A Bearish Outlook for California’s Low Carbon Fuel Standard

As California looks to lower its carbon emissions, it has turned to a policy program called the Low Carbon Fuel Standard. But reforms are needed to decrease the existing surplus, increase the price of credits, and create a competitive market.

The transportation sector is the single largest contributor to both greenhouse gas emissions (GHG) as well as liquid fuel consumption. In order to combat this, the California government has enacted a complicated policy program known as the Low Carbon Fuel Standard (LCFS). This program regulates fuel from production all the way to consumption and impacts a wide range of groups, from energy developers to station owners and even electric vehicle fleets. Although this program was put in place to reduce GHG emissions from liquid fuel, it has turned out to be problematic due to the over incentivization of electric vehicles within the policy framework. Reforms to the program will be necessary to sustain a competitive market for credits.

The LCFS program was enacted as a part of California’s GHG protocol, with the goal of reducing the carbon intensity of the transportation fuel pool by 20% before 2030 and 80% by 2050. LCFS is a significant part of this protocol because 50% of GHG emissions are from transportation. The government regulates and incentivizes the use of low carbon intensity fuel by awarding credits or deficits based on a yearly carbon intensity standard. This creates a market in which LCFS credits can be accumulated and traded between entities.

The framework for the LCFS program involves three primary methods for credit generation: pathway-based, project-based, and capacity-based crediting. Pathway-based crediting targets fuel directly at production through lifecycle GHG emission analysis. Project-based crediting targets carbon capture and other emissions reducing projects. Capacity-based crediting incentivizes zero emissions vehicle infrastructure.

Over the past year, LCFS credit price fell by 33% and is expected to continue sinking due to surplus in credits. This price crash of LCFS credits is primarily due to the ballooning credit bank and surplus in credits is expected to remain till at least 2024. The primary factor in the generation of such a surplus of credits is the increase in electric vehicle use. In the LCFS program framework, electric vehicle ownership is highly incentivized. A single electric vehicle can produce about 10 LCFS credits and reduces deficits by reducing gasoline consumption. As electric vehicle use is expected to quadruple by 2030, the surplus of LCFS credits will be further exacerbated.

In addition, a main source of credit generation, as well as deficit, is the production (blending) of fuels. Low carbon intensity fuels such as biogas and ethanol generate credits while jet fuel and diesel cause deficits. The amount of low carbon intensive fuels that can be produced is primarily limited by demand. Diesel engines make up 45% of California’s on-road demand. Diesel has a high carbon intensity and the infrastructure in place requires that higher carbon intensive fuel is used. However, the deficit caused by diesel consumption is not enough to offset the surplus of credits.

The LCFS market is just starting to become a major factor in the California economy, and monitoring LCFS credit prices will be essential going forward. With the expected growth in electric vehicles the price of LCFS credits is likely to face more downward pressure in the short-term. The downward price trend of LCFS credits mainly indicates the market’s perception of how easy it will be to hit this year’s benchmarks. However, this crash in price might be misleading by hindering the amount of investment made in decarbonization efforts. Possible methods to combat the sinking price of LCFS credits would be to implement more stringent restrictions, minimum price guarantees on LCFS credits, or reforming the LCFS program to decrease EV incentivization. Any of these methods would decrease the existing surplus, increase the price of LCFS credits, and create a competitive market for credits.

This insight is a part of our Undergraduate Seminar Fellows’ Student Blog Series. Learn more about the Undergraduate Climate and Energy Seminar.

Aditi Chintapalli

Undergraduate Seminar Fellow
Aditi Chintapalli is an undergraduate in the school of engineering studying mechanical engineering with a minor in geology. Chintapalli is also a 2022 Undergraduate Student Fellow.