UC Davis report examines economics of LCFS, cost containment mechanisms

November 2013

UC Davis researchers Gabriel E. Lade and C.-Y. Cynthia Lin recently published a new paper, "A Report on the Economics of California's Low Carbon Fuel Standard and Cost Containment Mechanisms." The report investigates a number of important issues such as concerns over market power in the state's fuel and credit markets, the role of dynamics and uncertainty on market outcomes, and incentives to innovate and invest in renewable fuels and their potential interactions with cost containment mechanisms.

The report finds that compliance costs may increase rapidly in the future if there are large differences in marginal costs between traditional fossil fuels and alternative, low carbon intensity fuels; or if there are capacity or technological constraints to deploying alternative fuels, particularly those with low carbon intensity.

In the absence of readily available, low CI fuel alternatives, the fuel market will adjust along two dimensions to maintain compliance with the LCFS: (i) increase the use of cheaper fuels below the Standard such as ethanol derived from corn starch and sugarcane; or (ii) increase fuel prices and reduce fuel consumption to a level where the Standard is technologically feasible. Both options will be associated with high LCFS credit prices. Because firms are able to bank credits over time, anticipated high costs in the future may lead to higher costs in the present before any constraints bind on the industry.

The potential for compliance costs to increase rapidly in the near future motivates our recommendation to institute a hard cap on LCFS compliance credits through a mechanism such as an unlimited credit window or noncompliance penalty. Both mechanisms guarantee that compliance costs will never exceed either the credit window price or the non-compliance fee, and provide a clear and transparent alternative compliance strategy. Both proposals have the additional advantage of generating funds which may be used to increase investments in low CI fuel technologies. Importantly, neither mechanism will compromise the greenhouse gas reduction goals set by Assembly Bill 32.

To read the full publication, click here