Moving Forward with the Low Carbon Fuel Standard

Last week’s Supreme Court decision to decline an appeal on the constitutionality of California’s Low Carbon Fuel Standard (LCFS) is further evidence that efforts to block policies bringing alternative fuels to market are missing the big picture. California voters, and their Legislature and Governor, have acted decisively and repeatedly to be leaders in addressing climate change through an ambitious set of carbon reduction policies, including maintaining the state’s goal to promote innovation in fuels and vehicles. California policies align with national polling which shows that two-thirds of Americans are concerned about climate change and support President Obama’s new climate rules. Politically, climate policy will get increased backing over time given that the Millennial generation is 76 percent more likely than their parents to favor environmental action.

Already, Millennials are more inclined to favor alternatives such as ride sharing and living densely. These new patterns could gain more momentum if war or other disasters or simply traffic congestion reduce the utility of individual oil-based car ownership in U.S. urban areas. Instead of buying cars and fuels, we could see a major transformation in how transportation services are delivered and priced in the next several decades. Automobile and technology companies understand the necessity of staying ahead of such trends. They are experimenting with innovative new business models in delivering transportation services and technology, including Daimler and BMW’s all electric car sharing programs as well as new entrants such as Uber and Lyft.

The Supreme Court’s decision that the LCFS will stand should be viewed as a signal to all stakeholders that now is the time for cooperation, transparency and creativity to facilitate carbon reductions in the transportation fuel sector, the largest contributor of California’s greenhouse gas (GHG) emissions. Customers and shareholders alike will increasingly be looking to industry leaders for alternative fuels solutions. Geopolitical unrest and severe weather will continue to disrupt fuel supply chains, perhaps more dramatically in the future, and the public will demand a response. Though LCFS has encouraged California’s refiners to buy cleaner, alternative fuels as they become available, most still don’t think returns are sufficient to make major investments of their own capital in clean fuels development. But consumers may demand diversity if they feel or perceive increasing price and supply insecurity in traditional fuel supplies.  A future shock to supply and price – and especially one akin to a 1973-style shortage – could trigger a permanent loss in demand for gasoline and diesel over time.

To date, some large energy firms operating in or marketing to California have taken a relatively passive role towards investing to meet the LCFS. With the Supreme Court declining to review the LCFS challenge, now is the time for a broader number of industry players to work collaboratively with policymakers, academics and the environmental community to find the most feasible pathways for the LCFS to succeed. Early industry experiments in drop-in biofuels were relatively small compared to the industry’s operations and have been generally unsustained. Some companies, such as Valero Energy Corporation remain more firmly in the game, having positioned itself with more than one billion dollars in renewable fuels assets and research including 11 state-of-the-art ethanol plants (with more than 1.3 billion gallons of ethanol production). Clean Energy also has a strong alternative fuel presence with its network of natural gas fueling stations.

The intention of the LCFS is to promote investment in these alternatives without picking winners, and hopefully, in its wake ultimately lower prices for fuels, and create choice for consumers. Innovative technologies are emerging from new agriculture and technology businesses in California but not sufficiently with oil and gas companies, who tend to shun high R & D spending in general. R & D spending by oil and gas firms as a percentage of total revenue averages about 0.3%, far lower than most other industries.

In fairness, industry’s warnings that cellulosic ethanol will not be sufficiently available to contribute to California’s 2020 targets will likely be correct. California regulators will have to take that into account, but also need to weigh heavily the need for regulatory certainty for the many companies who have made billions of dollars in investments in technologies and fuels that are succeeding. There is strong evidence that other fuels could pick up the slack where cellulosic ethanol might be falling short, including renewable diesel, electricity, natural gas in trucking, and other biogas/biofuels alternatives. UC Davis Institute of Transportation Studies (ITS-Davis) analysis shows that the LCFS is replacing oil with cleaner-burning fuels in cars and trucks, with the carbon emissions reduction in the first two and a half years equal to taking 500,000 vehicles off the road.

To be accurate, even if California has not necessarily elicited the production of more biofuels since the LCFS was implemented in 2011, it certainly elicited better biofuels. ITS-Davis research shows California’s LCFS has incentivized the de-carbonization of the overall U.S. biofuels supply chain by rewarding in particular the production and use of waste-based biofuels. From 2011 through 2013, California expanded the use of low-carbon alternative fuels (including non-biofuels) by 0.22 billion gasoline gallon equivalents (GGE)/year, and reduced total carbon emissions by 6.4 million MT CO₂e, taking close to a million cars off the road for a year. (LCFS Status Review, July 2014)

To date, the LCFS is generating credits far in excess of deficits (46 percent in the first half of 2013). Granted, some fuel shuffling is taking place with sugar and sorghum biofuels and cleaner biodiesel being shipped to California to gain LCFS credits. This shuffling is pushing higher carbon U.S.-based corn ethanol and more carbon intensive biodiesel to elsewhere in the United States, and not to California. However, besides encouraging improvements to existing biofuel facilities and new bio-digester and waste-based biofuel start-ups, the LCFS requirement has succeeded in incentivizing major industry players to venture into alternative fuels, including Waste Management, Clean Energy, and Southern California Gas Company. These companies, among others, are actively investing in new natural gas or biogas fuels and fueling infrastructure in the state.

The oil and gas industry has invested hundreds of billions of dollars in conventional and unconventional petroleum. Just as the oil industry response to clean air rules in the 1980s increased its productivity and profitability, so a broadening of lower carbon business models will position companies for a more resilient future that will include a large number of unpredictable uncertainties involving reliability of feedstock supplies, infrastructure security, a growing worldwide appetite for air quality regulation (if not carbon), and changes in consumer lifestyles and preferences.

Change is afoot. The U.S. market share of electric cars is increasing with more than a third of national sales occurring in California. Each additional gasoline gallon equivalent of electricity used in cars displaces three gallons of gasoline at a quarter of the price and one-third the carbon emissions, compared to gasoline. California cities and ports currently have some of the worst air quality in the country, which natural gas trucks can address by lowering particulate and carbon pollution by 10-20 percent, or even up to 90 percent of carbon emissions if biogas is utilized.

To meet California’s ambitious 2020 LCFS carbon intensity goal, the state will need to facilitate roughly an additional 1.9 billion GGE/year low-carbon fuels (or less if more electricity and hydrogen are deployed since they are more efficient).  This is not a trivial task.  Some NGOs are confident the target can be met. The oil industry is not.

Over the long term, we agree new technologies are needed for the LCFS to be successful. The question is: What is the best way to achieve that?

While some companies prefer policies that roll back the standard, policymakers are looking for more creative options. Chicken-egg infrastructure constraints continue to dominate the situation, leaving second best solutions like temporarily capping LCFS credit prices or delaying targets. The oil industry needs to come forward with more constructive proposals to improve its participation in diversifying and expanding fueling investments in line with technology efforts by GE, Tesla Motors, Toyota, and First Element Fuel. Rather than just arguing that targets must be abandoned because cellulosic technology is advancing more slowly than anticipated, the industry needs to offer concrete proposals for RD&D and infrastructure investments that they would be willing to commit to prospectively, were the state to respond constructively as well.

Government and academic energy models (and Wall Street reports) show oil companies risk measurable market share losses in the future fuels markets if they do not embrace  innovation in technology and business models. Tesla Motors, Honda, Hyundai, Mercedes-Benz, Nissan and Toyota are investing in their own charging and hydrogen refueling stations. They are collaborating with governments and universities in finding solutions to infrastructure challenges. Home fueling technologies could also proliferate.  Low carbon rulemaking is driving innovation and beginning to contribute strongly to California’s gross domestic product and tech industry leadership. The refining and marketing industry needs to cooperate instead of threatening doom and gloom.

Computing power and innovation have been driving dramatic change across other industries. The transportation fuels industry is not likely to be an exception. Changing consumer preferences and government policies aimed at reducing pollution and enhancing energy security are gaining momentum. This will spell dramatic adjustments to gasoline and diesel markets, giving the oil industry impetus for innovation and new strategies.

As last week’s Supreme Court news continues to reverberate, California’s commitment to reduce air pollution and carbon emissions from transportation fuels remains strong and its LCFS can serve as a model policy to foster innovation and bring clean fuels to the market that will ultimately benefit the consumers.