1. Subgroup 6: Indirect Effects of Other Fuels Draft Recommendations and Issues for Consideration Presented to the LCFS Expert Workgroup Indirect Effects October 15, 2010 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 1

2. Subgroup 6 Membership Blake Simmons, Sandia (Subgroup Co-Chair) Bob Larson, U.S. EPA (Subgroup Co-Chair) Phil Heirigs, Chevron Jesper Kløverpris, Novozymes Seth Meyer, University of Missouri Wally Tyner, Purdue University Paul Wuebben, SCAQMD Invited External Experts Brooke Coleman, New Fuels Alliance Bjorn Pieprzyk, Energy Research Architecture 2 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE --

3. Presentation Outline Review of workplan and SWG status update SWG has refined the view of indirect effects as those effects caused by changes in economic markets This presentation will focus on draft recommendations and differing perspectives for: – Petroleum – Military effects – Electricity Q&A 3 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE --

4. A Note on Perspective Management Many of the topics presented do not have unanimous agreement among all members of the SWG, and some are deeply contested In order to retain a balanced, professional perspective that recognizes these disagreements they are presented as “Perspective #1” and “Perspective #2” The final recommendations in the SWG report may take the “Supreme Court Approach” – e.g., majority and minority opinions – request CARB input on how to best handle this issue 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 4

5. Proposed SWG Principles Under Review ➢ There are direct and indirect effects for all fuels. ➢ It is essential that a common framework and “level playing field” is established for the definition of metrics and attribution of CI values for fuels in the LCFS. ➢ There are significant data gaps in the publically available databases relevant to the attribution of indirect effects of fuels that CARB should try to address over time. 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 5

6. Subgroup 6 Milestones: Update GoalDeadline Task 1Establish Criteria for Defining Indirect Effects of Other Fuels May 2010 ✔ Task 2Develop a List of Indirect Effects to be Assessed June 2010 ✔ Task 3Identify Significant Gaps in Current Indirect Effect Analyses July 2010 ✔ Task 4Identify Available Data Sets and Models for Indirect Effects as a Function of Fuel Type September 2010 ✔ Task 5Develop a Long-Term Work Plan for the ARB and LCFSOctober 2010 6 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE --

7. SWG Criteria for Defining “Indirect Effects of Other Fuels” Effects influencing GHG emissions and the carbon intensity (CI) of fuels: 1.Direct effects: All significant effects within the primary production chain or life cycle (cradle to grave) 2.Co-product effects: Significant effects caused by co-products from the production chain (handled by the system expansion – or displacement – methodology) 3.Other market-mediated effects: Significant effects caused by changes in economic markets, e.g. ILUC or changes affecting marginal electricity or petroleum supply, This also includes ‘carbon leakage’ as a function of and increased production/consumption and/or conversion technology. For this work group’s assessments, indirect effects were considered ‘market-mediated effects other than co-product effects’ (3) It is also recommended to consider carefully if direct and co-product effects (1 and 2) have been overlooked for some fuels 7 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE --

8. Current CA LCFS Approach in Determining CI Values 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 8 Fuel TypeMethod of Deriving CI ValueType of Data UsedAssessed for Impact on the Margin? PetroleumDirect, AttributionalAverage CANo Natural GasDirect, AttributionalAverage by fuel type/regionNo BiofuelsCombination of Direct, Attributional & Indirect, Consequential Average by fuel type/region; worldwide marginal for land use impact Yes. Included by substituting indirect/consequential/marginal land impact in place of direct/ attributional land use impact ElectricityCombination of Direct, Attributional & Indirect, Consequential Average CA for one pathway; marginal CA for another pathway Marginal CA pathway gets credit for assumed renewable energy and high efficiency NG on margin of electricity sector HydrogenDirect, AttributionalAverage by fuel typeNo

9. SWG Proposed Approach to Determining CI Values 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 9 Category A – Direct/Attributional LCA Direct EffectsAttributional LCA All significant effects within the primary production chain or life cycle (cradle to grave) All significant carbon emissions attributable to producing and using the fuel Uses average data Category B – Indirect/Consequential LCA Indirect EffectsConsequential LCA Market-mediated or other emissions occurring outside of the supply chain of the fuel as a consequence of a change in the system Predicts the market-mediated or other effects of a change in behavior within a predetermined economic or resource system Uses data that reflect the expected effect of changes on the margin of the system Note: The common focus on the margin in Category B should not be construed as a limitation of consequential LCA, as consequential modeling often goes far beyond marginal data into complex economic relationships

10. Petroleum 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 10

11. Substitution of Petroleum with Biofuels As petroleum resources become constrained, globally there may be a shift to higher carbon intensive crude oils. There is a mechanism built into the LCFS regulations that accounts for high carbon intensity crude oil (HCICO), and there is another EWG for CARB working on a screening method to identify HCICO It is uncertain which of these crude oils will be replaced with biofuels in the future. According to economic theory biofuels would displace the crude with the lowest economic value to the refiner. But due to market distortions the replacement of crude through biofuels depends on many factors which influence operational and investment decisions in the short-, medium- and long-term. In the short-term the crude oil extraction is mainly influenced by OPEC production cuts. Therefore a higher biofuel supply would result in OPEC production cuts in the short term. 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 11

12. EIA Global Projections by Fuel Type, in Three Cases World production of unconventional liquid fuels in three cases, 2007 and 2035 (mbd) World liquid fuels production in three cases, 2007 and 2035 (mbd) http://www.eia.doe.gov/oiaf/ieo/pdf/0484(2010).pdf -- Tables 28, 30 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE --

13. 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 13 Perspective #1: Potential Scenario for Displacement of Petroleum with Biofuels

14. Perspective #1: Global Supply of Hydrocarbons as a Function of Price and Emissions 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 14 Indicates that fuels available in the future may have higher CI values and prices as a function of time. Temporal aspects are uncertain and complex, as are other elements of the LCFS. The interplay between alternative fuel production and displacement of these higher CI fuels should be accounted for as a marginal effect. Brandt and Farrell, Climatic Change (2007) 84:241-263

15. Perspective #1: Marginal Petroleum – Subsitution of fossil fuels with biofuels Medium- and long-term effects depend on many factors: – Influence of OPEC market power in the future: Will the increasing market share lead to more market power in the future ? Or will the compliance rate of OPEC members decline? – Influence of increased biofuel supply on investment decisions – Ratio of production costs to carbon intensity: correlation with exemptions – Development of the future oil production is uncertain: The predictions of the future share of high carbon intensive petroleum vary widely - How many heavy and unconventional oil will be produced and when? – Therefore the prediction of a reference scenario (no biofuel production) is very difficult – Internalization of costs (e.g. climate protection objectives, deep water and Arctic restrictions) and therefore on political decisions 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 15

16. Perspective #2: Marginal Petroleum As presented in the LCFS Staff Report, carbon intensity of crude in CA has been decreasing to stable over many years. If the CI of crude were to increase, that would likely be addressed during a triennial review; there is already a mechanism that addresses high carbon crudes. EPA assessed the issue of marginal crude in the RFS2 rulemaking, and its modeling found that marginal effects were insignificant. 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 16

17. Perspective #1: Marginal Refining Effects Biofuels will displace gasoline and diesel that would otherwise been produced. The drop in demand of gasoline and diesel will reduce throughput and potentially shut down conversion units (e.g., FCCs, cokers). If conversion units are shut down or if throughput is reduced, there will be a drop in the carbon intensity of the gasoline/diesel produced because refining severity is reduced. This reduction in the marginal carbon intensity of gasoline/diesel should be assigned to biofuels as an “indirect” credit. 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 17

18. Perspective #2: Marginal Refining Effects Fuel providers are subject to LCFS targets in three months; the relevance of marginal refining effects is therefore not entirely clear, particularly in the short-term. Refiners’ response to reduced gasoline/diesel demand is unlikely to include shutting down conversion units as they represent significant investments that allow for processing of less expensive, heavier crude. More likely responses include: – Shift in product slate (e.g., produce more jet from gasoline boiling range products). – Rationalization in industry, i.e., least sophisticated refineries shut down. – Decreased imports and increased exports of finished product. 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 18

19. Perspective #2 (Continued): Marginal Refining Effects The refining component of LCA must accurately account for the processing steps and inputs (particularly hydrogen) required for the slate of crudes being run, but it should do so as part of a single average refining CI. If marginal effects were to be investigated, refinery-specific modeling would be necessary to estimate potential changes to product slate. If that assessment showed a decrease in gasoline/diesel CI, there is no basis for assigning that as a credit to biofuels. 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 19

20. Perspective #1: Recommendations – Marginal Refining Effects ARB’s current LCA methodology assigns an average refining efficiency to CA refineries to develop carbon intensity estimates for gasoline and diesel. Some subgroup members have suggested that an assessment of marginal GHG emissions from refining is more appropriate as a metric of indirect effects. This may necessitate a shift in the inclusion of these indirect effects in the LCFS. 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 20

21. Perspective #2: Recommendations - Marginal Refining Effects Instead of assessing marginal refining effects (which EPA has shown to be negligible), it may be more appropriate and accurate to assess refining as a single average value. The refining LCA must accurately account for all processing steps and inputs (e.g., hydrogen), but it should only do so as part of a single average refining CI for gasoline produced from a given slate of crude sources. 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 21

22. Military Effects 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 22

23. Perspective #1: Link and Costs/CI of Military Action for Energy Security Maritime and ground security is critical to the extraction and safe passage of certain crude oil resources: “[o]ur paramount national security interest in the Middle East is maintaining the unhindered flow of oil from the Persian Gulf to world markets at stable prices.” (see Crane et al. 2009. Imported Oil and US National Security. RAND Corporation, http://www.rand.org/pubs/monographs/2009/RAND_MG838.pdf, p. 61.)http://www.rand.org/pubs/monographs/2009/RAND_MG838.pdf The U.S. military is being used to provide this service for certain foreign oil supplies While oil is not the only reason for maintaining military presence in the Middle East, government documentation and testimony suggests that oil is the primary reason for military activity in the region While EPA and others recognize this link, these costs are not considered as part of current regulations (LCFS, RFS2) because they are considered too complex and/or controversial – but this same level of complexity and uncertainty exists in other indirect effects that are included in these same regulations - e.g., ILUC (see Liska, Adam J.; Perrin, Richard. Indirect land use emissions in the life cycle of biofuels: regulations vs science. Biofuels, Bioproducts & Biorefining (2009), 3(3), 318-328) 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 23

24. Perspective #1: Estimated marginal cost of U.S. military security for Middle East oil: 1980-2010 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 24 One way to attempt to measure the GHG intensity of a particular activity is to start with the marginal cost. For example, the 2008 ILUC paper published by Searchinger et al. in Science derived their deforestation- GHG estimates from the marginal cost estimates of more corn production calculated by Iowa State economic models. This approach has been adopted by the LCFS. By comparison, there is far more literature covering the marginal cost of U.S. military security for oil than studies covering the marginal cost of using more land. A.J. Liska, R.K. Perrin, Environment: Science and Policy for Sustainable Development (2010) 52(4), pgs. 9 - 22

25. Perspective #1: Recommendations for Including Military Emissions in LCFS The final LCFS regulation approved in April 2009 does not commit to one type of carbon LCA. Current LCFS utilizes both direct and indirect effects, and CARB staff have committed to including significant indirect effects. Two options for considering military effects that may not violate this approach under the current LCFS using the method proposed by Liska et al: – Military emissions could be considered an attributional, direct effect of securing and transporting oil from the Middle East to the United States. – Military emissions could be a consequential, market-mediated effect (i.e., a market response) of continuing to rely on Middle Eastern petroleum over time. 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 25

26. Perspective #2 EPA’s Assessment of Military Effects for RFS2 “We also do not believe that emissions arising from military activities can be readily attributed to the protection of oil imports. Military activities, even in world regions that represent vital sources of oil imports, undoubtedly serve a broader range of security and foreign policy objectives than merely protecting oil supplies. In the peer review of the energy security analysis that EPA commissioned, a majority of peer reviewers believed that U.S. military costs should be excluded absent a widely agreed methodology for estimating this component of U.S. energy security.” “While these potential military impacts have been estimated by some researchers, there is clearly no consensus on how much if any of the GHG emissions from military operations should be attributed to an assessment of petroleum’s GHG lifecycle impact.” 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 26 “Renewable Fuel Standard Program (RFS2) Regulatory Impact Analysis,” U.S. Environmental Protection Agency, EPA-420-R-10-006, February 2010. http://www.epa.gov/otaq/renewablefuels/420r10006.pdf.

27. Perspective #2: National Research Council – “The Hidden Costs of Energy: Unpriced Consequences of Energy Production and Use” “Dependence on imported oil has well-recognized implications for foreign policy, and although we find that some of the effects can be viewed as external costs, it is currently impossible to quantify them. For example, the role of the military in safeguarding foreign supplies of oil is often identified as a relevant factor. However, the energy-related reasons for a military presence in certain areas of the world cannot readily be disentangled from the nonenergy-related reasons. Moreover, much of the military cost is likely to be fixed in nature. For example, even a 20% reduction in oil consumption, we believe, would probably have little impact on the strategic positioning of U.S. military forces throughout the world.” 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 27 “The Hidden Costs of Energy: Unpriced Consequences of Energy Production and Use,” Committee on Health, Environmental, and Other External Costs and Benefits of Energy Production and Consumption, National Research Council, 2010. http://www.nap.edu/catalog.php?record_id=12794

28. Electricity Note: Currently under development and review by the SWG and only one perspective presented here 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 28

29. Perspective #1: Determining Effect of Marginal Electricity w/Consequential LCA Electricity production and demand will be market-mediated events subject to: – Increased # of electric vehicles – Increased solar, geothermal, wind sources – Increased natural gas sources – Increased coal sources Increased source of electricity production may have a consequential impact on the CI values on the margins that should be included as an indirect effect Marginal change in capacity may be included as part of the overall integrated energy system Installed and projected capacity trends will need to be revised as a function of time 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 29

30. Perspective #1: Impact of Plug-In and Fuel Cell Vehicles on Marginal Electricity Vehicle and fuel electricity demands are viewed as an incremental demand over current system capacity As demand cycles, the installed capacity is also put under stress and new sources are brought online from the “margin” Marginal generators are defined as those most expensive to operate and least efficient 1 These marginal effects may increase or decrease as a function of time and policy incentives 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 30 1 R. McCarthy and C. Yang, J Power Sources (2010) 2099-2109

31. Perspective #1: Draft Recommendations Current LCFS statute: – Assumes marginal electricity in CA comes from NGCC plants (79%) and renewable power (21%) – 104.7 gCO2-eq/MJ or 377 gCO2-eq/kWh Study by McCarthy and Yang 1 in CEC supported activity utilized EDGE-CA model indicate that these values are substantially different near-term – Offpeak profile in CA may be a good indicator of near-term marginal supply – NGCT plants will be a major source of marginal electricity – Marginal emissions may be 65% greater than in the current LCFS Recommend LCFS examine marginal electricity as a function of time and installed capacity to potentially adjust CI values 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 31 1 R. McCarthy and C. Yang, J Power Sources (2010) 2099-2109

32. Summary/Next Steps Continue on writing up final SWG document Strive for SWG consensus wherever possible, acknowledge when there is not Natural gas section also under development and will be presented as part of the final recommendations at Nov 4 EWG meeting 15-OCT-2010 INTERIM WORKING DRAFT FOR DISCUSSION WITH THE EWG -- DO NOT QUOTE OR CITE -- 32