There are lots of government policies that economists like to roll their collective eyes about and use as examples of bad incentives in economics textbooks. In many cases these policies are well intentioned, and may even be the best option in a second (or third, or fourth) best policy world, but we just can’t let it go. For many environmental economists, the Low Carbon Fuel Standard (LCFS) provides just such a target-rich environment. A wide list of criticisms have been made by Holland, Hughes, Knittel and others, but these high-level concerns can at times seem abstract.

Periodically, however, one comes across details about the implementation of a policy that can take you through-the-looking-glass and starkly illustrate what economists have been complaining about. One such case is the relationship between two of economist’s favorite boogeymen: the LCFS and incentives to drive electric cars.

The LCFS is intended to transition an economy from petroleum-based transportation fuels to alternative fuels that have a lower carbon-intensity (CI). One criticism of the LCFS is that it targets only one element of transportation-based carbon emissions; the CI of the fuel. It doesn’t reward driving a more fuel-efficient vehicle. It doesn’t reward driving less. In fact, in some cases it can reward driving a less efficient vehicle more often.

The LCFS works by charging firms for selling high CI fuels (fuels whose carbon content is above the standard) and using those funds to reward firms who sell lower CI fuels (whose carbon content is below the standard). In theory, competition would force sellers to pass this value on to customers in the form of lower fuel prices, thereby increasing demand for lower CI fuels and the vehicles that can use them.

Gasoline is a high carbon fuel. Electricity is a low-carbon fuel, but only when it is used in vehicles. Firms that sell gasoline pay a surcharge for LCFS compliance. Firms that sell electricity earn credits, when the juice goes to transportation. This is where the trouble starts. For most EV owners who charge at home, no one actually knows how much electricity goes to transportation. Most homes have just one electric meter, and it is costly to put in a separate service dedicated to vehicle charging.

Despite this lack of information, LCFS credits are being awarded every year to electricity distribution companies. PG&E just held an auction to sell off 65,000 of them. How does the State know how many credits PG&E should get? It appears that it assumes that the juice used by the handful of vehicles that do have their own meter is the same, on average, as that used by each of the other EVs. If you take the average daily charging of the metered vehicles, and multiply that by the number of vehicles in a distribution company region, then you get the amount of electricity that is assumed to be distributed for the purposes of home EV charging.

All sorts of potential problems can result. The metered vehicles are not a random sample. EV owners who do the most home charging have the most incentive to pony up for faster charging units and dedicated meters. And utilities may have an incentive to put the heavy charging vehicles on meters and keep the lighter ones off them. What if the metered vehicles are all long-range Teslas and the non-metered ones are all less-used Leafs? Or what if the metered vehicles do all their charging at home, and others utilize remote charging far more often? This system could also subtly disadvantage commercial EV charging operations, whose output is fully measured and (I would hope) isn’t going into DVRs.

Now, a reader may be tempted to say that EVs are still a small share of the transportation market, and a small fudge of the accounting can’t matter that much in the big scheme of things. Even if this overstates the value of EVs, this can help accelerate their adoption. If those arguments sound familiar, it’s because they were (and continue to be) made in defense of net-metering of residential solar systems. Those small fudges have grown to the point that we now talk about the uncertain financial future of distribution utilities.

How much money are we talking about? A Leaf, driven 12,ooo miles, uses about 3600 KWh per year, a Tesla probably about 4500 KWh per year. At a $100 LCFS price, the subsidy amounts to 8 cents/KWh. This, by the way, is about the marginal cost of electricity in California. If California reaches its goal of 1.5 Million EVs by 2025, that could mean upwards of $500 million in LCFS credits going to EV “fuel” that is poorly measured and possibly manipulable. Maybe EV credits for distribution utilities constitute a regulatory “make-up call” for net metering.

The only way to really know how much juice is going into the vehicles would be to either require separate meters in every home with an EV, or (my preference) have each EV submit to an onboard computer meter-read once a year. One could get an odometer reading off every vehicle, but not all miles travelled use the same amount of juice. The differences can be large. However, even if we can establish a system that accurately measures the juice going into a car, that may not guarantee that this would measure the juice going to driving. If there is enough of a rate difference, folks could get very creative with the home appliances they run through their car.

What this discussion illustrates are two of the shortcomings of the LCFS. First it applies only to one sector (transportation) and only the fuels content of that sector. Second, it subsidizes the consumption of carbon-creating energy, if that energy is used in transportation. Electricity used for plasma televisions is bad, creates carbon, and is discouraged by CA policy. The same electricity used for driving a quarter mile up the block for milk, with the AC blasting and the windows open is good, and rewarded by CA policy.

These inconsistencies may be tolerable at small scales, but as the transportation system integrates with the electricity and natural gas systems, regulating the same energy in different ways depending upon its usage will be untenable. If only there were policies that could reward and penalize fuel sources consistently, no matter what their use was…..

[Thanks to Nick Bowden from the TTP program at UC Davis for collecting a lot of the policy details in this post, any errors are my own.]