Double Whammy for State Fuel Suppliers (Daily Journal)

Double Whammy for State Fuel Suppliers

The California Air Resources Board (CARB) is poised to readopt the Low-Carbon Fuel Standard (LCFS) regulation in early 2015. With its readoption, CARB hopes to put to rest challenges that required a redo of the environmental analysis supporting the LCFS regulation. If all goes as planned, transportation fuel suppliers operating in California will face a regulatory environment in 2015 that is at once both more certain — with legal challenges to the LCFS largely resolved — and more daunting, as transportation fuels come under the “cap” on greenhouse gas emissions imposed by California’s cap-and-trade program.

Fuel suppliers in California have had to comply with the LCFS since 2011. One of several programs developed by CARB to implement the Global Warming Solutions Act (Assembly Bill 32), the LCFS seeks to reduce the “carbon intensity” of California’s transportation fuels by at least 10 percent by 2020. To achieve this goal, the regulation requires all “providers” (refiners, blenders, producers and importers of transportation fuels) to supply a mix of fuels that, on average, have a “carbon intensity” that is less than or equal to a target for a given year. Carbon intensity is a measure of how much carbon is emitted in the extraction, processing, transportation and use of a fuel. It reflects carbon emissions from “well to wheels” — from initial extraction to emissions from a tailpipe — and includes indirect emissions, such as from trucks used to transport the fuel.

Under the LCFS, fuel suppliers must offset carbon intensity deficits generated by conventional fuels (which produce more emissions than the carbon intensity targets) by either producing alternative fuels (such as biodiesel or hydrogen) that offset the deficits or purchasing credits generated by other suppliers. Some fuels are exempt from the carbon intensity requirements, including fuels for aircraft, interstate rail transport and ocean-going vessels.

Resolution of Legal Challenges to the Low Carbon Fuel Standard

CARB’s readoption of the LCFS will mark the end of a long recovery from a near-death experience for the regulation. In July 2013, in POET LLC v. California Air Resources Board, 218 Cal. App. 4th 681 (2013), the 5th District Court of Appeal held that CARB failed to comply with the California Environmental Quality Act and the state Administrative Procedure Act in adopting the LCFS. However, the court allowed the regulation to remain in effect, with carbon intensity standards frozen at the 2013 level, so long as CARB continued to “proceed in good faith and without delay” to correct those procedural errors.

In response to the court’s order, CARB has been moving forward with a plan to “readopt” the LCFS to cure the procedural defects in the current regulation and incorporate several substantive updates, including a cost-containment provision intended to increase market certainty about the maximum costs of compliance. CARB staff will likely present the readoption proposal to the board for approval in early 2015. After the interruption caused by the POET litigation, carbon intensity limits will resume their downward trajectory, with the pace of reductions steadily increasing from 2015 onward.

A separate federal court challenge to the constitutionality of the LCFS was rejected by the 9th U.S. Circuit Court of Appeals in September 2013. Rocky Mountain Farmers Union v. Corey, 730 F.3d 1070 (9th Cir. 2013). The U.S. Supreme Court denied a request to review that decision in June. Unless a new, successful challenge to the LCFS is mounted, fuel suppliers will be required to comply with the readopted LCFS through at least 2020, at which point the state may extend the program and adopt “more aggressive targets,” according to CARB’s May 2014 Climate Change Scoping Plan update.

A Second Greenhouse Gas Control Measure Aimed at Fuel Suppliers

In addition to increasingly stringent requirements under the LCFS, fuel suppliers will come within the greenhouse gas emissions “cap” under California’s cap-and-trade program beginning on Jan. 1, 2015. Since 2013, the cap-and-trade program has covered large industrial facilities and electricity generators. Beginning in 2015, the program will expand to cover fuel suppliers that exceed an emissions threshold of 25,000 metric tons or more of carbon dioxide (or CO2-equivalent greenhouse gases) annually.

Under the expanded cap-and-trade program, fuel suppliers will be required to obtain allowances or emissions offsets to cover the amount of greenhouse gas emissions that would result from the complete combustion of fuels they sell or import into California. Notably, purchasing greenhouse gas emissions allowances under the cap-and-trade program does not relieve fuel suppliers of their obligation to comply with the LCFS, so fuel suppliers must comply with two separate regulations that target greenhouse gas emissions from the same sources.

Costs and Benefits of the Expanded Cap

While this apparent overlap has generated controversy, most objections to the expansion of the cap-and-trade program to include transportation fuels have focused on the magnitude of its potential effect on gas prices. Several state legislators urged the governor to delay the expansion of the cap-and-trade program, citing concerns about increased gasoline prices. However, those requests came at the same time that gas prices were plunging due to market forces. A bill to delay the transportation fuel requirements for three years failed to come up for a vote in the state Senate. There is no indication that CARB intends to delay the expansion, which is now scheduled to take effect in less than two months.

There has been considerable public debate about the magnitude of the effect on gas prices of bringing transportation fuels into the cap-and-trade program. Allowances for calendar year 2015 emissions are priced at around $12 — close to the prices for 2013 and 2014 allowances. The program’s emissions “cap” will more than double in 2015 to accommodate emissions from newly covered sources, and CARB has to date largely succeeded in its goal of maintaining stable, relatively low prices for cap-and-trade allowances. The Legislative Analyst’s Office estimates that gasoline prices will increase approximately eight to nine cents for each $10 of allowance cost.

A recent analysis by Haas School of Business Professor Severin Borenstein predicts that the current regime of low, stable allowance prices is likely to continue after Jan. 1. Borenstein observes that, based on current allowance prices, the immediate impact on the price of gasoline is likely to be modest, around nine to 10 cents per gallon. In contrast, the Western States Petroleum Association (WSPA) predicts that bringing fuels under the cap will raise the price of gasoline by 16 to 76 cents per gallon, based on the assumption that allowances will increase in cost to somewhere between $14 and $70.

The Legislative Analyst’s Office predicts an increase of 13 to 20 cents per gallon, but notes it may be difficult for a casual observer to see any effect given the large swings in gasoline prices as the result of other market forces. Just in the past six months, gasoline prices have declined by approximately a dollar to a current low of about $3.15 per gallon. Notably, only at the higher end of the WSPA estimate does the impact of the cap-and-trade program reach a level that might stand out from the normal volatility in gasoline prices.

Despite their different assumptions, both industry and other analysts agree that the impact of cap-and-trade on gasoline prices is likely to be modest if allowance prices remain stable and low, as they have since the implementation of the cap-and-trade program in 2013. Of course, this suggests that the impact of putting fuels under the cap on fuel consumption and greenhouse gas emissions is also likely to be modest — particularly if crude oil and gasoline prices continue their current downward trajectory.

R. Morgan Gilhuly is the managing partner of, and Christopher Jensen is an associate with, Barg Coffin Lewis & Trapp, LLP — a San Francisco-based law firm providing nationally recognized expertise in environmental law and litigation. Mr. Gilhuly can be reached at [email protected] and Mr. Jensen can be reached at [email protected], or via the firm’s website: www.bcltlaw.com.