Transportation Climate Initiative May Have Significant Impacts on Fossil Fuels Commodity Contracts in the Northeast USA
Beginning in 2023, sellers and owners of fossil fuels for use in transportation markets in three states and the District of Columbia may need to purchase allowances for sales in those jurisdictions based on a recent agreement to implement a new cap-and-trade regime for emissions of carbon dioxide (CO2). Massachusetts, Rhode Island, Connecticut and Washington D.C. recently signed on to implement a cap-and-trade program that will set declining annual limits on CO2 emissions from the transportation sector. The proposed program differs from California’s Low Carbon Fuel Standard (LCFS) and the EPA’s Renewable Fuel Standard, which seek to reduce greenhouse gas emissions from the transportation sector by requiring transportation fuels to contain a minimum volume of lower carbon fuels (or a lower average carbon intensity from their fuels, in the case of the LCFS). Instead, the Transportation and Climate Initiative Program more closely resembles the cap-and-trade component of California’s AB32 and the Regional Greenhouse Gas Initiative’s market-based emission reduction program that set a cap on emissions and charge for the right to emit carbon. While the latter is focused on decreasing CO2 emissions from the power sector, California added allowance requirements for distributors of transportation fuels to the California market. The objective of the programs is to reduce the use of fuels that result in direct carbon emissions and make them more expensive than alternatives.1
The program framework is laid out in a Memorandum of Understanding (“MOU”) in which the signatory jurisdictions commit to pursuing the necessary legal steps to adopt statutes and/or regulations to set an annual limit for CO2 emissions, which will decrease every year until 2032, by which time the jurisdictions will have reduced CO2 emissions from the transportation sector by 30% relative to 2023 emissions. Each jurisdiction will create and offer allowances for CO2 emissions and then sell the allowances in a system that will have minimum and maximum pricing and will allow three-year compliance periods.
The MOU describes which entities must buy these allowances in general terms, leaving each jurisdiction with some flexibility in determining the regulated entities that will ultimately be required to purchase allowances. “State Fuel Suppliers” are identified as being required to obtain allowances but the MOU also makes the cryptic statement that “[t]he primary regulated Parties shall be Position Holders, namely those owners of Affected Fuels at fuel terminals.” Other entities that deliver Affected Fuel, defined as the fossil fuel components of motor gasoline and on-road diesel fuel delivered for final sale or consumption in a participating jurisdiction, will be added “only as necessary to ensure that all Affected Fuel is subject to an allowance holding obligation.” Either legislation or rule making will be needed to provide a clearer picture of the breadth of entities within the regulated community that will be impacted by the program’s requirements. However, the language certainly suggests that entities that own fossil fuels at a terminal will be responsible for purchasing the allowances. Entities that own or currently sell transportation fuels in these markets need to monitor the developments in each jurisdiction to better understand how the jurisdictions propose to define these terms.
For many midstream entities that provide terminaling services but do not own the fuels, it will still be important to monitor the states’ efforts to adopt legislation or promulgate implementing rules in order to comment and potentially raise legal challenges should the jurisdictions propose to define the terms broadly enough to impose the compliance obligations on terminal service providers. At a minimum, these terminals will be a primary focus for monitoring inflows of Affected Fuels into the respective jurisdictions. Given the wide range of options for introducing fuels into a state, the recordkeeping and reporting requirements needed to ensure that this system captures all Affected Fuels will likely be substantial. Alternatively, these jurisdictions may determine that it is “necessary” to impose the compliance obligation for the purchase of allowances on terminals to “ensure” that the program is effective.
Finally, the implementation of this program will likely be complicated because the delivery of fuels across state lines is so frequent and pricing and availability-driven that a number of tracking and tracing problems are easily foreseeable. This system could easily upend expectations of sellers with respect to sales in other states that result in the delivery of fuels into the signatory jurisdictions. Such sales could give rise to the allowance requirement even if the fuels were intended to be delivered to a different state at the time of sale. As a result, sellers of transportation fuels in neighboring jurisdictions may need to include contractual restrictions on the delivery of these fuels into signatory jurisdictions. Parties who learn that they are subject to these compliance obligations after the sales will obviously be less able to manage their compliance obligations after the fact and may face fines or penalties in addition to an unexpected compliance obligation. Participants in the fuels markets should carefully monitor, and be prepared to provide input into, the development of the draft model rule, which will be subject to a public review and comment period. The final Model Rule will serve as the basis for the individual programs in the states that have currently signed on, and any state that chooses to sign on in the future.
For information about this program and how it may affect your operations, please contact us.
1 At least in part, the rationale is that, without such programs, the price of traditional fuels does not represent the real “cost” of the product due to the impacts of their carbon emissions.
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.