LCFS credit for renewable natural gas

LCFS credit for renewable natural gas

December 08, 2021 | By Christopher Psihoules in Washington, DC, Emely Toro in Washington, DC and Caileen Gamache in Houston

More renewable natural gas projects have come on line in 2021 than in the entire 30-year history of RNG.

The Wall Street Journal predicted that RNG may make up nearly 30% of the total natural gas supply by 2040 compared to less than 1% today. RNG is methane gas from decomposing garbage, cow and hog manure and other organic sources that is cleaned and put into pipelines as a substitute for conventional natural gas.

All signs point to the development of RNG projects picking up significant pace as we enter 2022.

The industry is taking notice. This article provides some of the nitty gritty of monetizing the RNG wave and responds to both lender and developer questions.

State Credits

States and localities are playing the leading role in creating opportunities to monetize RNG.

The Pacific Coast Collaborative — a first of its kind regional agreement among California, Oregon, Washington and British Columbia that aims to reduce greenhouse gas emissions — helped to facilitate state programs such as the California low-carbon fuel standard or “LCFS” and clean fuels programs in Oregon and Washington.

Low-carbon fuel standard programs offer incentives for greener fuels, such as RNG, by awarding tradable credits to suppliers of transportation fuels to encourage them to reduce the carbon intensity of the fuels they supply. Much like the federal government has done for conventional biofuels and advanced biofuels by instituting a renewable fuel standard that requires blending a certain percentage of ethanol or biodiesel into motor vehicle fuels, the development of state low-carbon fuel standards will help unlock the clean fuel market across the United States.

This article focuses on the California LCFS. Other states that have adopted or are considering clean fuel programs have modeled them on the California LCFS.

In 2009, the Oregon Department of Environmental Quality created a standard with the same structure as the California LCFS. The Oregon clean fuels program was fully implemented in 2016 and uses the life-cycle greenhouse gas intensity calculations created or approved for the California LCFS by the California Air Resources Board. Credit prices in Oregon have generally been lower than in California and are currently averaging $124 per credit.

In May 2021, Washington state enacted HB 1091 enabling the implementation of an LCFS. The initial LCFS goal is to reduce greenhouse gas emissions from transportation fuels by 20% from the 2017 level by the year 2038.

The Washington state LCFS program must go into effect no later than January 1, 2023. The state is easing into it. By 2028, there cannot be more than a 10% carbon intensity reduction requirement unless there are both at least a 15% increase in biofuel production and approved plans for at least 60 million gallons of new biofuel production capacity in Washington state. This LCFS program, along with the California and Oregon programs, will work in conjunction with one another to cover the entire West Coast.

Various other states such as New York, Iowa, Minnesota, New Mexico and Colorado are still debating whether to adopt LCFS programs.

New York considered legislation in 2021 that did not make it to the governor’s desk, but advocates plan to try again in 2022. A bill that would have established an LCFS program and set the initial carbon intensity reduction target of 20% for motor vehicle fuels by 2030 did not advance out of committee.

The Iowa governor proposed requiring diesel fuel sold in the state to contain at least 11% biodiesel beginning in 2022. The percentage would have increased to 20% in 2024. A 15% ethanol blending requirement for mixing ethanol in gasoline would have taken effect in 2026. The proposal did not pass in 2021, but may be considered again in 2022.

Minnesota has been considering the use of biofuels and implementation of an LCFS program for some time. The Great Plains Institute, a Minnesota non-profit focused on energy and climate change, helped create an outline for clean fuel standards intended for Midwestern states. A “Future Fuels Act” (HF 2083) was introduced this year in the Minnesota house, but did not pass. The bill would have required a 20% reduction in the carbon intensity of transportation fuels by 2035. Minnesota’s largest source of greenhouse gas emissions is the transportation sector. The state set a target in 2007 of reducing transportation-sector greenhouse gas emissions by 30% by 2025.

A New Mexico bill — SB 11 — that would have adopted an LCFS program similar to the California LCFS failed to pass the state legislature in 2021. The bill would have gone beyond the California program by awarding credits for actions that reduce the carbon intensity in a list of non-transportation sectors as well. The bill proposed a 10% reduction in carbon emissions by 2030 and 28% by 2040.

Colorado concluded a clean fuel standard feasibility study in September 2020 and made the decision not to implement an LCFS program at that time. The proposed program was similar to the California LCFS program. Colorado is focused on reducing greenhouse gas emissions in the transportation sector, including through adoption of lower carbon fuels. Several tools under discussion include advanced biofuels, RNG and hydrogen for aviation and some heavy trucks. Proponents of a clean fuel standard are expected to revisit use of LCFS credits in the near term.

Because the existing state programs and the new programs being contemplated in other states are largely modeled on the California LCFS program, what follows is an overview of how California LCFS credits work and how projects can effectively structure transactions to monetize such credits.

California Overview

California awards LCFS credits to producers of low-carbon fuels. RNG qualifies for credits as long as it is used to replace conventional transportation fuel in California. The RNG does not have to be produced in California or even land there physically. The credits are currently worth around $150.00 per metric ton of CO2 reduced.

Petroleum importers, refiners and wholesalers are “obligated parties” who must purchase California LCFS credits to meet carbon-intensity benchmarks set by the California Air Resources Board for the fuel they supply.

Obligated parties supplying transportation fuel in California must file compliance reports each year that verify the number of LCFS credits they purchased from low-carbon fuel producers through formal agreements, over-the-counter agreements (for forward-looking trades and transfers), brokers or in the credit clearance market, which is a CARB-administered market for credits in case of a market shortage.

Each obligated party must reach the carbon-intensity annual benchmark set by CARB. Alternatively, obligated parties can comply with the benchmarks by physically reducing the carbon intensity of their fuels. An obligated party would do so by blending a low-carbon or renewable fuel with the carbon-intensive fuel to bring the mixture below the annual carbon-intensity benchmark set by CARB.

Owners of RNG projects can earn revenue by being awarded credits and then selling them to obligated parties.

Project Qualification

RNG projects must register with CARB on its LCFS reporting, credit bank and transfer system. The system tracks a fuel pathway certification process as well as the creation and transfers of credits. Obligated parties register on the system.

Each registered entity records its fuel transactions on a quarterly basis and files annual compliance reports. The carbon-intensity value of the fuels that obligated parties supply is determined by the fuel pathway and can be estimated using the CARB life-cycle analysis model (which assesses the greenhouse gas emissions for fuel per unit of transportation energy delivered in the life cycle or pathway of the fuel). Obligated parties also report the energy economy ratio, which is a comparison of miles-per-gallon equivalent between two fuels.

The simplest way to ensure that RNG projects will qualify for LCFS credits in California is to produce RNG that fits in one of the fuel pathways listed in the “lookup table pathways” on the CARB website. The fuel pathways show acceptable ways of producing and then moving RNG to California for ultimate consumption in the California transportation fuel market.

However, other approaches are possible where the owner of an RNG project can demonstrate how its RNG will reduce the carbon intensity of transportation fuels over time. To register a fuel not found in the lookup table pathways, the RNG project may submit a tier 1 (LNG, L-CNG and most RNG pathways) or tier 2 (all other fuels not in the table or tier 1) fuel pathway application on the “alternative fuels portal,” also via the CARB website.

The location where the RNG will be processed to become a natural gas must be registered to determine the carbon intensity score for the pathway. The source, such as a cluster of anaerobic digesters near dairy farms or a landfill, must be registered as an intermediate facility.

Transacting for LCFS Credits

California LCFS credits can be earned by supplying RNG for use as a transportation fuel or by installing RNG refueling infrastructure. (For more detail on how the LCFS program works, see “Financing California Hydrogen Projects Using LCFS Credits” in the December 2020 NewsWire and “Virtual Supply Arrangements for Hydrogen” in the June 2021 NewsWire.)

In order for an RNG project to qualify for credits, the final offtaker of the RNG must use the fuel in California as transportation fuel. However, virtual arrangements are possible.

Three key contracts are used in RNG projects.

The first is a feedstock supply agreement. In most instances, because the dairy farm or landfill has no use for RNG as transportation fuel, there is a feedstock supply agreement under which a dairy farm, for example, supplies the raw material for making methane. The supplier is usually paid an amount per MMBtu of RNG produced or a fixed price per ton (or equivalent measurement) of the raw input.

The next contract is an interconnection agreement. The RNG project must connect to an interstate gas pipeline so that a pathway to the California transportation fuel market can be established.

The last contract is an offtake agreement for the RNG. The offtake agreement usually comes in one of two forms. It can be a marketing agreement between the RNG project and a middleman who delivers the RNG to a company producing vehicle fuels for the California market, registers the transaction and receives LCFS credits. The credits and cash proceeds from sale of the RNG are then transferred back to the RNG project with a fee paid to the marketer.

Alternatively, the RNG project may enter into a fixed-price agreement where the RNG and associated environmental attributes are simply sold to the offtaker. The LCFS credits remain with the offtaker, but the value is factored into the price paid for the RNG.

Many RNG sales generating LCFS credits are virtual transactions.

In such cases, the RNG project sells RNG to an initial offtaker for distribution in the California transportation fuel market with an LCFS profit-sharing mechanism negotiated as part of the commercial agreement. The gas dispensed at the fueling station in California is not the same molecules produced at the RNG project. In fact, the RNG may never physically reach California. However, CARB certifies distribution of RNG via displacement.

How this works is simple: if RNG is produced by an RNG project outside California and injected into an interstate natural gas pipeline, the produced volume must match an amount of compressed natural gas withdrawn for use as a transportation fuel in California. This creates a pathway for California LCFS credits. The credits are then sold to an obligated party or to third parties who wish to purchase California LCFS credits.

At the same time the owner of the RNG project injects the gas into an interstate pipeline, it buys back the same quantity of “brown gas” (conventional natural gas) from the pipeline to resell. It may end up paying the same amount it was paid for the RNG to buy back the brown gas. It then resells the brown gas in the local market or consumes the brown gas onsite.

How to Verify California Transactions

Any RNG injected into a pipeline must maintain evidence of a chain-of-custody by CARB accredited LCFS third parties.

RNG projects can use book-and-claim accounting to keep track of the ownership and transfer of transportation fuel without tracking the physical fuel. Decoupled environmental attributes are used to represent the ownership and transfer of transportation fuel without regard to physical traceability.

The link between proving the energy economy ratio of the injected RNG and natural gas withdrawn at the other end of the pipeline for transportation purposes in California can be demonstrated by providing records of invoices and contracts. The records must show the quantities of RNG produced and injected at one end of the pipeline, the price per unit at which the environmental attributes were sold or purchased and proof that the entity has the exclusive right to claim the attributes.

Book-and-claim accounting is used to report transactions for up to three fiscal quarters for pipeline-injected RNG claimed as a transportation fuel in California. If a quantity of RNG is injected into an interstate pipeline in the first quarter of a given year, the quantity claimed for LCFS reporting must be matched to compressed natural gas dispensed in the California transportation fuel market no later than the end of the third calendar quarter of that year. Once quarter three ends, any unmatched RNG quantities expire for the purpose of LCFS reporting.

Once both the quantity of fuel and the associated LCFS credits are reported in the CARB LCFS data base as having been sold, the LCFS credits are treated as retired and can no longer be sold, transferred or claimed by any entity for any purpose.

Both the RNG project (or middleman acting as the pathway applicant) and fuel reporting entity must submit an attestation to CARB and keep records of attestations from upstream parties. The RNG project (or pathway applicant) must file an annual fuel pathway report and submit injection records that will remain subject to verification.

Current Market Conditions

As the NewsWire went to press, the California LCFS credits were trading for $150 per credit on average. Each credit represents one metric ton of CO2 reduced.

The most recent data posted shows the average credit price in the last quarter reached $185. In November 2019, CARB amended the program to cap the price for credits. The price cap was imposed to ensure a stable market and limit compliance costs to avoid derailing program support. The cap was set at $200 in 2016 to be adjusted for inflation, and it has increased year over year to a current cap of $221.67 per credit.