Briefing Report: Low Carbon Fuel Standard

A Plunge Into the Abyss?
Wednesday, July 3, 2013

One of the lesser known efforts in California’s headlong plunge into environmental perfection is the Low Carbon Fuel Standard (LCFS).  This obscure regulation adopted by the California Air Resources Board (CARB) in 2009 -- that fundamentally reconstructs the market for motor vehicle fuel in California -- requires the providers of gasoline and diesel fuel in California to reduce its carbon intensity by 10 percent by the year 2020.

Ever since its adoption, there has been a raging debate about whether California can reach the lofty goal of 10% reduction in carbon intensity by the required deadline.  The LCFS regulation is designed as a “forcing policy.” This means that CARB admits at the outset that the technology to meet the regulation does not exist in the beginning, and is designed to force technology to be developed to meet the ultimate goal.  This makes the regulation more expensive and market altering than it would have had it been based on existing technology and realistic timelines from the start.

Court Ruling on LCFS

The first reaction to the LCFS regulation was a lawsuit against CARB from the American ethanol industry.  Under current CARB regulations in California, ethanol (mostly produced in the Midwest) is blended with gasoline to increase its oxygen content to make it cleaner burning.  The LCFS mandate would require a less carbon intensive oxygenate blend, such as cellulosic ethanol made from sugar beets.  This type of ethanol is most prominently made in Brazil, but is also produced locally in California.

Midwest ethanol producers sued CARB in federal court and Judge Lawrence J. O’Neill ruled in December 2011 that the LCFS was a violation of the Commerce Clause of the U.S. Constitution because the regulation “impermissibly treads into the province and powers of our federal government, reaches beyond its boundaries to regulate activity wholly outside of its borders.”  In April 2012, the Ninth Circuit Court of Appeals granted CARB’s request for a stay of the preliminary injunction, which allowed CARB to resume enforcement of the LCFS during the pendency of the lawsuit.  On October 16, 2012, the Ninth Circuit considered oral arguments from the parties.  A ruling from the Ninth Circuit is expected sometime in 2013.

Impact of LCFS on Supply of Gasoline

While constitutionality is the issue in the court cases, practicality is the issue most pertinent to the day-to-day lives of Californians.  California has a commuter culture, and gasoline price and supply are vital issues to all working Californians.  Gas price spikes generate news headlines and prompt people to call their legislators in concern and often panic.  "How am I going to survive if the price of gas keeps going up?"

According to the Western States Petroleum Association, California consumes 42 million gallons of gasoline and 11 million gallons of diesel fuel per day.  That amounts to 1.75 million gallons of gas and 500 million gallons of diesel every hour, of every day of the year. LCFS is the greatest threat, in the opinion of many, to the ability of gasoline suppliers to continue to provide a reliable amount of fuel at an affordable price. LCFS is a top-down mandate to make cleaner burning fuels whether the technology exists to do so or not.  Is it feasible for the fuel industry in California (this mandate only applies in California) to retool itself to start implementing this lofty goal?  Or will this rigid mandate bring supply shortages and price increases that many middle class families will be unable to afford?

CARB designed the LCFS to reduce emissions by reducing the carbon intensity of transportation fuels in California by an average of 10 percent by the year 2020.  The LCFS achieves the 10 percent reduction by incrementally lowering the allowable carbon intensity in each subsequent year.  For example, modest targeted reductions of 0.5 and 1.0 percent were required for 2012 and 2013, respectively.  The reductions become more substantial with each year, such that by 2020, the 10 percent average reduction is achieved.  The regulation is also “technology neutral,” meaning that CARB does not care how the reduction is achieved, only that it must be achieved.  Thus the industry has flexibility as to how to lower carbon intensity of fuel.

It is important to note that the LCSF regulation is predicated on the ability of vehicles to run on a new blend of fuel.  Currently, gasoline in California contains 10% ethanol (E10), while the LCSF depends on vehicles with a 15% ethanol blend (E85).  Currently there are only 400,000 such “flex fuel” vehicles in California, and CARB assumes that 4.6 million of these vehicles will be on the road by the year 2020.

Many recent studies have concluded that there is currently a very limited supply of biofuels in California, and that production would have to increase immensely in order to comply with the LCFS.  A report from Charles River Associates, commissioned by the Consumer Energy Alliance in 2010, concluded that “it is impossible to bring to market sufficient quantities of new fuels with sufficiently low-emission factors to meet the low carbon fuel standard without reducing the total amount of transportation fuel consumed,” and describes the LCFS as “a policy that in effect rations gasoline until the required improvement in emissions per gallon is met.”

Two recent studies conclude that there is not enough cellulosic ethanol available to meet the California LCFS demand.  Andrew Chang & Company found that “due to increasing demand for Brazilian ethanol within Brazil and other countries with renewable/low carbon standards, the ethanol market is projected to be in deficit before even considering the LCFS program in California.”

Similarly, Sierra Research found that “CARB’s analysis of the LCFS assumes that up to 2.73 billion gallons of ethanol per year from sugarcane will be available for use in California by 2020.  Virtually all sugarcane ethanol…comes from Brazil and according to the California Energy Commission (CEC), no Brazilian ethanol has been exported to California since 2009.  The Brazilian government’s own export projections, cited by the CEC, suggest only 500 million gallons of sugarcane ethanol will be sent to the entire U.S. market in 2020.”

LCFS Impact on Gas Prices

According to CARB, the LCFS will have little effect on the price of gasoline.  Their internal estimates conclude that gas prices may increase by nine to thirteen cents per gallon.  They estimate that diesel fuel prices could decrease by four cents per gallon at the outset, and increase by 26 cents per gallon by 2020.

The reasons CARB offers these relatively low estimates are based on the assumption that increased investment in low-carbon fuels will reduce their price due to innovative technology and cost efficiencies associated with the rapid adoption of the LCFS goals between now and the year 2020.

A recent UC Davis study actually estimated that gas and diesel prices could be reduced due to the LCSF, because as vehicles adopt the new fuels, gasoline retailers would reduce their prices in order to keep their current customers.  The study points out, however, that it does not account for the supply of raw material for the new fuels, the level of demand for gasoline or diesel, or the production costs for the new biofuels.  None of these factors are currently known.

Other studies, however, predict the exact opposite will occur:  Consumers will see drastic increases in gasoline and diesel prices due to the LCFS regulation.

The Consumer Energy Alliance modeled a LCFS for 11 states in the Northeast and Mid-Atlantic region that projected a gas price increase of 11.1% and a diesel increase of 18.4%.  The study assumed that biofuels will meet current and future demand, and point out that if there were shortages, that prices would be even higher.

A controversial study by the Boston Consulting Group (controversial only in that it was commissioned by the Western States Petroleum Council), predicts that the price of fuel will increase by between 49 cents and $1.83 per gallon due to all the efforts of CARB to reduce greenhouse gases in the atmosphere.  The LCFS would account for between 33 cents and $1.06 of that increase.

A Stonebridge Associates study (commissioned by the California Trucking Association) predicts an increase of $1.47 per gallon increase in diesel fuel by 2020 due to the LCFS.  It also predicts an increase of $2.22 per gallon due to the combined effects of all CARB climate change programs.  They attribute these costs to the combined effect of increasing the cost of refining diesel fuel and taxes on the higher costs.

Will the LCSF Work?

It is clear that CARB believes that the LCFS is workable, and will continue to consult with interested parties and affected industries to consider modifications as the implementation period continues.  It is also clear that the regulation was adopted with the intention of “forcing technology” to proceed in a particular direction as fast as possible.

The industries affected by the LCFS rule appear to believe that the timeline is unrealistic and technology is nowhere near where it needs to be for even minimal compliance to be achieved.  The projected amount of ethanol will not exist and the requisite number of vehicles needed by the implementation date is not achievable.  The result would be large cost increases in fuel leading to negative economic impacts such as reduced economic growth, job losses and reduced tax revenues to the state.

As of today, only California has a LCFS mandate.  If other states adopt this kind of regulation, all of the problems pointed out here will increase exponentially.

Conclusion

If critics are correct and CARB’s Low Carbon Fuel Standard is impractical due to its significant effects on fuel supply, subsequent increases in fuel prices, then California could be headed toward a long period of gas price spikes and lost jobs due to the economic turmoil that results.

If consensus builds around the conclusion that the LCSF is flawed then perhaps CARB should consider incorporating flexibility within the LCSF regulation, should fuel suppliers be unable to meet its ambitious goals.

Extension of rigid timelines would be the most useful if markets cannot adjust within the current timeframe.  Most importantly, CARB should closely monitor the effect that these “technology forcing” regulations have on the price of gasoline and diesel fuel and consider suspension of the mandate if market prices get out of hand.  Gas prices can accelerate quickly when market conditions change even slightly in a state known for its heavily regulated gas formulas, lack of refining capacity, and reliance on the automobile.

 

For more information on this report or other Transportation & Housing issues, contact Doug Yoakam, Senate Republican Office of Policy at 916/651-1501.