Podcast - State Low Carbon Fuel Standard Outlook

Andy Kriha: One quick update before we get started today. Shortly after we recorded this episode, the California Air Resources Board announced that it would hold a public hearing to consider and likely vote on amendments to the California CFS on November 8, 2024. So later on in this episode, when you hear us say, "we don't know when that hearing will take place," pretend we said, "November 8." Instead, we'll be following this rulemaking closely. So tune into future episodes and look for our written client alerts to make sure you always have the latest information. And with that, please enjoy the episode.

Andy Kriha: Thank you for joining us in this episode of An Energized Exchange. I'm Andy Kriha, an associate in the D.C. office of Holland & Knight, and I am joined by Susan Lafferty, a partner at Holland & Knight. Today, we're going to be talking about state low carbon fuel standards and, basically, the state of the industry. Where are they at right now? We'll mostly be discussing California's ongoing rulemaking. It's quite a large rulemaking, one of the biggest overhauls of the program since its inception. We will also hit on New Mexico's new low carbon fuel standard statute, as well as which states might be next. There is not a lot new to report on the other two established programs of Oregon and Washington. We will note here at the start that Oregon is currently undergoing a rulemaking process to alter and reinstate its limited cap and trade program, which was recently struck down by a state court for procedural reasons but also faced some state constitutional questions. The Oregon cap and trade program, at least as it existed in its prior form before this court action, disproportionately impacted fuel suppliers compared to some of the more economy-wide cap and trade programs in other states. So, what happens with that program will be something to watch for those who are interested in the clean fuels program as well. And we are, as well, going to note for Oregon right at the end of our podcast today, a brief update on some arrests from a fraud case that we talked about in a prior podcast a little over a year ago. We'll also note briefly at the top here that Washington is undergoing major changes in its economy-wide cap and trade program as it looks to link with California and Quebec. That program also faces a repeal effort on the November ballot. So, developments there could impact future Washington clean fuels program efforts. But that remains to be seen.

So, with that, let's launch into the biggest piece of our program here today. And that is the California cap and trade program and specifically this rulemaking that's been happening since about, you know, February of last year. So that process started, like I said, about February of last year, there are some partial draft regulatory language that was released, along with some more vague ideas about other changes that could be made without any specific language. And those were released in conjunction with a workshop that was open to the public and open to public comment. There were several additional workshops and other opportunities for public input throughout all of 2023, including a full discussion at a full California Air Resources Board meeting in September of 2023, which ultimately led to full proposed rules released in December of last year. Those rules were supposed to be voted on by the full board in late March of this year. There were so many comments that they decided it needed additional time for consideration of those comments and to potentially make some additional tweaks. And so that board vote was delayed. There's no set timeframe for when a rule will be voted on. Or if any changes will be made in response to those comments. Under the proposal, the earliest any changes were set to be made were January of 2025, effective for the 2025 compliance year, with some of the more complex and difficult, more difficult to implement changes, set to occur in future years. And we'll note those as we go throughout this program. But that early timeline of January next year, as of right now, does not seem in jeopardy. However, however it meets monthly, we don't know until about 10 days in advance of when CARB meets, whether or not it's going to take up any particular issue. And so, by the time this episode is released, May's meeting will have occurred. It is not on the agenda for today's meeting. So the first time the board could consider it is June, and we just don't know if that's going to happen or not. The purpose of this rule is to implement the 2022 Scoping Plan update. That's a comprehensive document that benchmarks California's success to date with proceeding toward its economy-wide carbon reduction goals and implementing recommended actions to accelerate carbon reductions in the state. The common theme among the changes from this rulemaking is to implement stricter carbon reduction goals, as well as allowing the goals to automatically become more stringent anytime goals are exceeded. So, Susan, can I turn it over to you now to explain some of the specific changes that are being proposed here?

Susan Lafferty: First, phasing out all avoided methane crediting by 2040, which is a move that many referred to as a de facto ban of biomethane from the program. The second proposed change would require physical delivery of gas into the state of California beginning in 2027, which would not have been booked and claimed altogether but would have required a showing of a pathway of pipelines from the project into the state of California that actually flowed in the direction of California most of the time. So, at least 50 percent of the time. The proposed rule, most recently released in December 2023, actually significantly walked back these changes in part due to the outcry that came from many in the industry. So, under the newer proposal, neither would be applied to projects that break ground on or before December 31, 2029. These programs could continue to use book and claim accounting. Could take advantage of avoided methane crediting for up to three consecutive 10-year crediting periods. It would also allow for some avoided methane crediting through 2059. Projects that break ground on or after January 1, 2030, could avail themselves of the existing rules through 2040. Andy, I'm going to hand it back over to you to talk about what happens in 2041.

Andy Kriha: Yeah. So beginning January 1 of 2041, any projects that broke ground after that date you just mentioned, Susan, January 1, 2030, would not be eligible to generate LCS credits at all anymore. At that point, they would be treated as the equivalent of ultra-low sulfur diesel and would need the claim that PSI score for deficit-generating purposes. Additionally, any such projects would need to show physical delivery into California via nominations and pipelines that flow toward California most of the time. So for those projects beginning in 2041, it would look a lot more like those original 2023 proposals from the rules. Do note briefly here before we move forward, that projects using biomethane for hydrogen production would get an additional five-year grace period to come into compliance. So those projects would not need to comply with these rules until January 1 of 2046.

So with that, I want to move on to the next big piece of this rulemaking. And that is the auto acceleration mechanism. So right now, how the program is structured is each year, the benchmark carbon intensity score, against which fuels are measured as either a credit generator or a deficit generator, that steps down every year. This mechanism would allow the rate at which it steps down to increase. So the mechanism would be triggered for any year in which the credit bank, which — that refers to the number of credits out in accounts of private parties that have been generated but not yet retired — when that credit bank is greater than 75 percent of the total deficit generated for that year, and the total number of credits that were generated that year exceeds the total number of deficits generated that year. So two different steps there. The credit bank has to be a certain size for that year. And the number of credits generated in that year must exceed the number of deficits generated in that year. So if, in a given year, there were a million deficits generated and 1.1 million credits generated, and at the end of the year, there are more than 750,000 credits sitting in accounts, not retired, then the mechanism would be triggered. The mechanism cannot be triggered in two consecutive years. So it — most every other year and beginning in 2028, each time the mechanism is triggered, the annual CI benchmark scores would advance by one year relative to the current schedule. So this will result in greater deficit generation, lower credit generation, and, ultimately, assuming the program works just designed, lower carbon emissions. So, for example, right now, the proposed CI benchmark for gasoline for 2029 is 71.79. And for 2030, that decreases to 69.55. So a low carbon fuel that acts as a gasoline substitute with a carbon intensity of 60, in 2029, could generate credits on the difference between 71.79 and 60. So, they could generate credits on that, a difference of 11.79. But if the mechanism is triggered, it would only be able to generate on the difference between 60 and 69.55, or, you know, only 9.55. Note that regardless of where the credit bank stands following this year, the proposal does include a one-time 5 percent step down. No, again, no matter, no matter where we're at coming out of this year.

Next up, the last piece of, of this proposed rule that we want to spend, a decent amount of time on, is the change to the GREET 4.0 model. GREET is a model that's used to determine the carbon intensity of a specific fuel. It was originally developed by Argonne National Lab. Several variations have been published to meet specific use cases. A big thing that I'm sure we'll be talking about in future episodes of this podcast is the use of GREET for various tax credits under the Inflation Reduction Act. But here, the California LCF has been using it for quite some time. They're currently on the third version of the California-specific GREET model and are now looking to go to the fourth. The model covers every aspect of the fuel life cycle, including emissions associated with feedstock production, fuel production and transportation of the fuel from its production source to market. The proposal will make several technical adjustments to the way scores are calculated. Notably, it will include updates to the electricity generation resource mix for regional electric grids throughout the United States, as well as Brazil and Canada. So that's going to impact the score for any electricity used in the production process: fuel, updates to crude oil extraction and transportation emissions, updates to ocean tanker and truck transportation emissions, updates to the tailpipe emissions factors, for the combustion of the fuels. So that is, you know, when the fuels are actually being used in their end use case versus being transported to market. Updates to tallow and used cooking oil rendering emissions, and updates to the energy density of a handful of specific fuels. If adopted, existing pathways will be automatically adjusted beginning January 1, 2026. And any new pathways approved on or after January 1, 2025, would need to comply with the new factors immediately upon approval. So that was a lot. But that is the current state of the California rulemaking. And everything that goes into that. We will, of course, continue to keep you all updated on where that goes. But in the meantime, I think we wanted to start talking about the new states that have not previously had LCFS programs and what it's looking like elsewhere. So, Susan, can you tell us about New Mexico?

Susan Lafferty: Sure. I'll take one quick step back. Folks often still ask, what about a federal low carbon fuel standard? Of course, there is the Renewable Fuel Standard, the RFS, but that is not directly connected to low carbon fuel. So the likelihood of a federal program right now does not appear to be anywhere on the immediate horizon. Of course, it's an election year. So this will very much depend on who is in the White House and who is in Congress. But what we're about to talk about with New Mexico and with some other states that might be following suit are part of what could lead to a tipping of the scales towards more and more stakeholders. On both sides of the ledger, both the oil and gas interest as well as renewable interest, going to Congress and saying, hey, we really need something on the federal level as opposed to a patchwork of different programs. As we will see once these new programs are implemented, they are expected to be similar to the California low carbon fuel standard. But as we've seen in Oregon and in Washington, they are very much in the similar but different category. So New Mexico will be the next one that we expect to be similar but different. As Andy alluded to, in March of this year, New Mexico became the fourth state to adopt and pass into law legislation that calls for a low carbon fuel standard. The New Mexico Environmental Improvement Board is tasked with implementing this new program — it's called the Clean Fuel Standard — no later than July 1, 2026. Prior to finalizing regulations, the board is going to convene an advisory committee consisting of both in-state and out-of-state entities in the transportation fuel supply chain. Utilities, local and tribal governments, and environmental groups are included. The state is actually currently taking applications for the advisory committee through the end of May, through May 31. So if you are a stakeholder and listening to this, we would highly recommend participating. That will, presumably, help give insight, intel into where this program is going as well as input, which is, which is very important. The program is going to be designed to achieve at least a 20 percent CI reduction by 2030, and then a 30 percent reduction by 2040 relative to 2018 goals. The program is also set to include a trade credit trading scheme. That's going to be similar to what, again, we've seen in the other LCFS states. It's going to require utilities to reinvest their proceeds. It should be generally consistent with other state programs according to the legislation, and it also must not interfere with the federal RFS or future federal programs. Finally, the program is called to be technology-neutral and also to include both electricity and hydrogen. So this is another program that we will be watching. Presumably, there will first be some draft and or proposed rules that will solicit comment from the public. And again, that will be advisable to participate in. And that will take place leading towards the final regulations, which will have much more detail than what the legislation itself allowed for. So other states have obviously been talking for a number of years. And some others  seem somewhat close. So, Andy, do you want to review the bidding there?

Andy Kriha: Yeah. So there are at least eight other states that formally introduced legislation regarding LCS programs in this year's legislative sessions. States typically have very short legislative sessions that last one or two months. January through March is a fairly common timeframe. But a few have their sessions still ongoing as well. So the eight states that had bills introduced this cycle are Hawaii, Illinois, Massachusetts, Michigan, Minnesota, New Jersey, New York and Vermont. Certainly, anywhere where it has been introduced could be the next place. But I want to call two out that seems just a little bit more likely than the others.

The first is Minnesota, where the LCF has been a major talking point in legislative sessions for a few years now and has actually garnered some public discussion. Not just a bill that gets introduced and then doesn't go anywhere. And in fact, last year, in their 2023 session, a bill was passed and signed into law that created a lakefront working group. That group met between July of last year and January of this year and produced a report to the legislature that recommends implementing an LCS and, in fact, states, quote, "it could be the largest single policy for the reduction of carbon pollution from transportation in Minnesota." So, that certainly bodes well, I would say, for the future of a potential CFS there.

The other place that I would look to is New York. There hasn't been much publicly stated about this year's iteration of the bill. It has not moved at all since being introduced. But that doesn't necessarily mean nothing's going to happen. New York is one of those states where its legislative session is still ongoing. And last year's bill seemed similarly stuck for most of the session. And then all of a sudden, there was a lot of talk, a lot of reports with about a week to go in the session. That it had legs and might actually pass and, in fact, did pass in one chamber, during the final week, and was expected to be voted on by the other chamber on the final day. But came up short of actually getting to the floor and receiving a vote despite optimism right up until the last second that it would be voted on. New York's session extends through early June. So there's still plenty of time. We know that New York is currently working on implementing an economy-wide cap and trade program. It's actually already missed its statutory deadline for getting that program implemented. So there is some pressure to get that done sooner rather than later. And as we've seen in other states, particularly the three West Coast states, an LCFS is often seen as an ideal complement to an economy-wide cap and trade program. So as that program gets stirred up, we could see more of an effort for an LCFS there.

There will continue to be a push for LCFS programs in other states, particularly by low carbon fuel producers and their government affairs advisors. Certain low carbon fuels, notably RNG and biomethane, have already saturated the market in certain states, where there are already programs. And so additional incentives are likely to be needed to continue to expand the growth of those particular fuel sources. There is also support from some environmental groups for these programs. Although, the environmental support is somewhat complicated. You know, there are, of course, environmental justice concerns. There are certain groups that don't want any combustible fuels, whether low carbon or otherwise. So, potentially  some push in certain states, but not necessarily a group to rely on to push LCS programs through in every state. With that, I think it's time to end on a happy note. So, Susan, can you tell us the latest update in fraud in Oregon?

Susan Lafferty: I will. And that's a happy note only for those who like to see justice served, which, hopefully, is all of our listening audience. You know, actually, in a podcast over a year ago, we discussed the case of two individuals that defrauded the Oregon Clean Fuels program. They generated and sold about $2 million worth of credits from EV chargers that were actually never even installed, much less used for charging. The case resulted in a then-record $2.7 million fine from Oregon's DEQ, and that was in late 2022. Earlier this month, these two individuals were actually arrested on various charges, including multiple charges for knowingly making false statements to investigators, as well as racketeering charges related to the use of their ill-gotten gains from their scheme. That apparently went on even after they were fined the $2.7 million. So, this is just an anecdotal reminder that as new programs come on, and you are learning how to comply with those new programs, be sure to pay attention to how well your counterparties have also educated themselves about how to comply. And of course, you want to be on the lookout for even worse: somebody acting in a fraudulent manner. Many of you might recall the extensive fraud that took place in the federal Renewable Fuel Standard program in the very early years of that program. And generally, the best reminder is that these programs have a caveat emptor approach — that is, buyer beware. So when you buy credits, you will often be responsible for whether or not they are valid or invalid. So, hopefully, these podcasts are helping you take a step in the right direction in terms of understanding how the programs work and where you and your organization might want to dig a little deeper. So thanks so much for joining our latest Energized Exchange. We appreciate your time and look forward to talking to you in the near future.