The Intersection of Dairies and Low Carbon Fuels

Sean Penrith, The Climate Trust
Weekly Policy and Finance Update – July 3, 2017

The Intersection of dairies and low carbon fuels.

Back in 2014, the Biogas Opportunities Roadmap pointed out that more than 11,000 biogas systems could be developed across the country, but found that market uncertainty was the key barrier, rather than limited investor appetite. The dairy and livestock sector in California delivers more than half the state’s total methane emissions. To this end, CA is tackling its methane emissions from dairy operations as part of its Short-Lived Climate Pollutant reduction strategy. Key short-lived pollutants include black carbon, methane and tropospheric ozone. Reductions of these powerful pollutants can deliver near-term results in the fight against climate change.

Part of the 2016 bill SB 1383 directs the CA Air Resources Board (ARB) to deploy a strategy by 1/1/18 to achieve methane reductions of 40% below 2013 levels by 2030. The bill also calls for a pilot financial mechanism designed to address the market uncertainty for environmental credits, and more specifically, Low-Carbon Fuel Standard (LCFS) credits generated by dairies producing low-carbon transportation fuels. Methane emissions from dairy manure account for 25% of the total dairy and livestock emissions of 118 MMTCO2e as of 2013. In early 2016, LCFS credit prices were in the $130 range and dropped to $56 that July. Currently they are trading for $80 per tonne.

To kick this strategy off, ARB recently hosted the SB 1383 Diary & Livestock Subgroup #2 meeting in Sacramento. This group is charged with ‘fostering markets for digester projects.’ Their goal is to develop in the near-term ‘voluntary and incentive-based approaches’ that might preempt ARB needing to implement methane regulations on diaries in 2024. This discussion was followed later in the day with another meeting to squarely address the call for a pilot financial mechanism to mitigate economic uncertainty and spur investment and development of low-carbon fuels.

ARB staff shared two possible mechanisms for consideration. The first was the Contracts for Difference (CfD) approach where the LCFS producer is guaranteed a specific credit value. If the market rises above that price, the producer pays the CfD administrator the difference, and if the market dips below, the administrator pays the producer the difference. The second is a put option contract originally piloted by the World Bank for their methane and climate mitigation program. Here, the producer pays a premium in order to guarantee a minimum value for an LCFS credit. If the market price is lower, the producer can call on the administrator to pay that minimum value. If the market rises higher, no money is exchanged. In either mechanism, the credit price can be determined via a reverse auction.

We are fans of the put option approach since as the market increases in credit value, the producer can take advantage of it and not have to pay anything to the administrator. If the put option contracts are designed to be tradable, that is even better! The Climate Trust was just this month awarded a USDA Conservation Innovation Grant to pilot an “Environmental Price Assurance Facility.” We are enthused by the possibility of offering our pilot platform for use under SB 1383’s pilot financial mechanism to offer participating dairy operations much needed price assurance as they gear up to deliver low-carbon transportation fuels. Stay tuned.