LCFS in Limbo

California’s Low Carbon Fuel Standard has been brought to a halt, at least temporarily. How will it affect ethanol producers?
By Kris Bevill | March 05, 2012

The battle over the legality of California’s Low Carbon Fuel Standard has been ongoing for more than two years and it probably won’t be fully resolved any time soon. In late December, however, a California district judge handed down the first ruling in the case, delivering a preliminary victory to the plaintiffs, which include the Renewable Fuels Association, Growth Energy and various corn growers and ethanol/feed marketers. The judge found that the LCFS violates the dormant Commerce Clause of the U.S. Constitution, and halted the California Air Resources Board from continuing to enforce the regulation. CARB has since appealed the ruling and many believe it will appeal its case all the way to the U.S. Supreme Court, if necessary. Both sides express confidence that they will ultimately win but, for now at least, carbon intensity (CI) ratings are a nonfactor for producers selling into the largest ethanol market in the U.S.

The Issue
The LCFS is a regulatory measure designed by CARB with the intent of reducing greenhouse gas (GHG) emissions from the state’s transportation sector by 16 million metric tons by 2020. To determine the amount of emissions associated with specific fuels, CARB identified a number of production pathways to be evaluated for their carbon intensity. The formulas determine—after a full, life-cycle analysis of the fuel, including such factors as the energy sources used to produce the feedstock and fuel, emissions from transportation involved in producing and delivering the fuel to its endpoint, and storage and use of the fuel—the amount of CO2 equivalent per megajoule of fuel energy. The policy also allows for parties to submit applications for new or modified pathways if the process used to produce a fuel is not already addressed in the CI Lookup Table.

The ethanol industry takes issue with CARB’s methodology for determining carbon intensity because it includes indirect land use change calculations, a concept that continues to be debated and re-evaluated by scientists. The lawsuit, however, focused on a separate legal matter. The plaintiffs argued that CARB’s CI ratings placed Midwest ethanol at a disadvantage to California ethanol, and therefore violated the Commerce Clause, which exists to prevent states from attempting to regulate activities beyond their borders. In his ruling, Judge Lawrence O’Neill said that while it may be true that there are differences in the carbon intensities of Midwest and California ethanol when using CARB’s methodology, the policy negatively affects the price and desirability of Midwest ethanol in the California market and “the price differential is based on transportation and out-of-state electricity—both factors that discriminate based on location.” Therefore, the judge ruled that the policy does attempt to regulate activities beyond California’s border and violates the Commerce Clause.

Midwestern Views
For ethanol producers located outside of California, the court’s decision was a definite win. California’s ethanol market represents a little more than 1 billion gallons per year, making it the single largest ethanol market in the nation. Midwest ethanol producers need California. And while CARB has said previously that many of the Midwestern gallons would qualify for the program initially, producers felt otherwise. Todd Sneller, administrator of the Nebraska Ethanol Board, says a number of plants evaluated the standard and tried to determine which pathways would allow at least a portion of their ethanol to qualify, but discovered it would mean they would essentially have to segregate gallons that were produced under certain parameters—using only locally grown corn and no natural gas, for instance—which is a nearly impossible task. Additionally, some of the older Midwestern ethanol plants that use coal-fired boilers would be shut out of the market entirely. “The LCFS makes it virtually impossible for those plants to supply a portion of their ethanol to that market,” he says. Without the LCFS in force, those producers regain the opportunity to market their product into California.

Bring in Brazil?
Another issue for U.S. ethanol producers is CARB’s preferential treatment of Brazilian sugarcane ethanol. Under the LCFS, sugarcane ethanol enjoys a low CI rating, which prompts obligated parties to demand imports from Brazil in order to comply with the program’s carbon reduction requirements. The results of this requirement played a role in the well-noted events on the international market last year, whereby U.S. producers exported record amounts of ethanol to Brazil to supply its shortfall in production while Brazilian ethanol was still being shipped to the U.S. “We are exporting ethanol from the center of Nebraska by rail to Brazil so the Brazilian sugarcane ethanol can be exported to California,” Sneller says. “That’s just an extraordinary example of how well-intended public policy can really go all wrong and promote enormous inefficiency.”

Because Brazil was short on ethanol last year, the LCFS probably did not impact Midwestern producers as strongly as it would have if Brazil had produced ample supplies and not required U.S. imports. Regardless, Marty Lyons, president of ethanol marketing firm M-Pact BioFuels LLC, agrees with Sneller that the policy poses negative impacts on Midwest ethanol producers. “The California court ruling that stops CARB from implementing the LCFS puts all U.S. domestic ethanol plants on a level, competitive field and eliminates a clear discrimination against ethanol producers outside California,” he says. “Additionally, it seems beyond rational that California would want to have Brazilian ethanol gallons shipped to California at the expense of domestic ethanol supply. U.S. ethanol production is the best low-carbon path for California because our industry has a keen safety and environmental focus.”

Local Angle
California ethanol producers, of which there are only a handful, all agree that no policy should discriminate against U.S. ethanol based solely on its geographic origin, according to Lyle Schlyer, president of Pixley, Calif.-based Calgren Renewable Fuels LLC. His overall view of the LCFS is positive, however, and he says it is an effective method of inspiring technological improvements to reduce the carbon footprint of ethanol facilities. “Why not have policies that reward those of us that successfully achieve the policy objectives that are being sought?” he says. “We [Calgren] saw the LCFS as precisely that.”

Calgren has taken several steps to reduce its carbon footprint in order to supply lower carbon fuel for the LCFS. Calgren does not dry any of its distillers grains, for example, and neither do any of the other California producers, according to Schlyer, partially because it lowers the plant’s CI rating. If there is no incentive for lowering the CI rating, he says the company may consider purchasing a dryer. Other projects at Calgren, such as erecting a co-generation facility and anaerobic digester, require substantial investments, but were considered to be worth it in order to achieve a lower CI rating and boost demand for the facility’s ethanol. Without that driver, the investment may not be worth it, he says. “Natural gas is so cheap right now that it’s hard to justify these kinds of projects, except that it will lower the carbon intensity of the ethanol we produce and consequently can act as a reasonable incentive when no other incentive exists,” Schlyer says. “Even though we want to do our part environmentally, [without the LCFS] we’d feel compelled to assess every project straight up and down in terms of its commercial impact.”

Several Midwest ethanol producers, including Poet LLC and Archer Daniels Midland Co., took steps last year to improve their processes in the eyes of CARB, filing pathway amendments to reflect their technology improvements and lower the CI rating of ethanol produced at their facilities. Schlyer believes that if the renewable fuel standard [RFS] were the only driver, companies like Calgren and the more innovative Midwestern producers wouldn’t be as interested in making technological improvements because the RFS doesn’t effectively reward their good behavior. For example, unless the RFS is modified to allow corn ethanol to qualify as an advanced biofuel, corn ethanol will never be allowed to generate the more valuable renewable identification numbers [RINs] associated with that category of fuel, no matter how efficiently that corn ethanol is produced, he says.

But Sneller says the entire ethanol industry is constantly being motivated to improve its efficiency in order to comply with federal regulatory requirements and also to improve the profitability of production, so the LCFS isn’t that critical in spurring innovation. “There’s a whole list of compliance issues that ethanol plants are facing every day,” he says. “They’re constantly in pursuit of technologies that address those issues on the one hand and at the same time promote efficiencies, because if they can make investments in their plant that allow improved efficiency, that typically means better economics.”

What Now?
Representatives from both sides of the lawsuit were unable to comment on the pending legal matter. Both sides, however, have repeatedly expressed their optimism for victory. In early January, CARB asked for a stay on the injunction, which would allow it to enforce the LCFS through 2012. The agency’s request was denied. Following the decision, Bob Dinneen and Tom Buis, heads of the RFA and Growth Energy, respectively, released a joint statement saying that the court’s decision demonstrated the strengths of their claims against the LCFS. “American ethanol advocates will continue to oppose CARB’s effort to reinstate this punitive policy that illegally seeks to dictate the production and transportation of ethanol and other fuels outside its border,” they said. Meanwhile, a CARB spokesman simply stated, “ARB believes we’ll prevail in this matter.”

As for ethanol producers located in California and throughout the Midwest, the effects of a policy in limbo are already being felt. “The immediate impact on Midwestern producers is that as long as there is a stay on enforcement of that provision, ethanol that is produced in a very efficient manner and shipped in an efficient manner can continue to go to the traditional markets in the western U.S., including California,” Sneller says. The impact is especially positive for producers on the western edge of the Corn Belt who have been servicing that market for many years, including veteran plants like Hastings, Neb.-based Chief Ethanol Fuels Inc., which has marketed its ethanol to California for more than 25 years, according to Sneller. He points out that transportation companies contracted to ship ethanol from the Midwest to California will also benefit from the situation.

For California producers like Calgren, however, the impacts of a halted LCFS are less than positive. Schlyer says refiners who had previously signed agreements to purchase Calgren’s lower-carbon ethanol at a premium rate have already been in touch to try to renegotiate their contracts. “The blenders have to decide whether they should be trying to acquire our low-carbon-intensity ethanol or buy the cheapest ethanol,” he says, adding that he believes those who had previously agreed to pay more for lower carbon ethanol are now being punished for it. “Frankly, they did the right thing and the court slapped their hand for it,” he adds.

CARB will likely rework its policy to eliminate portions found to be in violation of the Commerce Clause, but it’s unknown if and when the policy will be allowed to come back into play. It is clear that the policy, and its hiatus, impacts producers differently depending on location, but in general, ethanol producers would appear to widely support an amended program that eliminates geographic distinctions and provides support for environmental improvements. Schlyer believes the industry and CARB should work together to correct any geographic discrimination in the LCFS. Ultimately, he’d prefer a self-certification program that rewards participants who meet the policy goals and heavily penalizes noncompliers. Sneller says many Midwestern producers would support the LCFS if it’s properly structured. “In a properly constructed program, you can accomplish several different objectives, some of them practical in terms of efficiencies that would allow consumers access to lower-cost transportation fuels, but in the other, rewards the producer for their environmental performance according to that particular compliance matrix,” Sneller says. “If done properly, that’s a good outcome.”

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LCFS Reduction Requirements

California’s Low Carbon Fuel Standard came into effect in 2010, but producers and importers were not required to demonstrate a reduction in carbon intensity (CI) until 2011. The initial reduction was minimal, just 0.25 percent of their CI rating, but reduction requirements would have doubled this year to 0.5 percent and increased by half a percent each year after, maxing out at 10 percent in 2020.

 

Author: Kris Bevill
Associate Editor, Ethanol Producer Magazine
(701) 540-6846
kbevill@bbiinernational.com