The Barrel Blog

No matter how many times I looked at it, I couldn’t accept that there wasn’t a free rider problem in the setup of the California Low Carbon Fuel Standard.

Since I was assured repeatedly by state officials that a free rider problem could be dealt with by the state, I sort of wondered what I was missing. But now a refiner in the state thinks there might be one too, based on a comment it submitted to the California Air Resources Board on LCFS implementation.

The irony is that it came after a change in the regulation that does appear to give CARB an enforcement vehicle to ensure there are no free riders among the state’s refiners.

“Free rider” is a standard economics concept referring to somebody who benefits from, for instance, government spending or a regulation, etc., but does not pay anything for those benefits.

As it applies to the LCFS, here was the possible free rider problem: the state has set a goal to reduce by 2020 the wellhead-to-wheel carbon emissions of the state’s transportation fuels by 10% from a 2010 baseline. Most of the onus for that is going to fall on the state’s refiners. And while refiners are subject to all sorts of reporting requirements, the test of whether the refining industry is meeting that goal will be judged against the entire industry, not individual refineries.

So the inherent free rider problem is that a rogue refiner could run a high-carbon fuel slate, not bother to buy enough LCFS credits to do its part toward a 10% reduction, and the state has little recourse, since its enforcement mechanisms were aimed at the industry as a whole.

It was interesting to discover that somebody else thought the problem existed: Kern Oil & Refining. It apparently also sees a free rider problem, though it doesn’t use that term in its letter to CARB.

In that recent letter signed by Melinda Hicks, the company’s manager for environmental health and safety, Kern said the “average refinery” approach would hurt what she said were “low-energy-use, low-complexity refineries, whose (carbon intensity) for finished products, in reality, are necessarily lower than the industry average relied upon in the regulations.” Kern is clearly a smaller, lower-complexity refinery, with a 26,000 b/d operation in Bakersfield.

So Hicks’ perspective is from a refinery that believes its carbon intensity-rating is going to be significantly better than the industry norm, because of its size. That’s not precisely a free rider problem; it’s more like a really good student complaining that his education is being held back because his classmates aren’t too bright.

But the letter asks CARB to modify its system so that it does not “unjustly distribute (carbon) deficits across the industry–penalizing one refiner for another refinery’s choices.” That does sound like a free rider concern. So does this: “The current industry average approach unnecessarily incentivized refiners to process (high-carbon crudes) because the deficits incurred if/when the industry average exceeds the target baseline are then spread across the entire industry.”

And the consequence of that is laid out later in the letter: “A refiner may opt to purchase lower CI (carbon intensity) crude oil at premium prices in order to avoid generating any deficits. However, as currently proposed, if the industry average exceeds the baseline target, this refiner would still incur deficits.”

But David Clegern, a spokesman for CARB who has handled a variety of questions from The Barrel on this issue, read the Kern letter. Clegern has noted several times in the past that CARB has all the data on individual refinery carbon intensity, and previously had provided a somewhat vague picture of CARB officials attempting to work with these recalcitrant refineries to get in line. Nothing he said was ominous, but you couldn’t help but interpret it as a “you’re not playing nice with the other boys and girls” type of discussion that would get a refiner’s attention.

But earlier this week, he pointed to a proposed CARB amendment from last December, well before Hicks wrote the letter for Kern. Either Kern didn’t read the proposal, or isn’t confident it deals with its concerns. 

“When the Board approved staff’s proposed LCFS amendments last December, it directed staff, in Resolution 11-39, to ‘evaluate and propose, as appropriate, an option for regulated parties to have their deficits for gasoline and diesel determined on a refinery-specific basis that accounts for the carbon intensity of domestic and imported crude oils, intermediate products and finished fuels,’” he wrote The Barrel. “We are seeking 2011 crude oil information for all California refineries to consider this approach.” That sounds like putting into the regulations a method for dealing with either refiners exceeding the basic guidelines by a lot, or companies that are going to produce far fewer carbon emissions than the standard calls for, which is what Kern suggests it is going to do.

For Kern, the scenario it paints for its own impact is stark. It believes that if some free rider refineries buy high carbon crude and generate deficits, it could cost Kern “anywhere from $217,000 to $1.2 million annually…because other refiners chose to process (high carbon crudes) and regardless of whether Kern itself stayed below the baseline.”

Its solution: “an individual compliance approach under which all refineries would stand on their own merit in comparison to the industry baseline.” It also seeks a small-refiner exemption to any refiner processing less than 5% of the state’s total crude capacity.

According to Kern’s letter, CARB is considering such a small-refiner exemption. But the letter says that discussions on it have gone on for several years and the earliest it would be added would be next year.

The full text of Kern’s letter can be found here.

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