Renewable fuel producers face lower Q2 results as California LCFS prices fall

While expectations abound for record high second quarter earnings from petroleum-based refiners, producers of renewable diesel are facing a more uncertain landscape as supply increases have eaten into the value of a key price component -- California state regulatory credits

California has been the magnet for renewable fuels like renewable diesel and sustainable aviation fuel both made in the US and abroad due to the state's clean air policies.

"California's Low Carbon Fuel Standard (LCFS) is the poster-child for successful low carbon fuel initiatives, but recently the program has become over supplied with credits (the mechanism for program compliance) as more RD volumes are being sold into the California market — an impact that could potentially decrease RD margins by 20-50 cents/gal within the next two years," Raymond James analysts wrote in a June 24 research note.

Many US renewable fuel projects currently underway are geared to moving fuel to California to layer once lucrative state-level credits on top of the federal $1/gal Blenders' Tax Credits and RINs, credits from the Environmental Protection Agency's Renewable Fuel Standard.

The price of California's LCFS credits have fallen to their lowest level since 2017, with third-quarter to date 2022 credits averaging $92.42/mt, according to Platts assessments. This down from the average $104.34/mt in the second-quarter 2022.

According to Raymond James calculations, this cuts the LCFS margin uplift for producers to around 60 cents/gal, compared with the $1/gal to $1.45/gal uplift when LCFS credits were trading around $200/mt.

"A 40 to 85 [cent/gal] difference is an astronomical amount in RD economics as the product is uneconomic in the U.S. without regulatory subsidies and programs, and LCFS credits have historically represented 50 — 70% of the total RD margin," the note said.

Raymond James attributes weaker LCFS prices to a 36.5% increase in RD volumes between 2019 and 2021 "and an increase of low- or no-carbon electricity generation as renewable fuel producers have oversupplied the California LCFS market in an attempt to chase margins and have exceeded mandated Carbon Intensity (CI) reduction targets. This oversupply has led to an over-generation of credits and an increasing surplus in the credit "bank," the note continued.

Standalone RD

While LCFS credits have dropped, the price of RINs remain strong. The value of D4 biodiesel RINs averaged $1.69/RIN in the second quarter of 2022, according to Platts assessments, that makes the RINs value for a gallon $2.87/gal, since one gallon of RD creates 1.7 D4 RIN.

"While diesel prices remain high, LCFS credit prices are expected to stay weak before starting to rebound as petroleum product prices fall back and renewable diesel feedstocks remain elevated," said S&P Global Commodity Insights in a June 29 research note.

Expectations are for CARB diesel prices to average $146.48/b in 2022, or around $3.44/gal, according to forecasts by S&P Global Commodity Insights.

The price of petroleum-based San Francisco CARB diesel averaged $4.13/gal in the second quarter while the price of US West Coast renewable diesel without credits averaged $2.92/gal, according to Platts assessments.

While the spread between the two fuels has narrowed so far in the third quarter – with CARB diesel averaging $3.69/gal and RD without credits averaging $3.45/gal, the price of RD with credits are more than double -- averaging $7.81/gal.

"High diesel prices imply less of a need for the LCFS credit price to make RD producers whole. Renewable fuels production is currently competitive even without LCFS support," according to Platts Analytics.

As diesel prices remain high, LCFS credits are expected to remain low.

"However, fundamentals should reverse as prices for diesel fall faster than for feedstocks," Platts Analytics wrote, forecasting that the cost of RD feedstocks will rise to $6.75/gal in 2022, before falling to $5.94/gal in 2025.

CARB scope changes ahead

California is moving forward to tighten LCFS and reduce carbon fuel intensity as part of an effort to meet that state's aim for carbon neutrality by 2045, a move which could bolster sagging LCFS prices.

According to research from Tudor Pickering Holt, carbon intensity target reductions of 25% to the 2010 baseline by 2030 will still result in an oversupplied market. Current goals are for a 20% reduction for 2030.

"However, a 25% target would raise 2026 credit generation by +12% (and more in future years), cutting the oversupply to 3.7mmt," wrote TPH in a July 12 research note.

"..our modeling shows that a 2030 target CI reduction of 30% would return the LCFS program to shortages by 2026. Under this scenario, deficit generation would be +25% higher in 2026 and +45% higher by 2030, which more than offsets new credit supply from RD, RNG, and electricity for EVs.," he wrote.

RD producers will benefit from more LCFS programs based on the California model. Neighboring Oregon has implemented a similar program, but it pales in size and scope to California's. Washington and Canada are expected to have similar programs in place in 2023.