In recent LCFS amendments, CARB introduced a new price cap on all LCFS credit transfers and authorized limited future credit borrowing.
By Joshua T. Bledsoe, Brian F. McCall, and Kevin A. Homrighausen
On November 21, 2019, the California Air Resources Board (CARB) passed Resolution 19-27, approving several amendments to the Low Carbon Fuel Standard (LCFS) program designed to foster stability in the LCFS market and promote access to electric vehicle (EV) transportation for disadvantaged and low-income communities in California.
Concerns of Credit Price Run-up
The LCFS is a key pillar of California’s efforts to reduce greenhouse gas (GHG) emissions in the transportation sector. As discussed in previous posts, regulated entities must either: (1) ensure that fuels supplied in California meet annual, decreasing carbon intensity (CI) targets (e.g., by blending biofuels into gasoline and diesel); or (2) procure and surrender credits to CARB. Regulated entities can buy LCFS credits in the bilateral market or in the Credit Clearance Market (CCM), a CARB-administered market intended to supply cost-controlled credits in the event of a market shortage. The rulemaking appears to reflect CARB’s acknowledgment of long-held concerns in the LCFS market that deficit generation will outstrip credit generation, and the CCM will be unable to adequately cap credit prices. The steady advance of LCFS credit prices since the summer of 2017 is well documented in CARB’s Credit Transfer Activity Reports. The most recent LCFS amendments are intended to ensure that the CCM will continue functioning in the event of a credit shortage and to safeguard against a potential LCFS credit price run-up.
Summary of Amendments
After considering the initial and final staff reports, written comments, and public testimony, CARB unanimously passed Resolution 19-27, which amends Sections 95481, 95483, 95485, 95486.1, 95487, 95491, and 95495 of Title 17, California Code of Regulations. The amendments include six key changes to the LCFS program:
- Maximum Tradable Price for LCFS Credits. The first amendment places a price cap on all LCFS credit transfers at $200 in 2016 US dollars, adjusted for inflation. This cap extends the existing price cap on credit transfers in the CCM to the sale of credits in the bilateral market. CARB staff argues that by prohibiting credit transfers in excess of this maximum price, regulated entities can clearly assess their compliance costs while protecting consumers and investors from credit price spikes and instability wrought by a potential a LCFS credit shortage. However, the new amendment does not address how CARB will enforce the new price cap on transactions if the cost of LCFS credits are “bundled” into the price of alternative fuels and thus reported as a zero or near-zero transaction. In these situations, parties might negotiate veiled LCFS credit prices, rendering the price cap “illusory,” to quote one public comment.
- Limited Future Credit Borrowing. The amendments seek to promote stability in the CCM by allowing CARB to borrow up to 10 million LCFS credits that presumably will be generated by future base residential EV charging. These so-called “holdback” credits will be distributed among California’s largest utilities, which then will be obligated to pledge those credits to the CCM. Upon the sale of these pledged credits, the utilities will be required to spend the sales revenues to bolster future EV sales. As discussed below, this amendment seems consistent with CARB’s favoring of electrification over other approaches to decarbonizing fuels. According to CARB, this provision supports the LCFS by allowing regulated entities to meet outstanding deficit obligations in the event of a statewide LCFS credit shortfall.
- Mandatory Compliance Plans. This new provision requires deficit-generating entities that have participated in the CCM for two consecutive years to submit a Compliance Plan outlining how they intend to maintain compliance with the LCFS. Once CARB approves a participant’s Compliance Plan, the participant will then be required to submit an annual implementation report. If CARB finds that a participant’s implementation report deviates from its Compliance Plan, then the implementation report may be made public. However, CARB acknowledges that it will work with participants to redact confidential trade secrets and information. Once again, this provision is intended to provide stability in the LCFS credit market by demonstrating to CARB, stakeholders, and consumers that regulated entities will continue to achieve compliance with the program.
- Removing Buyer Liability. In the past, entities purchasing credits in the CCM ran the risk of having to replace those credits should they later be invalidated. Instead, this new provision states that invalidated CCM credits will not be removed from regulated entities’ accounts. This buyer protection provision is designed to allay regulated entities’ concerns over participation in the CCM.
- Holdback Credit Revenues for Disadvantage Communities. The amendments require utilities to invest revenue from the sale of holdback credits in projects that support transportation electrification in California’s disadvantaged and low-income communities. CARB views this environmental-justice-orientated provision as part of an equity-based framework that seeks to expand access to EVs.
- Clarification of Base Electricity Credit Allocation. Finally, the amendments attempt to clarify how base credits generated by residential EV charging may be allocated in certain circumstances. When these credits are generated in the service area of a utility that is ineligible to receive those credits, the credits will be issued to large utilities that are then directed to reallocate them to the Clean Fuels Reward (CFR) program. According to CARB, this provision is intended to ensure that the CFR program, which is entirely funded by the LCFS, remains solvent.
As part of the rulemaking, CARB staff also prepared an economic analysis of the LCFS amendments. CARB conservatively estimated that the new LCFS credit cap would result in US$2.9 billion in lost LCFS credit revenue over the next 10 years, despite modest revenue increases over the next three years. At first blush, this substantial decrease in revenue may appear to discourage investment in low-carbon fuels. However, CARB is betting that capital providers and low-carbon fuel producers will find the increased stability in the LCFS market to be worth the cost of implementing a credit price cap. Similarly, consumers may appreciate the effect that the credit price cap will have on the cost of traditional fuels, as LCFS compliance costs generally have been passed through to the pump. One study estimated that in 2018, the LCFS program resulted in consumers paying an extra 12¢ per gallon of gasoline. The same report found that even under the US$200 CCM price cap, this cost could rise to 69¢ per gallon by 2030. Although drivers historically have been unaware of how the LCFS increases gasoline prices, their familiarity with the program could change if credit prices in the bilateral market were to spike — potentially making the LCFS program politically untenable.
In the lead-up to, as well as during, the November 21, 2019, CARB board meeting, the board received 17 written comments and heard testimony from 12 relevant parties, including individuals, energy producers, nonprofits, advocacy groups, utility companies, and other relevant LCFS stakeholders. Overall, public commenters expressed general support for the proposed amendments, emphasizing their appreciation for the board’s desire to protect the stability of the LCFS and promote environmental justice by extending electric transportation services to disadvantaged communities. In some cases, commenters expressed concerns that the new provisions did not go far enough in either of these respects, or would benefit from additional clarification. Finally, a minority of comments outright opposed certain amendments, arguing that they would likely overburden the LCFS program.
CARB received several comments from organizations representing traditional and low-carbon fuel producers. Although opinions from these groups were divided, the majority of fuel producers expressed support for the proposed amendments. One organization representing petroleum, natural gas, and other energy suppliers expressed concern that the credit borrowing provision, by establishing a 10 million credit borrowing limit, may not adequately ensure the program’s stability in the face of a substantial credit shortage. The same organization argued that the new Compliance Plan provision may require entities to divulge sensitive commercial information. Regarding the new credit price cap, some fuel producers characterized the provision as a welcome source of market security, while others argued that a price cap may be unnecessary or may prove counterproductive by discouraging otherwise costly investment in low-carbon fuels. Finally, one organization recognized that by borrowing future credits solely from EV charging, the new amendments fail to adequately incentivize investment in other forms of low-carbon fuel. Despite the LCFS’s foundational commitment to fuel neutrality, these new amendments appear consistent with CARB’s more recent favoritism to electrification — a subject that was previously discussed in the context of capacity crediting for EV chargers.
The remaining comments CARB received from public agencies, nonprofit advocacy groups, and low-carbon project developers generally supported the proposed amendments. These submissions placed significant focus on the amendments’ environmental-justice objectives while encouraging CARB to revisit provisions related to the administrative costs associated with LCFS compliance.
The recently passed amendments reflect an intention to ensure that regulated entities, investors, and consumers feel secure in the LCFS market and a desire to extend the benefits of the program equitably among Californians. CARB views the LCFS program to be at the forefront of market-driven GHG reduction measures and believes that its evolving structure will continue to serve as a model for future programs at the state, national, and international level. Latham & Watkins’ Environment, Land & Resources lawyers will continue to track and report on low-carbon fuel programs.