California’s LCFS: Unlocking Value in Low-Carbon Liquid Fuels (Part 2)

Executive Summary

The Low Carbon Fuel Standard (LCFS) is the most significant emissions reduction program for California’s transportation sector—it is expected to deliver more GHG reductions than all other transportation programs combined. The LCFS program requires a 10% reduction in transportation fuel carbon intensity by 2020, with a released draft regulatory text indicating a proposed 18% reduction by 2030.

The LCFS program operates on a simple system of deficits and credits. Petroleum-based transportation fuels (i.e., gasoline and diesel) with a carbon intensity (CI) higher than the standard generate deficits; these deficits must be offset by credits generated by fuels with a CI lower than the standard. Compliance (i.e., submitting credits to offset deficits) is required annually. Credits can be banked without holding limits and are not identified or distinguished by the year in which the credit was generated (i.e., no vintages). At the end of 2016, there were nearly 10 million banked credits in the program.

Credits have been assigned a dollar value based on a metric ton of CO₂-equivalent emissions, a value which has ranged between $17/MT and $125/MT. Roughly $1.5 billion of value has been traded in the form of lower carbon transportation fuels through 2017. With the credit banking activity forecasted to plateau or decrease in 2017 combined with the steeping compliance curve, the LCFS market is poised to increase in value by ten-fold over the next several years. The pricing forecasts, and forecasted deficit generation—linked to gasoline and diesel fuel consumption—suggest that the annual market value of credits traded will approach $4 billion by 2022 (or ~$190/MT), with a cumulative market value exceeding $17 billion in 2022.

We have focused on a five-year outlook for the LCFS program, but even bigger changes are on the horizon. The path to the proposed 18% reduction by 2030 will require even more significant changes than what we have seen in the market to date. There will be complementary initiatives that will help ease the compliance costs—most notably, efforts to reduce gasoline consumption through smarter and sustainable land use planning, programs to encourage adoption of more efficient, advanced vehicle technologies, and state-level investments in alternative fuels. The 18% carbon intensity reduction target will be challenging to meet based on ICF modeling.

Getting lost in the jargon of the LCFS program is easy to do—credits, deficits, carbon intensity, etc.. However the most important takeaway for investors and other market participants: The LCFS program represents the most significant state-level transportation fuel market opportunity in the United States.