March 20, 2023
The Sierra Nevada has been pummeled by severe winter storms which have delivered feet of snow in recent weeks. In the wake of these storms, Californians are left dealing with giant snowbanks, weighty snow accumulations straining roofs, and even flooding. But that’s not the only storm California is dealing with. A flood of renewable diesel production and snowballing net credits have left California’s Low Carbon Fuel Standard (LCFS) with a historically large and growing credit bank. This glut in the LCFS credit market has tanked credit prices, giving renewable fuels investors pause and leading the California Air Resources Board (CARB) to consider amendments to the LCFS program to take advantage of this opportunity to increase carbon reduction requirements and keep the program relevant.
CARB aims to adopt the next set of amendments to the LCFS regulation in 2023, becoming effective as early as 2024. Through initial amendment workshops, CARB has indicated an intention to increase the stringency of the 2030 carbon intensity (CI) reduction target and extend the reduction goals to 2035 or later. So, what would an increase in the stringency of the program do to credit balances (and ultimately credit prices)? And exactly how aggressive should CARB get with these targets?
Stillwater’s Carbon Crew tracks the LCFS (and other LCFS-style programs in North America) closely. Our regularly updated off-the-shelf reports provide insight into how CARB might answer these questions. We produce an LCFS Credit Price Outlook each quarter with primary credit price outlook cases assuming the LCFS’ CI reduction schedule continues at 1.25% through 2030 (as prescribed in the current version of the regulation) and that the same reduction trajectory continues beyond 2030, resulting in a CI reduction of 26.25% in 2035 (even though the regulation has not yet been extended beyond 2030).
To provide insight into the potential impacts of regulatory changes currently under discussion, we include our Accelerated CI Reduction Case which incorporates concepts CARB has presented via workshops and our thoughts on a viable reduction schedule to increase the chances of achieving the goals of the program. In CARB’s February 2023 workshop, Staff indicated an openness to a step-change in CI reduction in 2024 on top of a steeper CI reduction curve out through 2035. As such, in the Spring 2023 edition of our LCFS Credit Price Outlook, we modeled an Accelerated CI Reduction Case which includes an immediate step-change in the CI reduction target to 15.5% in 2024 (instead of the 12.5% reduction under current regulations); the annual targets then ramp up steadily to a 30% CI-reduction target in 2030 (up from the currently prescribed 20% reduction) and extend out to 2035 with a CI reduction of 45%.
The figure below illustrates Stillwater’s Base Case (i.e. Current Regulation Case) plus our most recent Accelerated CI Reduction Case given supply, demand, and regulatory factors for each case.(1)
LCFS Credit Bank Scenarios
As illustrated in the figure above, we expect that quarterly credit surpluses under the current regulation would continue at a steady pace through the outlook period as the market absorbs increases in RD production, the EV population grows, and the CI of renewable natural gas (RNG) continues to decline. The Accelerated CI Reduction Case is a variation on the Current Regulation Case in which credit balances are shown growing in 2023 as deficit generators are expected to build their credit banks ahead of the very steep CI reduction step change assumed for 2024 and a continuing ramp-up in program stringency through the outlook period. Unlike the Current Regulation Case, however, in this case the market is seen as being net deficit from 2024 onward, and net deficits produce upward pressure on credit prices.
For the program to remain viable, the cumulative bank of credits needs to remain positive so that parties requiring credits can stay in compliance through purchases of available credits, while not becoming so large as to depress prices to a level where developers of new low-CI fuel production projects are unable to secure funding. Given historic precedent, if the credit bank is perceived as too large or too small, CARB will continue to adjust the program with each regulatory amendment process to keep it viable while maximizing CI reductions.
Given the sizeable excess credit trend observed in the past couple of years, CARB will make program CI reduction changes. If, as we have modelled, those changes involve a 3% step change (to 15.5%) in 2024 and a linear slope to a 30% CI-reduction target in 2030 and 45% CI-reduction target in 2035, our modeling shows that expected growth in renewable fuels production would not be sufficient to cover anticipated deficit generation through 2035 unless the electrification of the light-duty fleet occurs more rapidly than we estimate. If the viability of the program is threatened, CARB would be expected to make additional changes to the program to maintain viability.
What does all of this mean for LCFS credit prices? Great question! Contact us to find out. 🤓
(1) Full descriptions of the supply, demand, and regulatory factors for each case are provided in Stillwater’s LCFS Credit Price Outlook report: https://stillwaterpublications.com/credit-price-outlook/