Viewpoint: RD, fuel demand weigh on California LCFS

New low-carbon fuel supplies will add pressure in 2022 on California Low Carbon Fuel Standard (LCFS) credits already trading near three-year lows.

California this year recorded some of the nation's largest drops in transportation fuel demand compared with pre-pandemic levels in 2019. The slump in associated LCFS deficits helped push spot credits down nearly 30pc this year, dropping in November to their lowest levels since 2018. Federal mandates and US refiner strategies threaten to deluge California with renewable diesel credits in 2022.

A $1/USG federal blending tax credit offers a first layer of support for biodiesel and renewable diesel (RD). Proposed federal Renewable Fuel Standard (RFS) mandates for 2022 will add a second.

The US Environmental Protection Agency (EPA) projects that refiners, importers and other obligated parties will rely on renewable diesel and biodiesel to meet a 21bn ethanol-equivalent USG renewable fuel blending requirement for 2022. The price for credits associated with biodiesel and renewable diesel used to comply with the RFS have averaged about $1.54/USG since EPA proposed the mandates earlier this month, compared with about $1.03/RIN in January.

Low-carbon crosshairs

California's LCFS and Oregon's Clean Fuels Program complement the LCFS with an additional layer of incentives. While the RFS mandates minimum volumes, LCFS programs set a maximum carbon intensity for transportation fuels each year. Fuel distributors supplying low-carbon fuels including renewable diesel and biodiesel receive credits that offset deficits incurred by conventional, higher-carbon fuel.

The combination of compliance incentives and significant fuel demand has kept California lucrative for renewables. California accounted for more than 60pc of US renewable diesel blending in 2020, based on EPA and state data. That increased to 70pc of renewable diesel blended in the US through the first half of this year.

California LCFS credit prices began sinking in August. Credit generation climbed faster than the state's transportation fuel demand after business and travel restrictions imposed to limit the spread of the coronavirus in 2020. That imbalance lingered, even as the state eased restrictions.

California has consistently reported one of the five largest deficits to 2019 gasoline demand in all but one of the first nine months of the year, according to EIA data. State data show that September taxable gasoline volumes supplied fell to a more than 20-year low, trailing the same month of 2019 by 7pc. CARBOB represented almost 80pc of all LCFS deficits generated in the second quarter, the most recent period for which data are available.

The official balance of LCFS credits and deficits for the third quarter will be published at the end of January. But third quarter taxable gasoline gallons fell by 12pc compared with 2019. Taxable gallons have closely tracked volumes associated with official LCFS deficits, falling within 0.7pc of the second quarter California Air Resources Board (CARB) data.

Lower and lonesome

Some producers have urged CARB to halt the drop in credits to signal support for long-term investments needed to deliver low-carbon fuels. California and Oregon cap credit prices, but regulators for both states have said they will not set a floor.

Low credit prices indicate room for tougher standards, regulators said. But neither program can lower targets quickly.

Because any new LCFS standards must align with ongoing, broader updates to California's policies on climate change, new targets will not be implemented before 2024, CARB staff said.

Lower credit prices could offer some long-term advantages, Darling Ingredients chief executive Randall Stuewe said this month. Darling partnered with US independent refiner Valero on the largest US renewable diesel producing joint venture, Diamond Green Diesel, and processes renewable feedstocks as part of its core business.

Prices well below their maximum levels will help LCFS programs spread to new markets and set tougher future goals, he said.

"That gives regulators the courage to accelerate the trajectory of decarbonization," Stuewe said.

Other North American markets are pursuing their own LCFS programs. Washington state regulators are crafting rules for a program legislators approved earlier this year, which could start in 2023. Canada also continues to refine its Clean Fuel Standard, an LCFS program that could begin trading in early 2023. Minnesota, New York, New Mexico and other states have all considered adopting similar programs for their markets.

But the status quo of California's leading incentives and lagging demand will keep the state flush with credits in 2022.

By Elliott Blackburn