine whether it would be possible to sever the 2015 Alternative Diesel Fuels (ADF) regulations (which essentially were adopted to counteract the effects of NOx emissions from increased use of biodiesel) from the LCFS regulations themselves – an issue not raised in the Court’s supplemental briefing request.[2]

It appears likely that the Court of Appeal will determine that the biodiesel provisions of the LCFS regulations can be severed given that: (i) both POET and ARB indicated in their supplemental briefs that severability should be possible – though severance is the first choice of neither; and (ii) the Court of Appeal previously has signaled it would prefer not to vacate the entire LCFS.[3] Just as importantly, if not more so, the Court of Appeal will have to decide how to maintain the “status quo.” The Court of Appeal has several options, including: (i) “re-freezing” carbon intensity (CI) targets at 2013 levels; (ii) preserving the current status quo, which would freeze CI targets at either 2016 or 2017 levels; or (iii) suspending the operative effect of the current and former LCFS regulations entirely. Another possible variation may be to freeze only the diesel CI targets as biodiesel serves as a replacement for diesel and not gasoline.

At oral argument on the morning of March 23, 2017,[4] the Court of Appeal remained focused on the aforementioned issues. The Court of Appeal questioned both sides as to whether the biodiesel provisions could, as a practical matter, be severed from the rest of the LCFS regulations, and asked POET how best to craft a remedy so that ARB “would pay attention.” POET suggested that, if the Court of Appeal was unwilling to strike down the entire LCFS program (POET’s apparent preferred outcome), freezing the diesel and biodiesel provisions at 2013 levels until ARB was in full compliance would be appropriate. ARB, by contrast, argued that a non-textual remedy was most appropriate. In other words, ARB argued that the modified Writ simply could order ARB to stop issuing LCFS credits to biodiesel producers. ARB emphasized that allowing the LCFS CI targets to ratchet down annually per the expected schedule was critical to the success of the program, and to the development and deployment of low CI fuels. ARB also argued that the modified writ, if not properly crafted, would jeopardize the state’s ability to meet the overarching goal of the LCFS – to reduce the CI of transportation fuels by 10% from 2010 levels by 2020. In the event the Court of Appeal did feel the need to impose a restriction on biodiesel, ARB advocated suspending the issuance of new biodiesel credits through the end of 2017; at that point, ARB argued that the new ADF regulations would become operative, mitigating the NOx emissions at issue in the case.

The Court of Appeal was cognizant of and interested in the potential implications of a remedy not only on ARB but also on market participants who buy, sell, or trade LCFS credits, or who have made infrastructure and investment decisions based on assumptions of continued implementation of the LCFS program. In response to questioning from the bench, ARB painted a dire picture of a market compromised by repeated setbacks and a regulatory regime unable to meet its overarching mandate. The Court of Appeal inquired how long it would take ARB to respond to a modified Writ. ARB replied that if the Court of Appeal voided the entire LCFS regulation or required textual severance of the biodiesel provisions, ARB would need to conduct a new rulemaking, which would take approximately two years. If, on the other hand, ARB only needed to analyze NOx emissions from increased biodiesel usage driven by the LCFS, ARB indicated it could do so within approximately nine months.

The Court of Appeal did little at oral argument to tip its hand as to its preferred remedy, asking relatively few questions and rarely interrupting counsel. That said, based on the tentative ruling and the discussion at oral argument, the Court of Appeal seems inclined to: (i) sever biodiesel provisions from the LCFS regulation, which would mean that biodiesel would not be able to generate LCFS credits until ARB satisfies its obligations under the modified Writ; and (ii) freeze (rather than suspend) the CI targets for diesel. Further, it appears ARB will, at a minimum, need to estimate the amount of increased biodiesel use attributable to the LCFS, and support that estimate with a robust administrative record, before the modified writ will be discharged. However, we caution that the Court of Appeal could take several different approaches and “reading the tea leaves” at oral argument is notoriously difficult.

As initially flagged in our March 2, 2017 post, the implications of even the relatively tailored remedy outlined above could be very significant. At a minimum, there likely would be a market reaction, with a concomitant impact on LCFS credit prices.[5] Such a remedy could destabilize the LCFS to a degree that ARB’s attempts to extend the program beyond 2020 could be further delayed or stymied. Further, the Court of Appeal’s final ruling, due within 90 days of the oral argument, could have ripple effects on other climate programs being implemented by ARB, as well as the overall strategy to achieve the reductions in greenhouse gas emissions necessary to comply with Senate Bill 32.