The knock-on effect: The curious case of California's LCFS program

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“The knock-on effect: The idea that one action or event has secondary or indirect consequences. In economics the knock-on effect is a reminder that the economy operates as a system in which any action will have subsequent reactions that cease only when a new equilibrium has been reached.” - Oxford Press Dictionary of Economics

It’s very easy for policymakers to fall into the trap of thinking that there is some invisible line marking the boundary by which a particular policy affects the environment. The mistake that’s often made is failing to consider the knock-on impacts of the policy on market participants decision making, including those from outside the sphere of influence the policy is directly targeted at.

Government policies tend to be most effective when they directly address the problem they are trying to solve. Once they start to impact indirectly, or try and influence more than one policy outcome, policies inevitably result in unintended consequences, invariably negative.

It’s with that in mind that we look at California’s Low Carbon Fuel Standard (LCFS) program. To recap, the current target underpinning the LCFS program is a 20% cut in the carbon intensity of the states transportation fuel pool by 2030, and by 80% by 2050, compared with a baseline year of 2010 (see Everything you need to know about Low Carbon Fuel Standards (LCFS)).

The LCFS imposes a market based carbon cost on transport fuels that have a carbon intensity (CI) score above the state’s requirements, and in theory at least, is designed to incentivise the transportation sector to gradually move towards meeting the targets.

The CI score is a measure of all the greenhouse gases (GHG) emissions associated with the production, distribution and consumption of a fuel. CI scores are developed based on a life-cycle analysis methodology, with varying scores due to feedstock types, origin, raw material processing efficiencies and use within transportation.

Each LCFS credit represents one tonne of CO2 reduced below this requirement. If an obligated entity (such as refiners, petroleum importers and wholesalers) has a deficit of LCFS credits then they are required to either generate additional LCFS credits or purchase them from another entity that has a surplus, and who is willing to sell them.

Technology neutral, or not technology neutral

At first glance there’s much to be admired about the scheme. It gives the appearance at least of being technology neutral. It is up to the market to decide where to invest in innovation and how much capacity is required to meet the target.

Dig a little deeper and you find that’s not strictly true.