ICCT Proposes Novel Funding Mechanism for Ultralow-carbon Fuel in California

10.19.16 | Blog | By:

ICCT has developed a novel financing mechanism to support ultralow-carbon fuel (ULCF) production in California using a contract for difference (CfD) policy and released a paper about it this week. The organization notes that to meet California’s ambitious climate change goals, a substantial portion of the state’s emissions reductions must come from the transportation sector.

ICCT notes that while a transition away from petroleum and first-generation biofuels must come in part from increasing use of ultralow-carbon liquid fuels, defined as fuels with a carbon intensity of 30 grams of carbon dioxide equivalent per megajoule (gCO2e/MJ) or less, the production of these fuels has thus far fallen far short of volumes needed to substantively reduce transport sector emissions, ICCT said. Despite proof-of-concept technical demonstrations for a variety of ultralow-carbon fuels, economic barriers hamper their commercialization and widespread adoption.

Existing policies for low carbon fuels, including the Low Carbon Fuel Standard, the Renewable Fuel Standard, and the Second Generation Biofuel Producers Tax Credit, should substantially mitigate these economic barriers in theory. However, policy uncertainty and fluctuating credit values have reduced the effective support seen by investors.

The CfD ICCT is proposing would provide a guaranteed 10-year price floor for ULCF producers.

“A strike price, or price floor, would be established for low-carbon fuel producers through a reverse auction: projects competitively bid for the lowest break-even price for their fuel production. The winning projects with the lowest bids then enter a contract for a 10-year period with a guaranteed price floor that would begin after a short period to allow for construction time. The market value of the fuel, which consists of its sales price plus the value of all existing incentives it qualifies for, is then subtracted from the strike price. If the market value is lower than the strike price, then California would pay the difference. Thus, whenever market or policy shifts occur that drop the market value of a finished fuel below the agreed-upon strike price, the policy would pay out the difference such that the price floor is reached. Existing incentives provide the bulk of the benefit while the CfD provides a measure of policy insurance.

Implementing a CfD program would minimize spending by leveraging existing financial incentives for low-carbon fuel production. By leaning on other, existing programs for support, the proposed program acts more as insurance against policy and market uncertainty than as a primary financing mechanism. Unlike a flat per-gallon subsidy, the California Climate Investment Fuels Program (CCIFP) would only make payments when the market value of fuel plus the total support from other policies falls short of the level necessary for financial viability of the producers. The proposed policy incorporates other mechanisms to maximize its cost-effectiveness, most importantly a reverse auction to determine a guaranteed minimum price (i.e., a price floor) for the CfD.

The reverse auction drives the price floor downward by having projects bid against one another to offer their lowest break-even price. Limiting the program to only ULCFs in conjunction with a price floor established competitively through reverse auctions helps to ensure that the program supports only the most cost-effective (i.e., lowest cost per ton carbon abated) fuel projects. Further, if the program incorporates payments back into the fund by producers when the market value exceeds the price floor, the fund is then able to grow on its own and support additional projects.”

To ensure quality, ICCT says the qualifying projects under the CCIFP would need to demonstrate their readiness, production capacity, carbon intensity (CI) and sustainability and social benefits before participating in an auction. Factors such as the use of waste or demonstration of benefits to economically disadvantaged communities in California could function as tiebreakers in a reverse auction or provide additional benefits, such as additional guarantees, to winning projects.

While the program has the potential to support substantial new production, ICCT says its costs would be low: annual funding would comprise only 3% of the Greenhouse Gas Reduction Fund (GGRF) fund at its 2015 level. As the CfD program grows over time, the minimum bid unit for participation could also grow in turn, so that the program steers from supporting smaller facilities toward full-scale, commercial facilities over the first 10 years of the program. Depending on the number of bidders and their project size, a single auction could support one or more projects. In the case that funding is provided to the CCIFP annually, but is not guaranteed from year to year, the program still could support substantial volumes of ULCF.

The figure below illustrates such a scenario for a potential 2018-2030 CCIFP program that employs the proposed CfD policy mechanism. According to ICCT, the figure shows that the program grows in that business-as-usual scenario from supporting 4 million gasoline gallon-equivalents (GGE) of cellulosic ethanol in the first auction to nearly 50 million GGE of annual production by 2028. This leaves a substantial amount of money in the fund to protect against high liabilities if policy support for biofuels suddenly decreases. As the projects that would be supported through the program would likely be dependent on the contracts in order to secure investment, ICCT says a CfD program could be a prime driver for significant expansion of ULCF production in California.