A National Low Carbon Fuel Standard: Tradable Credits System Design and Cost Savings
Jonathan Rubin, Dept. of Resource Economics and Policy, University of Maine, 207-581-1646, jonathan.rubin@umit.maine.edu
Paul N. Leiby, Env. Sciences Division, Oak Ridge National Laboratory, 865-574-7720, leibypn@ornl.gov
Overview
In the quest to reduce greenhouse gas emissions regulators face the question of whether it makes sense to target specific sectors of
the economy or simply set reduction targets for the nation as a whole. Most economic models projecting the effects of economywide carbon targets find that the transportation sector is likely to be unresponsive to carbon pricing compared to other sectors of
the economy (Energy Information Administration 2009, p. 32). Thus, if the transport sector is play a significant role in reducing
GHG emissions, sector specific policies will be necessary. In 2007, California established a Low Carbon Fuel Standard (LCFS) to
reduce the carbon intensity of California’s transportation fuels by 10% by 2020. California’s LCFS regulations allow fuel
providers to meet the reduction obligations by blending low-GHG biofuels into gasoline and diesel, purchasing credits of low
carbon alternative fuels (LNG, hydrogen and electricity), or by applying credits that they banked in previous years. Regionally, 11
Northeast and Mid-Atlantic states signed a MOU which affirms each state’s commitment to continue working together to evaluate
and develop a LCFS framework by 2011 (The State of Connecticut, The State of Delware et al. 2009). The concept requires
regional fuel suppliers to reduce the average carbon intensity of fuels used in the region by 10% over 10 years.
A related type of regulation is EPA’s Renewable Fuel Standard (RFS). The RFS was implemented pursuant to the Energy Policy
Act of 2005 (EPACT). It was updated by the Energy Independence and Security Act of 2007 (EISA) and is now generally known
as RFS2. EISA established minimum annual volume requirements for several categories of biofuels that must be sold by producers
and importers of petroleum-based transportation. Like a LCFS, RFS2 includes mandated GHG emission reductions for each
category of renewable fuel. Unlike California’s LCFS, RFS2 does not include electricity or natural gas in its program.
A LCFS has two distinct advantages over a RFS. First, a LCFS is technologically neutral. A LCFS does not promote any type of
fuel (i.e., biofuel) or fuel-vehicle system over another. Secondly, a LCFS, unlike a RFS, rewards inframarginal reductions in
carbon intensity. That is, rather than viewing a fuel as attaining a biofuel carbon target, as in the RFS2 program described below, it
also rewards reductions in lower carbon fuels within a category.
In this paper, we do not address the larger question of the wisdom of policies to promote low-carbon fuels (for a review see,
Gardner and Tyner (2007). Martinez-Gonzalez (2007), Gardner (2007), Schmitz, Moss et al. (2007), de Gorter and Just (2010)).
Rather we look at the implications of different designs for a national LCFS in terms of costs and carbon leakage and calculate
possible saving from different credit trading systems. We follow the lead of California and the Northeast and Mid-Atlantic regional
initiatives which places the compliance burden on gasoline and diesel producers and importers. We base the LCFS credit trading
system on a similar flow-credit system for fuel economy pursuant to CAFE regulations (Rubin, Leiby et al. 2009).
Methods
Modeling Heterogeneous Firms and Regions
This credit system views responsible parties as meeting an average carbon intensity standard through sales of fuels and change in
fuel carbon intensities alone. It does not address the net costs or the consequences of changing the demand for various fuels based
on a cross-subsidy of vehicle technology.
For each firm m, and fuel class v, the total credits (or deficits) generated, G, each year is given by the weighed mix of fuels sold:
𝐺𝑚𝑣𝑟 = ∑ 𝑅𝑓𝑣𝑚𝑟 ∗ 𝐸𝑓𝑣𝑚𝑟
(1)
𝑓∈𝐹𝑣
Where Efvmr is the amount of reference fuel v displaced by fuel f by firm m in region r. The variable Rfvmr is the amount by which
the replacement fuel carbon intensity 𝐼𝑓𝑣 ⋅ 𝜔𝑓𝑚𝑟 differs from standard 𝐼𝑣̅ adjusted for the energy economy ratio of fuel f to v, 𝜖𝑓𝑣 .1
𝐼𝑓𝑣 ⋅ ωfvmr
𝑅𝑓𝑣𝑚𝑟 ≡ ((𝐼̅𝑣 −
) ⋅ 𝜖𝑓𝑣 )
(2)
𝜖𝑓𝑣
1
This formulation follows the California LCFS, and accounts for the different end-use efficiency of some vehicles types.
A profit maximizing RP m in region r has the following objective function, given the sales of fuel, 𝑃𝑓 ⋅ 𝐸𝑓𝑣 , minus the costs of fuel
production, 𝐶𝑓𝑣𝑚𝑟 (𝐸𝑓𝑣𝑚𝑟 , 𝜔
̂𝑓𝑣𝑚𝑟 , 𝜔𝑓𝑚𝑟 ), and net revenues from credit sales or purchases less any credits, S, purchased at a safety
valve price of Ps. The price of fuel f, Pf, is assumed to be given to a price-taking firm.
𝑇
2
𝑀𝑎𝑥
̂ 𝑓𝑚𝑟 , 𝜔𝑓𝑚𝑟 ) ] − 𝜋𝑣𝑚𝑟𝑡 𝑁
∑ 𝛿𝑡 ∑ ∑ ∑ [ 𝑃𝑓𝑟𝑡 𝐸
– 𝐶𝑓𝑣𝑚𝑟 (𝐸𝑓𝑣𝑚𝑟 , 𝜔
− Ps Svmt (3)
𝑓𝑣𝑚𝑟𝑡
𝑣𝑚𝑡
𝐸𝑓𝑣𝑚𝑟𝑡 , 𝑁𝑣𝑚𝑟𝑡 , ω𝑓𝑚𝑟𝑡 , Bvmt
𝑡=1
v=1 f∈F r∈R
Additionally, there is an equation of motion for the bank account to account for low carbon credits generated, purchased and sold.
𝐵𝑣𝑚𝑡 = 𝑅𝑣𝑚𝑡 + 𝑁𝑣𝑚𝑡 + 𝑆𝑣𝑚𝑡 + 𝐵𝑣𝑚(𝑡−1) , ∀ 𝑡 ≥ 1
(4)
Data and Scenarios
For the numerical simulations our primary data on fuel costs and quantities is from the AEO 2010. We use Argonne National
Laboratories VISION model with supplements the AEO with longer time horizons (ANL Transportation Technology R&D Center
2011). We use well-to-wheel carbon intensity of conventional (gasoline and diesel) and alternative fuels based on the US EPA’s
regulatory impact analysis of the renewable fuel standard (US Environmental Protection Agency 2010).
Results
We examine the cost implications of various phase-down paths of a potential LCFS. Several factors influence the stringency of
the phase-down schedule: the base carbon intensity, the target carbon intensity and the rate of decline from the baseline to target.
We choose three base level carbon intensities (CIs) from which regulatory reductions might depart: the CI of 2005 gasoline and
diesel – (as used in the RFS2 regulations); the 2012 CI of petroleum-based gasoline and diesel; and the average CI of all on-road
transportation fuels in 2012. From these base level CIs, we evaluate four schedules for CI phase down toward a target CI reduction:
10% by 2022, 10% by 2030, 15% by 2030, 20% by 2030. For each of these regulatory CI paths, we determine the cost of
compliance through the use of lower carbon fuels, the time path of carbon emissions, and the time path of LCFS credit prices
depending on the allowable degree of credit trading across regulatory categories and the allowable banking of credits.
Conclusions
A NLCFS can be an effective mechanism to reduce the carbon intensity of the transportation sector. What is clear is that
lowering the carbon intensity of our national motor fuel system at any reasonable carbon cost will depend crucially on the timely
availability of advanced biofuels as envisioned under EISA. Credit prices vary from under $10 to well over $300/MTCO2e,
depending on the elasticity of biofuel supplies, the achievable CIs of biofuels, and the CI level under the base (RFS2) case. Given
the large degree of cost uncertainty, we find a very large value for the two types of credit flexibility that we examine: trading
across regulated fuel sectors (gasoline and diesel) and time flexibility – the ability to bank credits in the early period of tightening
of standards.
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