Wednesday, January 10, 2007

Fuel Decarbonization

Once again, the states are taking the initiative in shaping an aggressive climate change policy, and California leads the way. Governor Schwarzenegger's latest announcement in this area is a proposal to force oil refiners to reduce--either directly or virtually--the carbon content of the fuels they produce, thus attacking the problem of greenhouse gas emissions at a major source. This approach, which echoes the recent breakdown of auto/oil cooperation on emissions reduction in Europe, puts more of the burden of reducing CO2 from transportation on fuel suppliers, rather than carmakers. This has one very important benefit and several serious drawbacks, though some of the latter may be mitigated by the manner in which California's Air Resources Board (CARB) chooses to implement this change.

The Governor's plan, described in his annual State of the State speech yesterday, would require refiners and blenders to reduce the carbon content of gasoline through greater use of ethanol or the production of other alternative fuels, such as hydrogen. It would go well beyond existing federal and state ethanol mandates by scrutinizing the "well-to-wheels" carbon content of the alternatives used to reduce or offset petroleum carbon. This could create a significant advantage for cellulosic ethanol over corn-based ethanol in the longer term, and for hydrogen from renewable, rather than fossil fuel sources. It is less clear how this proposal will mesh with the state's recently enacted carbon cap-and-trade system, which targets reducing California's greenhouse gas emissions by 25% by 2020.

Although many oil and gas companies have begun to address the greenhouse gas (GHG) emissions resulting from their own activities, through measures ranging from energy efficiency projects to large-scale tree planting, most have assumed that the responsibility for mitigating the carbon content of the fuels they sell would rest with automakers or consumers. I have always doubted that assumption, because capital-intensive industries such as oil tend to have less political clout than labor-intensive ones such as car manufacturing, and because consumer interests often trump business interests. The Governator and his advisors have read the tea leaves, and they see the benefits of putting more of this burden on the oil industry.

The clear advantage of this approach is that, once implemented, it will reduce the GHG emissions of every car on the road in California, without waiting for technologies such as hybridization to become mass-market, and for the existing vehicle fleet to turn over. In other words, this step would make at least a modest dent in automotive CO2 emissions within a few years, rather than requiring a generation before the full effect was felt. For the growing number of people who have become convinced that climate change is a serious problem, this is a compelling argument. It has the added benefit of simultaneously addressing growing concerns about US energy security and our vulnerability to unreliable oil suppliers.

The disadvantages of this measure start with the underlying premise that GHG emissions are best addressed at the source. This is a holdover from decades of dealing with pollutants such as carbon monoxide and oxides of sulfur and nitrogen, which could only be dealt with in this way, and which have largely been removed from automobile exhaust through fuel reformulation and improved catalytic converters and engine controls. GHG emissions are fundamentally different, and all CO2 emissions are equivalent, as are all CO2 reductions, anywhere on the planet. This creates the opportunity to make the cheapest cuts first, globally, achieving the greatest impact for the least cost. Refinery-based fuel limits distort that principle and reduce the benefits of an economy-wide cap-and-trade system. If refiners and blenders are at least allowed to fold the new 10% decarbonization standard into their emissions caps, and then choose the optimum mix of direct cuts and trading to achieve the required reduction, then this shortcoming would be partially negated.

The bigger problem is timing. Depending on how long a period over which this new rule is phased in, it could significantly distort the markets for ethanol and for gasoline. Californians already pay the highest gasoline prices in the nation, because California's reformulated fuel standards are already the most stringent in the nation. If the 10% carbon cut comes in too rapidly, it could cause a larger dislocation than the recent phaseout of MTBE and require more ethanol than the state can produce, putting California in competition with other regions that are aggressively promoting alcohol fuels and likely requiring foreign ethanol imports, which incur a high tariff. Every time California has ratcheted up its gasoline standards ahead of the rest of the country, California consumers have paid a high premium at the pump. It would be interesting to assess how much of the desired emissions benefit could be achieved by simply raising the state gasoline tax, without mandating a further change in fuel formulation.

California's initiative on greenhouse gas reduction can't be viewed in isolation, because of the size, influence and economic importance of the Golden State. Six years of federal caution on this issue have created a growing gap between the public's perception of the climate change problem and of the appropriateness of the government's response. California and like-minded states are filling that gap with interesting but potentially conflicting measures. Sooner or later, the federal government must step into this arena to harmonize these actions and create a consistent national approach to this truly global problem, or else risk losing control of a key sector of interstate commerce and economic leverage.

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