Energy Law Alert: California Appeals Judge's Low Carbon Fuel Standard Ruling

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On December 29, 2011, Federal District Court Judge Lawrence J. O'Neill, Eastern District of California, Fresno Division, found that the California low carbon fuel standard (LCFS) violates the dormant commerce clause because it discriminates against out-of-state corn-derived ethanol and favors in-state corn-derived ethanol, and impermissibly regulates extraterritorial conduct. He also found that the government failed to establish that there are no alternative methods to advance its goal of reducing greenhouse gas (GHG) emissions to combat global warming. In turn, on January 5, 2012, California's Air Resource Board (CARB) filed a Notice of Appeal in the U.S. Court of Appeals for the Ninth Circuit to appeal that ruling.

The lawsuit had been consolidated and was separately brought by multiple plaintiffs, including the National Petrochemical and Refiners Association, the American Trucking Association, the Renewable Fuel Association and several farmer groups. In 2009 CARB adopted the LCFS, which requires a 10% reduction in the carbon content of motor fuels sold in California by 2020. The LCFS was developed as part of CARB's larger effort to implement AB 32, the Global Warming Solutions Act of 2006, which requires GHG emissions in California to be reduced to 1990 levels by 2020. Addressing the transportation sector, the LCFS requires a 10% reduction in the carbon intensity (CI) of motor fuels sold in the state by 2020. The CI is calculated on a life cycle basis, taking into account not only the GHG emissions at the time the fuel is combusted but also the emissions associated with its production, transport and indirect land use change. It is the life cycle transport issue that negatively impacts the out-of-state producers and, according to Judge O'Neill, the commerce clause. To sell ethanol and compete in the California motor fuels market, Midwest producers must reduce their fuel's CI or buy low carbon credits from California producers whose CI score is below the required state-wide average of that year.

In addition to finding that the disparate treatment of ethanol was unconstitutional, the District Court found that CARB was attempting to control fuel not only in California but also outside the state via its policy, and thus attempting to improperly control conduct beyond the boundary of the state. The Court also considered the disastrous results that might occur if every state enacted its own LCFS standard with extraterritorial impacts.

The District Court's ruling is important in multiple respects but is likely just the first in a series of decisions on the underlying dispute. California occupies a unique position under the Clean Air Act due to its statutorily established authority to establish stricter standards than the federal government. However, the area of GHG reduction is arguably distinct from the regulation of criteria pollutants because GHG emissions result in global rather than local impacts. CARB stressed, however, that the impact from global warming is also local and includes rising sea levels and other state-level costs. The District Court has yet to rule on additional issues, but due to its ruling on the commerce clause, it ordered an injunction against enforcing the LCFS while litigation is pending, and the Ninth Circuit has presumably been asked to address the constitutional issue and the corresponding injunctive relief.

To address the compliance confusion caused by the ruling, CARB responded by issuing Low Carbon Fuel Standard Supplemental Regulatory Advisory 10-04B. In the Advisory, CARB stated that, "as long as the injunction remains in effect, ARB will respect the Court's ruling and withhold enforcement of the LCFS requirements, including enforcement of the requirements described in this supplemental regulatory advisory." Thus CARB appears to be proceeding on two somewhat contradictory tracks by recognizing the federal limitation on CARB's authority while seeking to finalize the components of the LCFS program and impose the obligations associated with it. Market participants in California will effectively be required to make strategic decisions regarding the final result in the case. If market participants are confident that the LCFS will remain overturned, compliance strategies for LCFS need not be pursued. However, if one anticipates that CARB will be ultimately successful in reinstating the LCFS, then market participants must be prepared for the complications and market implications of the program.

If you have any questions about this alert, please contact your Stoel Rives attorney.

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