For most municipal debt issuances, these revenue streams are often limited to sales tax, property tax, some form of utility user tax, or a combination of all three. However, with the constantly evolving capital markets and its investor base, issuers are demanding more creative ways to pledge alternative revenue sources to take the pressure off their other revenue streams.

In this article, we will take a closer look at the world of Low Carbon Fuel Standard Credits (LCFS) and how some transportation agencies are pledging them as a revenue source to issue green debt for their respective capital needs.

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The State of California is known for being the leader in crafting and implementing programs/policies toward limiting greenhouse gas (GHG) emissions and setting some ambitious goals toward this mission, with the LCFS program being one of those initiatives.

The primary objective of this program is to reduce the carbon intensity (CI) of fuels used within California often attributed to the transportation sector, such as gasoline and diesel fuel, and responsible for over half of California’s GHG emissions. This program was created in 2011 by the California Air Resources Board (CARB) as part of several AB32 measures to reduce GHG emissions throughout the state 20% by 2030 and 80% by 2050. Post-enactment of this program in California, more states like Oregon, Washington, and New York joined in and started their own programs similar to the one described above.

Now, it’s important to understand how the LCFS markets are made and the dynamics between the LCFS credits and deficits. It’s also important to know the parties that are involved in buying and selling of LCFS credits, also known as regulated entities.

A regulated entity can be described as a producer of petroleum fuels, importers, wholesalers, and refiners; these entities are often tied with the sale of petroleum fuels in their respective state. Under the LCFS program in California, these regulated entities are required to demonstrate that the CI of their fuels does not exceed the California threshold set under the LCFS program. As long as these entities stay below the set benchmark for the calendar year, determined through the compliance of their operations, they will be generating LCFS credits; if they exceed the given threshold, they will be in the deficit and will need to either:

• Substitute clean fuels for petroleum-based fuels

• Buy LCFS credits in the market from regulated entities that have not exceeded their threshold and have credits to sell

The second option sets the base for a dynamic market with trading volume in billions of US dollars and an opportunity for the American transportation sector. Furthermore, the program allows low carbon fuel-related projects and agencies to take part in this program by allowing them to register as regulated parties.These parties can take part in the market to sell their unused credits for additional streams of revenues, as shown in the example of a local transportation agency below.

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Along the San Francisco Peninsula, a commuter rail service, known as Caltrain, started the project of electrifying approximately 82 miles of its track. This plan entails converting diesel-hauled trains to electric trains with the main objective of “improving Caltrain system performance and curtail long-term environmental impacts by reducing noise, improving regional air quality, and lowering greenhouse gas emissions.”

Under the aforementioned criteria regarding the regulated entities, this initiative will not only reduce/eliminate the agency’s dependency on petroleum fuels, but also qualify them as a regulated entity under the LCFS program to sell their unused credits in the open market and generate additional revenues; these LCFS credit revenues can then be used as a revenue stream and pledged to raise capital for current or future Caltrain capital/operating projects.

In December 2020 Norton Rose Fulbright, the project finance group, published a report stating that, “Prices are volatile, but have generally trended upward over time. In fact, credits were becoming so valuable that state regulators imposed a price ceiling of $200 in 2016 that adjusts every year for inflation. The ceiling in 2020 is $217.97 per credit. Despite this intervention, regulators commented that the LCFS market is functioning as intended and providing a strong signal for investment in low-carbon fuels. In November, credits were trading at well over $200 per credit.”

As the investor base for municipal debt is evolving, the issuers and related parties are coming up with creative ways to finance their projects and raise capital through innovative deals. We have seen more and more governmental agencies paying attention to their environmental footprint and coming up with projects that are able to be funded through green debt and reduce their emissions.

Along the same lines, the LCFS market is relatively new; as more states see the value and jump on board, the markets will become larger with more players and liquid.

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Disclaimer: The opinions and statements expressed in this article are for informational purposes only and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned. Opinions and statements expressed reflect only the view or judgement of the author(s) at the time of publication and are subject to change without notice. Information has been derived from sources deemed to be reliable, the reliability of which is not guaranteed. Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professionals and advisers prior to making any investment decisions.