California Takes Next Step to Formally Impose Stricter Limits on RNG Projects Under the LCFS With Eventual Phaseout

The California Air Resources Board (“CARB”) reviews the state’s Low Carbon Fuel Standard (“LCFS”) program every five years as part of the broader scoping plan required under the California Global Warming Solutions Act. On December 19, 2023, CARB published proposed amendments to its LCFS program in response to changes called for by the 2022 Scoping Plan. Amongst other sweeping changes, CARB is specifically proposing to (i) phaseout LCFS crediting for renewable natural gas (“RNG”) projects after 2040, (ii) impose new limits on RNG injected into the common carrier pipeline network that could severely restrict the eligibility of out-of-state projects to generate LCFS credits, and (iii) eventually phaseout avoided methane crediting for RNG projects. The public comment period for these proposed changes opened on January 5, 2024. These changes reflect CARB’s view that the best use of RNG long-term will be in hard-to-electrify, non-transportation industrial sectors and are likely to have several long-term impacts on the market for RNG given how LCFS credits tend to drive the price for RNG. However, as explained below, the immediate effects on the RNG market are somewhat tempered by CARB’s approach to phasing out RNG under the LCFS.

California’s LCFS Program

Enacted in 2007, the LCFS program is designed to encourage the use of cleaner, low-carbon transportation fuels in California, encourage the production of those fuels, and thereby reduce greenhouse gas (“GHG”) emissions and decrease fossil fuel dependence in the state’s transportation sector. Fuel producers, importers, and certain other parties in California are subject to the LCFS program. Parties that sell or offer for sale transportation fuels in California are required to meet annual carbon intensity reduction targets or buy LCFS credits to meet the standards. LCFS standards are based on the “carbon intensity” of gasoline and diesel fuel and their respective substitutes. Low carbon fuels below the carbon intensity benchmark generate credits, while fuels above the carbon intensity benchmark generate deficits. Credits and deficits are denominated in metric tons of GHG emissions (avoided or emitted based on the baseline and the corresponding reductions) and credits can be sold, banked, or used to satisfy a compliance obligation.

RNG has been a major success story under the LCFS, but it has saturated the California transportation sector’s demand for compressed natural gas, with RNG providing 97% of the compressed natural gas dispensed as transportation fuel in California. According to Bloomberg, RNG production has increased 20-fold over the past 10 years, and RNG continues to increase its share of fuel used for natural gas powered vehicles. Currently, the LCFS regulations allow for RNG producers to generate LCFS credits if the RNG is injected into the common carrier natural gas pipeline system, and a corresponding volume of fuel is matched to compressed natural gas or liquified natural gas dispensed in California. This flexible approach (known as “book and claim accounting”) has had national impacts in terms of supporting RNG growth and represented a practical approach given that biomethane molecules are indistinguishable from fossil-based natural gas. In addition, RNG producers have been able to benefit under the current LCFS rules for avoided methane crediting for the capture and reuse emissions that would otherwise be released to the atmosphere. This approach has allowed RNG producers and dairy farms, in particular, to benefit from lower, or even negative, carbon intensity scores and corresponding higher LCFS credit values.

Now, however, CARB has proposed a more restrictive approach based on its determination that zero-emission vehicles represent the best method for reducing GHG emissions from the transportation sector. According to CARB, given that natural gas also represents only 3% of transportation fuel demand in California, support for biomethane should shift to better incentivize other low carbon fuels and promote the use of RNG in non-transportation sector applications, such as its use as a feedstock for the production of renewable hydrogen. This approach seemingly ignores the role RNG could play with continued support from the LCFS for the displacement of other more carbon intensive fossil fuels besides compressed natural gas, such as the replacement of vehicles fueled by diesel, or the role it could play in charging electric vehicles.

Overview of the Proposed Changes to the LCFS Program

The December 2023 amendments to the LCFS program include the following:

• New Carbon Intensity Benchmarks: CARB proposes to increase the 2030 carbon intensity targets from 20% to 30%, including a one-time 5% reduction of the carbon intensity benchmark in 2025. These stricter requirements are largely in response to the perceived overproduction of certain fuels such as renewable biodiesel. The change in benchmark values will ultimately impact LCFS credit values for qualifying fuels under the LCFS.
• Elimination of Intrastate Fossil Jet Fuel Exemption: CARB proposes elimination of the existing exemption for intrastate fossil jet fuel from LCFS regulations beginning in 2028. This opens the door for LCFS credit prices to support increased production of sustainable aviation fuel.
• Expansion of Zero Emission Vehicle Infrastructure Credit: CARB proposes new credits for the construction of fast electric charging or hydrogen refueling infrastructure for zero-emission vehicles.
• New Crop–Based Biofuels Criteria: CARB proposes new tracking requirements for crop-based feedstocks used in biofuel production in order to counter potential deforestation effects and other adverse land use changes.
• Crediting RNG Projects: CARB proposes a number of changes to LCFS provisions related to RNG, largely in an attempt to phaseout its usage as a transportation fuel by 2040 in favor of other transportation fuels such as renewable hydrogen.

There are numerous other changes in CARB’s proposal, including phasing out project-based crediting for petroleum projects by 2040, new requirements for hydrogen, and a requirement that direct-air-capture carbon capture and sequestration projects be located within the United States, amongst others. Notably, the proposed rules do not include a requirement that would have phased out LCFS crediting for crop-based fuels but seek instead to impose additional sustainability requirements for crop and forestry-based feedstocks.

Crediting Changes for RNG Projects – A Closer Look at the Proposed Changes

For projects that break ground after December 31, 2029, CARB’s proposal would phaseout pathways for crediting biomethane/RNG used in vehicles after December 31, 2040, but RNG projects can continue to be certified or recertified for LCFS crediting through 2040. CARB proposes to define “break ground” as the “earthmoving and site preparations necessary for construction of the digestor system and supporting infrastructure that starts following approval of all necessary entitlements/permits for the project.” After that date, any volumes of these fuels from these fuel pathways used in compressed natural gas vehicles would be reported with the same carbon intensity score as what CARB assigns to ultra-low sulfur diesel, meaning that after 2040, RNG use as a combustion transportation fuel would generate a deficit under the LCFS. CARB believes that the 2040 date will minimize RNG market disruption by providing more time to find offtakers for non-transportation fuel uses in an attempt to avoid stranding assets. While still unwelcome, some opponents of RNG were urging CARB to phaseout crediting for RNG under the LCFS by 2025. The December 2023 amendments to the LCFS program also contain two other significant restrictions related to crediting RNG projects prior to the phaseout: (1) new limitations on the current book and claim accounting approach and (2) the phaseout of “avoided methane” crediting.

New Traceability Limits on Book-and-Claim Accounting

Currently, LCFS regulations allow for book-and-claim crediting (i.e., indirect accounting) of RNG when the fuel is injected into the North American natural gas pipeline system. Consequently, the majority of these credits come from renewable natural gas injected into pipelines outside of California.¹ CARB is seeking to reverse this trend by requiring operators to demonstrate that RNG is carried through common carrier pipelines physically flowing within California or toward an end use in California. The proposed amendments further specify that such eligible pipelines must flow toward California at least 50% of the time on an annual basis. CARB states that this new requirement will reduce the state’s overall methane emissions by displacing the existing fossil-based natural gas found within instate pipelines with RNG actually produced within California.

CARB incorporates the same test for determining pipeline flow as the one used by the State’s Renewable Portfolio Standard (“RPS”). The test is set forth in the California RPS Eligibility Guidebook and generally requires a demonstration of the following:

1. Each segment of the pipeline on the delivery path from the point of injection to the point of receipt physically flows toward California at least 50 percent of the time on an annual basis.
2. If storage is used, then the pipeline must flow in the direction of the facility from the injection point to the storage point and from the storage point to the receipt point at the facility at least 50 percent of the time on an annual basis.
3. Contracts for the delivery (firm or interruptible) or storage of the gas with every pipeline or gas storage site operator transporting or storing the gas from the injection point to the final delivery point.

If finalized, the requirement to demonstrate deliverability for projects that break ground after January 1, 2030 for RNG take effect on January 1, 2041, and on January 1, 2046 for biomethane used as a feedstock for the production of hydrogen.

Avoided Methane Crediting Phaseout

Avoided methane crediting is a mechanism under the LCFS program whereby credits are awarded to methane producers who capture GHG emissions that would otherwise be released directly to the atmosphere. For example, dairy farms or biomass landfills that directly capture and reuse methane emissions are awarded credits which can be later invested in emissions technologies such as anaerobic digesters. For RNG projects that start construction after December 31, 2029, CARB is proposing that the LCFS program’s avoided methane crediting will end in 2040, for RNG used as transportation fuel, and in 2045 when used as a feedstock to produce renewable hydrogen. For RNG projects certified prior to January 1, 2030, CARB may renew the crediting period for up to three consecutive 10-year periods. Accordingly, there is still a path for certain RNG projects to continue generating LCFS credits after the 2040 phaseout deadline proposed by CARB.

Takeaways

RNG may be a victim of its own success, as CARB no longer views RNG as playing a significant role in decreasing the carbon intensity of transportation fuels within the state. Nevertheless, these changes, whatever their intent, have the potential to disrupt the national RNG market given how the price of RNG is tied to the value of the LCFS credit. Washington and Oregon have similar programs to the existing LCFS requirements, but credit prices in those markets still lag behind the potential value the LCFS represents. The public comment period for the proposed amendments began on January 5, 2024, closes on February 20, 2024, and will be followed by a public hearing scheduled on March 21, 2024.

¹ California Air Resources Board, Public Hearing to Consider the Proposed Amendments to the Low Carbon Fuel Standard, Staff Report: Initial Statement of Reasons at 31 (January 2, 2024).

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.