By Joshua T. Bledsoe and Max Friedman

In two recent posts, we discussed how California’s Low Carbon Fuel Standard (LCFS) had been thrown into a state of potential upheaval by two interrelated legal challenges commonly known as POET I and POET II, including a recent oral argument before the California Court of Appeal for the Fifth Appellate District (Court of Appeal) in POET I. That proceeding aimed to determine whether a lower court correctly dismissed a writ of peremptory mandate (the Writ) requiring the California Air Resources Board (ARB) to remedy violations of the California Environmental Quality Act (CEQA) that occurred during promulgation of the original LCFS regulation. ARB re-adopted the revised LCFS regulations in September 2015, but POET, LLC (POET), a South Dakota-based ethanol producer, contended that these revisions failed to properly discharge ARB’s responsibilities under the Writ.

Court Rules Against ARB over NOx Analysis

In its published April 10, 2017 opinion in POET I, the Court of Appeal largely agreed with POET, reversing the lower court’s dismissal of the Writ and holding that ARB had failed to comply with CEQA’s requirement that it analyze the degree to which nitrogen oxide (NOx) emissions from biodiesel fuels had been and would be impacted by the implementation of the LCFS rules. The Court found that ARB’s failure to properly define the scope of the project caused ARB to use an improper baseline against which NOx emissions could be measured. As a result, the Court concluded that ARB’s analysis of NOx emissions from biodiesel fuel was deficient under CEQA, and the environmental analysis was inadequate as an informational document disclosing the entirety of the project’s impacts.

The Court of Appeal therefore directed the lower court to deny ARB’s request for dismissal of the Writ and to “[s]et aside its 2015 approval of the parts of the final [CEQA] Environmental Analysis addressing NOx emissions from biodiesel.” The Court further directed ARB to conduct a year-by-year analysis of whether the project as a whole—i.e., the implementation of the LCFS rules—is likely to have caused an increase in NOx emissions, with respect to both the program’s past operations and its future impacts. This entails establishing a baseline for NOx emissions, and the Court directed ARB to use the conditions as they existed at the time the environmental analysis for the original LCFS regulations commenced (and in no event to use a year later than 2010 for the baseline). ARB must also determine whether any increase in NOx emissions that it identifies has had or is likely to have a significant impact on the environment, or whether impacts are cumulatively considerable, and must address mitigation measures or alternatives, if appropriate.

Silver Linings for ARB

While POET succeeded in forcing ARB to conduct further CEQA analysis, this opinion was far from a total loss for ARB. Indeed, given the Court of Appeal’s previously expressed skepticism as to ARB’s CEQA procedures with respect to NOx emissions from biodiesel, this opinion represents something of a “best-case scenario” for ARB under the circumstances. Indeed, the Court of Appeal agreed with ARB that it was possible to segregate provisions relating to conventional diesel fuel and its substitutes from the rest of the LCFS, allowing the other provisions to continue according to the re-adopted schedule. Further, the Court decided not to throw out or strike text from the diesel and biodiesel fuel provisions of the LCFS, or even return them to their 2013 levels, as POET had suggested at trial. Instead, the Court of Appeal froze the carbon intensity (CI) targets for diesel and biodiesel fuel provisions at 2017 levels until ARB has completed its corrective action by conducting its baseline analysis and until the trial court has approved this analysis and discharged the Writ. This holding has important implications not only for participants in the LCFS program, but for CEQA practitioners, as well.

The freeze at 2017 levels is far from optimal for ARB, because it will prevent the CI targets from diesel and biodiesel regulations from ratcheting down in 2018, as the CI targets applicable to other fuel types (e.g., gasoline) will continue to decrease. Nevertheless, at trial, ARB suggested that it could conduct its analysis in about nine months. If true, ARB could be in a position to return to trial court and again request discharge of the Writ in early 2018 (although further challenge from POET appears likely based on the history here).

The Court of Appeal also preserved the 2015 Alternative Diesel Fuels (ADF) regulations, which essentially were adopted to counteract the effects of NOx emissions from increased use of biodiesel. To the extent that ARB is required to mitigate NOx emissions under CEQA, these ADF regulations, which take effect in 2018, may go a long way to doing so. Likewise, the Court made clear that ARB “need not suspend its consideration or approval of additional fuel pathways for diesel fuel and its substitutes.” This will give ARB some discretion in how it considers alternatives and potential mitigation.

While the Court’s opinion gave ARB the opportunity to correct the procedural deficiencies with respect to its re-adoption of the LCFS rules with only minimal impact to the overall LCFS implementation scheme, the Court of Appeal also indicated that its patience with ARB had come to an end. The Court repeatedly asserted that ARB had not acted in good faith (a rare finding in our experience) in its NOx emissions analysis, and that the leniency of its remedy resulted from its desire that “the relief granted . . . should serve the public interest by protecting the environment and providing information to the public and decision makers,” rather than “punish agency bad faith.” If, after ARB completes its revised NOx emissions analysis, the trial court were to find that ARB had still not met its statutory burden and done so expeditiously and in good faith, the Court of Appeal ordered the trial court to immediately vacate all LCFS provisions relating to diesel fuel and its substitutes (not just biodiesel), to suspend operation and enforcement of those provisions, and perhaps to consider imposing further sanctions on ARB. In short, this appears to be ARB’s last chance to comply.

Implications for ARB and LCFS Practitioners

Still, for those engaged in the LCFS markets, the Court of Appeal’s opinion must come as something of a relief. At least for the time being, this opinion ensures that the LCFS markets will continue to function essentially unchanged, though it remains to be seen how the LCFS credit prices will react to the result of this case. Likewise, this opinion results in no immediate impact for regulated parties submitting quarterly LCFS reports in 2017 or for the annual LCFS reports to be submitted online by April 30th, 2017 via the LCFS Reporting Tool. Indeed, even the 2017 annual report to be submitted by April 30th, 2018 would be unaffected by this ruling, though subsequent reports would be impacted if CI targets remain frozen at 2017 levels next year.

But with the 2020 deadline imposed by Executive Order S-1-07 for ARB to fulfill its mandate to reduce CI of gasoline and diesel by 10% from 2010 levels fast approaching, ARB still faces difficult choices. ARB had already been forced to back-load the ratcheting down of CI targets, placing a heavy burden on the 2018-2020 period, due to the years when targets were frozen at 2013 levels as a result of an earlier ruling in this case. As a result of the most recent opinion, ARB will either have to further steepen the compliance curve in 2019 and 2020, or else miss its statutory CI-reduction target in 2020.

Adding further complexity to this situation is the fact that these issues will be revisited when POET’s parallel challenge to the re-adopted LCFS regulations, POET II, comes before the Fresno County Superior Court on July 26th, 2017. Many of the same issues will be before the POET II court, which is why the court delayed oral argument until after POET I had been resolved by the Court of Appeal. While it is likely that the POET II court will simply borrow the rulings of the Court of Appeal in POET I, and many of the POET II issues may be precluded by res judicata, there remains a real possibility that the POET II court could upend certain other portions of the LCFS regulations. This added uncertainty will not be resolved for months—or even longer if the POET II court’s ruling is appealed.

Finally, a comment in the Court of Appeal’s opinion raises the possibility that the entire LCFS regulatory scheme could become subject to extreme political pressure and perhaps further legal challenge. The POET I court stated that “the public is entitled to know that ARB and [its governing] Board were willing to accept the risk of higher levels of NOx emissions, with the attendant increase in smog and human health impacts, in exchange for lower overall emissions of greenhouse gases to combat global warming.” Although the court did not address the potential implications of this comment, a finding that ARB had accepted higher NOx emissions in the name of improved overall greenhouse gas emissions could subject the entire LCFS regulatory regime to pressure from groups arguing it violates AB 32, the state’s overarching climate change mitigation statute. AB 32 mandates that “[p]rior to the inclusion of any market-based compliance mechanism in the regulations, to the extent feasible and in furtherance of achieving the statewide greenhouse gas emissions limit, the state board shall . . . [d]esign any market-based compliance mechanism to prevent any increase in the emissions of toxic air contaminants or criteria air pollutants.” Cal. Health & Safety Code § 38570(b). LCFS is a “market-based compliance mechanism,” and NOx is a “criteria air pollutant,” so a finding that NOx levels have increased as a result of LCFS could lead environmental justice and other groups to argue that LCFS had not complied with this statutory requirement to the maximum extent feasible. Further legal challenges could even argue that the entire LCFS program is invalid under AB 32. For this reason, not only will ARB need to ensure that it rigorously adheres to CEQA procedures in conducting its NOx analysis, the results of that analysis will have potentially critical implications for the LCFS program, as well.