Otmane El Rhazi from The Barrel Blog.
John Kingston is President of the McGraw Hill Financial Global Institute and Director of Global Market Insights. He continues to observe energy markets after his many years with Platts.
The price of Low Carbon Fuel Standard credits is going to rise. It’s just a question of when.
That’s the view of Professor Daniel Sperling, member of the California Air Resources Board, director of the Institute of Transportation Studies at the University of California, Davis, but more importantly, the intellectual father of the California Low Carbon Fuel Standard.
Sperling sat for an interview with me March 25 at a joint event in Long Beach, California sponsored by Platts and GlobalView. At the time of the interview, the Air Resources Board’s most recent monthly report on the price of LCFS credits showed them to have sunk to an average of $24/mt in February, the lowest level since a full calendar year credit price of $17 in 2012. (CARB only began publishing monthly average prices recently.) In the second quarter of 2014, they averaged $35 per credit.
So while a declining price could be taken as a sign that the program is working just fine, Sperling cautioned that these levels are not likely to stick around. That’s actually part of the plan.
Sperling noted that the required cut in the carbon intensity of California transportation fuels this year — and last year — was a mere 1% from a 2010 baseline. But that isn’t going to last, with CARB expected this summer to vote on a package of amendments that will tighten those requirements. “Next year it’s 2 percent, then 3.5%, then 5%, then 7.5% and then 10%,” he said. “It’s all backloaded. So looking at the market now doesn’t tell you much except that meeting 1 percent is easy.”
He added: “As an academic, I will say it seems pretty likely the price is going to go up as we get to five and then 7.5 percent, and the market will get tighter. It’s just economics 101.”
The package of amendments Sperling expects CARB to approve this summer puts a limit on how high the price of credits can go: $200/mt. He says since it applies only to the required 10% reduction, and the very loose formula that each $10 in the price of an LCFS credit — or a cap & trade credit — means about 1 cent in the wholesale price of gasoline, even if LCFS credit prices hit $200, it would translate to 20 cents per gallon. By contrast, the introduction of cap and trade on the fuels market January 1 is widely seen as having added about 10-12 cents to the wholesale price of gasoline.
There is a small break in the logic here though. Sperling regularly talks about how for the LCFS to really work, it needs to spur innovation. And he said that when the requirements under the LCFS get “real steep” starting 2-3 years from now; “that’s when you’ll start to see real change.”
But what happens if the price goes to $200 per credit and that’s not enough to really spur enough innovation to get the industry toward an overall 10% cut? What happens if everybody just tries to buy $200 credits and there’s no incentive to produce more since the price isn’t higher? That’s always the risk when a market gets an artificial cap; the normal market-clearing mechanism doesn’t work as well as it should (though the market-clearing aspect of prices, when dealing with a government mandate, would always be far from perfect.)
Sperling wasn’t asked that question specifically, but he did say his “academic hat” would argue that high prices are good. “We’re trying to elicit new investment and if it isn’t happening at low prices, then the price goes up and brings more investment,” he said.
But the political reality is that “to have high (gasoline) prices is politically disastrous.” Hence the cap, so that runaway LCFS credit prices don’t turn into soaring pump prices.
Sperling is upbeat about the future of the LCFS, even if he doesn’t think the low credit price means much more than the current requirements aren’t that stringent. Yes, the rise of commercially-available quantitites of cellulosic ethanol has been a setback. But corn ethanol production, he said, is getting increasingly carbon efficient, with byproduct oils from the parts of the corn that were to make cellulosic increasingly being used to help produce biodiesel. And “bolt-on” cellulosic ethanol facilities that produce small quantities of it, attached to existing ethanol plants, are producing small amounts of that low-carbon feedstock.