A legal storm in the energy industry that has been rumbling in the distance for three years is likely to come to a head this summer as petroleum refiners, ethanol producers and Washington lobbyists pursue their battle with state agencies in Sacramento.

The latest flare in this clash between a powerful pantheon of US energy titans and federally influential regulators in California occurred last week, after a temporary injunction was lifted by a US court of appeals in San Francisco.

The California Air Resources Board now has the green light to continue implementation of its “transformative” standard, which aims to reduce the carbon intensity of transportation fuels by 10% by 2020.

The Low Carbon Fuel Standard, first proposed in 2007 under former Governor Arnold Schwarzenegger, was designed to stimulate innovation and investment in transport fuels with lower carbon intensity such as advanced biofuels, natural gas, electricity and hydrogen.
Opponents of the LCFS say it’s too expensive because the supply of advanced biofuels is insufficient and the costs of compliance are too.

Last week’s court decision marked a key development in the ongoing legal challenge first brought in December 2009 by ethanol lobbying groups, the Renewable Fuels Association (RFA) and Growth Energy. The groups argue that the Low Carbon Fuel Standard is “unconstitutional” because it violates the commerce clause, which was intended to stop states from introducing laws that would discriminate against businesses located in other states.

Where California Leads?

“One state cannot dictate policy for all the others, yet that is precisely what California has aimed to do through a poorly conceived and, frankly, unconstitutional LCFS,” they said.

In December last year, Judge O’Neill in a Fresno court ruled in their favour bringing the implementation – after an arduous and meticulous rulemaking process – grinding to a halt.

The RFA this week said that it will continue to fight the LCFS through the courts. “We think Judge O’Neill’s initial ruling was based on sound legal precedent. The LCFS is unconstitutional, unlawful and punitive,” said a spokesman.

Since 2009, other opponents of the LCFS have filed additional commerce clause challenges largely because some types of ethanol brought to the Californian market from the Midwest will not meet the standard. Canadian tar sands companies have also complained that the LCFS is a barrier to entry to the Californian market for its heavy crude.

California’s ARB based LCFS standard on full lifecycle emissions – “well to wheels” or “seed to wheels” – which include transport to the state and the carbon-intensity of the electricity used to produce fuels.

The explicit intention of the California LCFS is that this regulation should be transformative.- Chris Malins

The carbon intensity of US ethanol is already relatively high compared with ethanol produced in other countries. US corn ethanol, for example, produces 103 grams per megajoule of energy, where as French corn ethanol produces 49 grams per megajoule, according to energy data published by the UK government.

Midwestern farmers lobby groups joined forces with refiners and truckers: Rocky Mountain Farmers Union; Redwood County Minnesota Corn and Soybean Growers, the American Petrochemical and Refiners Association; American Trucking Associations; Center for North American Energy Security; and the Consumer Energy Alliance.

The American Petrochemical and Refiners Association cites a report from Charles River Associates, which claimed that a national LCFS could raise gasoline and diesel prices by 80% within five years.

Major Disruption Threat Cited

Catherine H Reheis-Boyd, president of the Western States Petroleum Association which is not one of the petitioners, said that refiners on the west coast are also “disappointed and concerned” by the decision to lift the stay of enforcement.

“California refiners already face very difficult economic conditions and allowing CARB to begin enforcing the LCFS during the legal review will put them in an even more precarious position. The LCFS as currently written is not a feasible regulation that refiners can comply with without incurring unacceptable cost burdens and without potentially risking major disruptions in the market for transportation fuels.

“Subjecting refiners to short-term enforcement of a regulation that we believe ultimately will be found unconstitutional is unwise, extremely costly and disruptive.”

Dr Chris Malins, clean fuels program lead at the International Council on Clean Transportation, said: “The explicit intention of the California LCFS is that this regulation should be transformative. This rule provides the investment framework for the investments that will move the industry forward and make supplies of these fuels available. It’s easy to overstate how much is possible in 2012 when there’s no cellulosic fuel in the market yet and therefore the whole thing can’t work.

“You need a solid, reasonably predictable framework that gives market confidence for those investments to happen. At the same time, it is in the nature of something transformative that it can be challenging.”

On the Other Hand

But lower carbon fuel producers have also stepped into the arena with submissions to the courts detailing loss of business and investment deal flow.

Inbicon, a subsidiary of Danish-owned DONG Energy, is one of many companies that have told Judge O’Neill of the regulatory uncertainty resulting from his injunction last December.

Inbicon is a biomass conversion company which turns crop waste into cellulosic ethanol “drop-in” fuels and other petroleum replacement products. Read more about drop-in fuels here.

Christian Morgen, the general manager in the international sales and marketing team, said:
“Following the issuance of the injunction … the business success that Inbicon expected to have in the Californian market has been jeopardized. In particular, it creates uncertainty that discourages equity and financial investment in Inbicon projects. Projects slated for 2012 will be put on hold. This could harm Inbicon’s ability to grow its business in the United States.

“I believe plants such as Inbicon Biomass Refineries can provide a strong economic boost to the state’s economy and create thousands of good jobs… Many winners can emerge from this process – but not absent an LCFS in California.”

Clean Energy Fuels, based in Seal Beach, California, specialises in compressed natural gas (CNG) liquefied natural gas (LNG) and renewable natural gas (RNG).

Harrison Clay, the president of Clean Energy Renewable Fuels, said in court submissions said that the company had been planning to sell credits it had earned through an LCFS market mechanism, similar to the tradable Renewable Identification Numbers already used in the ethanol industry under the Renewable Fuel Standard 2.

Clay said the company had just signed a contract worth $1.2 million just before the injunction. But less than two weeks later, the regulated party that entered into the credit contract with the company indicated that it wanted to back out of the deal because of regulatory uncertainty.

Propel Fuels, based in Redwood City, California, also told the judge about investment disruption: “The absence of the LCFS will create confusion in the market and potentially reduce the availability of equity and project financing. Limiting investor appeal could damage Propel’s ability to grow and scale inside the United States.”

San Francisco algal biofuels company Solazyme, and Seattle biofuels producer, Imperium Renewables, have also expressed concerns over investment risk created by the legal actions.

The Low Carbon Fuel Standard blazed a trail when it was proposed under former Governor Arnold Schwarzenegger as way to meet California’s pioneering AB32 climate change legislation requiring a 25% reduction in GHG emissions on 1990 levels by 2020. Not only was the LCFS the first such standard introduced in the US, it was the first in the world.

Read more about AB32 here.

At that time, as many as 16 states had similar legislation on its books. But the legal challenge has curtailed progress. Other states will be watching with interest what happens in California. Oregon, Washington, New Hampshire, New Jersey, Maine, Connecticut, Delaware, Maryland, Massachusetts, New York, Pennsylvania, Rhode Island and Vermont still have proposals that could be revived by the failure of the legal challenge.

The removal of the temporary stay is a signal that Carb and its LCFS will eventually prevail when the final ruling is expected this summer, said Timothy O’Connor, director of the Environmental Defense Fund’s California climate and energy initiative.

“This isn’t game over for this legal challenge, but it’s a very strong signal that ARB is on firm legal footing,” he said.

Support For A National Standard?

Such a result could trigger a resurrection of political support for a national standard and bolster the strength of the California Air Resources Board to push through complex regulations in economically challenging times, which are then gradually adopted by other states and eventually also at a federal level – a reputation for leadership cherished in California.

“We’re hoping that this type of effort led by California picked up by other states can lead to really something progressive nationally,” said O’Connor.

California’s cap and trade system, another key piece of the AB32 legislation, has so far escaped industry challenge in the courts ahead of its first compliance period in January 2013.

A positive ruling on LCFS could provide greater regulatory certainty for the cap and trade program, he said.

“Folks are probably going to sue regardless, but this doesn’t give more red meant in front of the barking dog. It takes away what would be a really obvious ability for plaintiffs to sue but it’s not necessarily going to take it off the table entirely.”