California LCFS guides advanced biofuels industry

FROM THE JULY ISSUE: Carbon credit prices recover and multiple new pathways are certified as the state’s program gets back on track.
By Heather Zhang | June 13, 2017

California’s efforts to reduce carbon emissions from the transport sector are racing to make progress in the advanced biofuel industry, promising healthy growth in demand for sustainable low carbon transport fuel and offsetting any negative effects of pricing drops in the federal program.

Developments of advanced ethanol supply, in both domestic and international markets, have begun to inundate Californian minds as they consider the potential positive effects of a small ethanol feedstock percentage shift that would help fulfill the world’s most ambitious carbon cutting transport mandate—the state’s Low Carbon Fuel Standard.

With the California Air Resource Board gradually completing the recertification of the ethanol pathway after the program was readopted in September 2015, the average carbon intensity (CI) of ethanol has significantly dropped from 81.8 grams of CO2 per megajoule (CO2g/MJ) during the fourth quarter of 2015 to 70.36 CO2g/MJ during the fourth quarter of 2016. The reduction in average CI value has largely been driven by the improved carbon profile of corn ethanol, as well as the increased consumption of other types of ethanol produced from more advanced feedstocks. Compared to the more than 9 percent increase in corn-based ethanol use in 2016, consumption of ethanol produced from molasses, sorghum and waste beverages increased more than 114 percent from 2015 to 2016, to 128 million gallons.

Brazilian sugarcane ethanol consumption saw an immediate growth when the industry gradually firmed the readoption of the LCFS program during the second half of 2015. LCFS credit prices that had dropped to $20 in early 2015 were driven back to the $90 level seen before the recertification announcement. Despite a shutdown of arbitrage opportunities in 2016 because of the high price of Brazilian anhydrous ethanol year-round, the northbound trade resumed during the first quarter of 2017, thanks to the workable LCFS credits and D5 and D6 RIN spread. RINs are the renewable identification numbers used for compliance with the federal Renewable Fuel Standard. D5 RINs cover advanced biofuels, including sugarcane-based ethanol, while D6 RINs are for conventional biofuels, such as corn-starch ethanol.  

In addition to the increased volume consumption in the program, the pathway recertification and new applications have built momentum in the advanced ethanol sector. Under CARB’s LCFS program, 34 Brazilian pathways have been certified as of May 2017, up from five pathways in June 2016. The average CI value of the 34 pathways was up just over 2 CI points to 46.5 CO2g/MJ, while the minimum CI remained at 38.98 CO2g/MJ. The pathways for sorghum-based ethanol from California, Texas and the Midwest increased to 18 from the 14 pathways last June, with the lowest CI value at 30.63 CO2g/MJ. A new Guatemalan pathway for molasses-based ethanol was approved in May, with CI being evaluated at the level of 40 CO2g/MJ. Besides the already certified pathways in South America, producers are also eyeing opportunities in Mexico to utilize any economic advantage of the local feedstocks.
Brazilian Arbitrage
In early February, the D5/D6 RIN spread stretched as high as 51 cents per RIN, helping breathe some air back into Brazilian ethanol prospects to the U.S. At that time, the arbitrage looked to be close to the breakeven point for Brazilian ethanol with a CI of around 33 versus U.S. ethanol with a CI of around 72. But flexibility by Brazilian ethanol players helped improve export chances, and achievable freight rates to the U.S. West Coast also improved arbitrage opportunities. This triggered the first volume traded into U.S. in 2017. Since then, the arbitrage opportunities periodically opened based on the intraday RIN and LCFS prices. While D5 RINs were traded in a healthy volume compared with last year, the physical Brazilian ethanol trades also extended February’s pace, with talks of several new reservations of Brazilian ethanol. The annual imported ethanol from Brazil to the U.S. is expected to grow from last year’s 8 million gallons. At least two vessels carrying a total of around 20 million gallons of ethanol have been discovered so far this year, with cargos being reserved early and due to be delivered in the second quarter.

In late May, sinking anhydrous ethanol prices in Brazil, paired with a midweek draw from inventories boosting U.S. ethanol prices, prompted the price gap between low-CI Brazilian ethanol and U.S. corn-based ethanol to tighten. The spread between D5 and D6 U.S. corn-based ethanol narrowed to under 30 cents because of the improved outlook of D6 RIN prices. U.S. ethanol remains the more cost-effective option on average in the California LCFS market. The forward curve of Brazilian ethanol is likely to see a flat market structure, while any rises in U.S. ethanol prices are likely to be the more uncertain factors affecting international trading opportunities.

Aemetis, California’s largest biofuel producer, plans to move its first-generation footprint to advanced biofuels via a $120 million cellulosic ethanol plant the firm sees as critical to meeting demand growth for clean, high-octane ethanol fuel. The firm expects cellulosic ethanol to achieve CI scores between 20 to 30 CO2g/MJ. At May’s LCFS monthly average price of $73, the cellulosic ethanol would generate incentives of 38 to 44 cents per gallon through LCFS tickets. An improving LCFS outlook is likely to enhance these incentives in the second half of 2017, if the LCFS resumes its uptick.

Aemetis also is eyeing a long-planned strategy to improve margins by expanding its overall ethanol production footprint from 60 MMgy to 100 MMgy over the following year, including all conventional ethanol and cellulosic ethanol productions. The firm also plans to improve margins by increasing its share of cellulosic ethanol from zero to 25 to 35 percent. The multinational manufacturer of advanced fuels and chemicals says it expects continued RFS enforcement going forward and positive impacts of driving demand under the LCFS program, creating a healthier supply and demand balance to support expanded investments in the biofuels industry.

Propel Fuel, a leading California low-carbon fuel retailer in 2016, announced its partnership with Pacific Ethanol, which operates low-carbon ethanol plants in Stockton and Madera, California. The partnership will bring locally produced and high-performance E85 to the California market, which can be consumed in flex-fuel vehicles. Propel serves 70 percent of California’s E85 market, which has expanded 600 percent in the past six years to exceed 12 million gallons in 2014.

Meanwhile, Pacific Ethanol also received approval from the U.S. EPA to be eligible for cellulosic ethanol production at its Stockton plant, produced from corn kernel fiber. Pacific Ethanol estimates up to 1 MMgy of cellulosic ethanol will be produced at its Madera facility this year. The installation of a 5-megawatt solar photovoltaic (PV) power system at its Madera facility will displace more than 30 percent of the grid power consumed, which should cut utility costs by more than $1 million per year and improve its CI score. In March, CARB approved two production pathways from the facility, including a corn ethanol pathway with a CI of 72.73 CO2g/MJ and a sorghum ethanol pathway with a CI of 80.51 CO2g/MJ.

LCFS prices in the first half of the year dropped from the high of $100 in late January to the $70 level by the end of May. During the first quarter of 2017, LCFS trades at OTC market saw a liquid session, with over 533,000 tons traded in Q1, up 104 percent from the same period last year, according to Prima data. The significant increase in trading volumes is largely a result of market participants fulfilling the short-term demand during the first quarter, before they approach the April reporting deadline. On the supply side, utility sector auctions increased the short-term contribution of credits during the first quarter and some have argued the workable Brazilian ethanol trades contributed additional supply. The actual volume increases, however, may not be enough to help the industry meet the tougher mandates in 2017. The LCFS market will stay tuned and wait for any possibility of uptick of the LCFS in the second half of the year with more supports being gained from obligated parties, and further price balances in the long term with the current banked credits gradually dropping down to breakeven level.

Compared with last year, the LCFS is faced with less policy uncertainty, as SB32 and AB197 bills were passed last summer, ensuring the continuation of the program through 2020. The scoping plan released in late 2016 outlined a 10 percent CI reduction between 2020 and 2030 as the reference case and proposed alternative CI reductions of 25 and 18 percent.

Author: Heather Zhang
Research Analyst, Prima Markets