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Jan 23, 2025
By Scott Gerlt • ASA Chief Economist
Federal tax credits for biofuels continue to evolve. The Inflation Reduction Act was enacted in August 2022 and restructured biofuels tax credits (for more information on the IRA, read this previous Economist’s Angle). The legislation extended the Biodiesel Blenders Tax Credit, established a separate sustainable aviation fuel tax credit and transitioned future tax credits to a carbon intensity basis. The Treasury Department just released guidance on the next phase of the credits, the Clean Fuel Production Credit.
Background
The first stage of IRA tax credits was 40A and 40B, which are named for the section of tax code where they are housed. 40A was the Biodiesel Blenders Tax Credit (BTC). This credit provided $1.00 per gallon to blenders of biodiesel, renewable diesel and certain types of sustainable aviation fuel (collectively known as biomass-based diesel) with petroleum fuels. The BTC was first established in 2004 and maintained through a series of short-term extensions, some retroactive. The BTC could be claimed by entities that blended both imported and domestically produced biomass-based diesel. The IRA extended the BTC through the end of 2024.
The 40B tax credit for domestic SAF producers for calendar years 2023 and 2024 was first established under the IRA and could not be stacked with the BTC. The credit amount depended on the carbon intensity of the fuel’s production, including the feedstock that was used to produce it. In practical terms, this results in a higher credit for any SAF that generates lower greenhouse gas emissions in its lifecycle. The credit value was equal to $1.25 per gallon of SAF plus $0.01 for each percent of lifecycle greenhouse gas emissions reduction below 50% compared to petroleum-based aviation fuel. If SAF did not achieve at least a 50% reduction in carbon intensity, the fuel did not qualify for the 40B credit. The maximum credit per gallon is $1.75. For more information about the 40B, see this Economist’s Angle.
The 40A and 40B credits expired at the end of 2024 and a new credit, the Clean Fuel Production Credit, or 45Z, took effect January 1, 2025. The 45Z credit can be claimed by producers of more types of biofuels than the 40A and 40B credits. Not only are BBD and SAF eligible, but so are ethanol and renewable natural gas, among others. Unlike the 40A/BTC, the 45Z credit is available to producers of biofuels instead of blenders. As such, imported biofuels are ineligible for 45Z. Additionally, all credit levels are based upon the carbon intensity of the biofuel. Gone is the flat, per-gallon credit to be replaced by one that depends upon the feedstocks used.
The Inflation Reduction Act gave Treasury general instructions for determining the CI of biofuels. The SAF CI must be calculated with the International Civil Aviation Organization Carbon Offsetting and Reduction Scheme for International Aviation (ICAO-CORSIA) model or other methodology similar to ICAO-CORSIA that satisfies Clean Air Act Requirements. For non-aviation fuels, the IRA specified the Department of Energy’s Argonne National Laboratory’s Greenhouse gases, Regulated Emissions, and Energy use in Technologies (ANL-GREET), or successor, model. Treasury deemed SAF CI could also be calculated using ANL-GREET with a few modifications to meet compliance with the Clean Air Act.
The IRA specifies the tax credit formula once the CIs are established. For SAF, the new credit formula is $1.75-$0.035 x fuel emissions rate in kg of CO2e per mm BTU so long as the emissions rate is below 50[i]. Non-SAF biofuels will receive a tax credit equal to $1.00-$0.02 x fuel emissions rate in kg of CO2e per mmBTU for fuels with emissions rates less than 50[ii]. For example, biodiesel with a CI of 60kg CO2e per mmBTU would not receive a credit, whereas one with a score of 40kg CO2e per mmBTU would receive $0.20 per gallon. The tax credit will be adjusted for inflation starting in 2025.
45Z Guidance
While the 45Z credit could be claimed for fuels beginning January 1, 2025, Treasury did not release interim guidance until January 10. Treasury announced that 45Z credits would be based on new modeling from the Department of Energy. DOE created a new version of the GREET model for 45Z called 45ZCF-GREET that reduced user data requirements from the traditional GREET model (GREET R&D). The new version would be used for non-SAF fuels and could optionally be used for SAF. SAF producers would have the option of taking the better CI score from ICAO-CORSIA or 45ZCF-GREET. Of particular importance, SAF producers using ICAO-CORSIA can utilize default scores or can alternatively customize the CI score for their operation. The 45ZCF-GREET model utilizes some information from a biofuel plant so that each operation obtains an individual CI score for biofuels produced from each feedstock.
A couple of important caveats were released with the January 10 interim guidance. First, imported used cooking oil is ineligible for the tax credit if the GREET model is used. This automatically excludes renewable diesel and biodiesel produced from imported UCO from 45Z credits. Concern about the integrity of UCO imports has arisen over the past couple of years. Treasury cited this concern along with indirect effects of foreign UCO demand on palm markets to halt crediting until further guidance is published to improve substantiation and record keeping.
The other important caveat with the interim guidance is that it is an intent to propose regulations. This distinction allows the credit calculations to take effect immediately. It also provides the opportunity for feedback on the rules. However, since the guidance has not been promulgated through final rulemaking, it could be replaced by the administration at any point.
Table 1 provides CI scores for several prominent BBD feedstocks in the 45Z. While the ICAO-CORSIA default scores are constant for everyone, the 45ZCF-GREET scores (which includes all renewable diesel and biodiesel) are not. Instead, the 45ZCF-GREET scores are based on default inputs and historical industry averages. As a result, those numbers may not represent any particular plant or even the current cross-section of the industry. Feedstocks that are historically considered waste, such as UCO, tallow and corn oil, do not have indirect effects, including land use change, associated with them. This provides much lower CI scores for those feedstocks.
Table 2 shows the corresponding tax credit amounts from the modeling results. For SAF from soy, the GREET model provides the highest credit amount, as the CORSIA model would not provide a credit. The preferred model for SAF is feedstock dependent, as one option does not clearly dominate the other. Renewable diesel from soy oil gets $0.15 per gallon while biodiesel from soy oil gets $0.33. Canola is ineligible for credits with any fuel using the default values, as its CI score is above 50kg CO2e per mmBTU in all cases. Waste feedstock credits for ground fuels typically range from $0.60-$0.70 per gallon.
The guidance does not include an ability to improve CI scores through climate smart agriculture, although Treasury does plan to include this option in the future for soybeans, corn and sorghum. Importantly, this option will only be available for biofuel plants using the 45ZCF-GREET model.
USDA Releases Climate Smart Agriculture Guidance
On January 15, USDA released an interim rule to establish guidelines for the use of climate smart agriculture for biofuel feedstocks, which Treasury can incorporate into final guidance on 45Z. As part of this interim rule, USDA released a feedstock carbon intensity calculator in beta version called USDA FD-CIC that likely will be incorporated into 45Z in the future, albeit in a form that includes the feedback USDA is currently seeking. The USDA FD-CIC allows users to select the crop and county of production. Users can choose CSA practices including no till, reduced till, cover crops, nitrogen inhibitors and fertilizer timing options. The tool will then show the percent reduction in CI from the production of the crop (feedstock).
Table 2 shows results for soybeans and corn in McLean County, Illinois, that adopt no-till and cover crops. The emissions from producing the soy crop decrease by 107%, which means the production of soy results in a net reduction in GHG emissions. Corn production with those two CSA practices has a 63% reduction in its CI. For soy biodiesel, soy production is about one quarter of the CI score. Reducing emissions by 107% results in over a nine-point benefit in the soy CI score worth $0.19 per gallon.
Corn ethanol does not qualify for the 45Z credit using the 45ZCF-GREET defaults, as its score is just over 50kg CO2e per mmBTU. However, including CSA pushes it under that threshold. This change is worth $0.36 per gallon of ethanol. Using national average yields, these practices would result in about $15 per acre for soybeans and $186 per acre for corn if all the benefits accrued to the farmer, which might have implications for crop rotations. Realistically, the biofuel plant and other stages of the supply chain would likely capture part of the credit to cover their administrative costs plus any economic rents.
USDA’s proposed guidelines for utilizing CSA crops utilize mass-balance accounting past the first point of aggregation for the crop. While oilseed and grain handlers at this point and beyond can blend from different sources, they must keep track of the relative amounts of CSA crops. This de facto requires farmers to be in the direct supply chain of biofuel producers to realize opportunities for premiums from CSA practices.
Changing Credit Stacks
Federal tax credits are not the only source of revenue for BBD producers. Biofuel production also generates credits (RINs) under the Renewable Fuel Standard, and some states offer biofuel incentives. The largest of the state programs is California’s Low Carbon Fuel Standard and is where most of the domestically produced renewable diesel is consumed. The combination of these credits is often called the “credit stack.” Given the BTC and RIN value did not vary by feedstock, California’s LCFS, which provided higher incentives for waste feedstocks, was responsible for incentivizing UCO imports, as returns were often higher with UCO.
The 45Z credit has the potential to compound the disincentive to use domestic soybean oil over imported UCO by changing the federal tax credit from a flat rate to one that pays more for waste feedstocks. Two important provisions in the proposed guidance can help offset this. The first is the current prohibition on credit generation for biodiesel and renewable diesel produced from imported UCO. The second is the future inclusion of CSA practices to help lower soy’s CI score.
Figure 1 shows the representative credit stacks for renewable diesel and biodiesel produced from soybean oil and imported UCO. Also included are potential 45Z tax credits with the inclusion of the no-till and cover crop CSA practices. The graph inherently represents all CSA benefits accruing to the biofuel producer.
Biodiesel returns are almost identical using imported UCO or soybean oil. Adding in CSA practices gives the nod to the seed oil. Renewable diesel returns remain higher for imported UCO than with soybean oil. Only when CSA practices are added to the mix do soybean oil returns slightly exceed those from imported UCO. While the imported UCO restriction and potential CSA practices help attain more parity between imported UCO and soybean oil, they do not appear to financially prohibit the former’s use.
Implications
Several observations about the transition from the BTC to the 45Z credit are apparent. The credit amounts for all feedstocks, and especially soy, tend to be much smaller in the new program. Waste feedstocks tend to be even more heavily incentivized than before with 45Z, providing higher credit values than with virgin oils. The restriction on imported UCO helps reduce but not eliminate the incentives to import the feedstock. Imported UCO does remain eligible for SAF with the ICAO-CORSIA model.
The CSA benefits will potentially allow soybeans to provide more value compared to waste feedstocks by accounting for on-farm practices. The amounts for soybeans are not large enough to encourage much adoption of the practices. Instead, only soy producers already utilizing the practices or in an area providing soy for biofuel plants are likely to benefit from CSA inclusion in 45Z.
There is still much uncertainty with the 45Z tax credit. The intent to propose regulations could be changed, and the final rules could look different. Likewise, values and guidance for CSA practices are only preliminary and cannot be claimed until Treasury releases final guidance. Furthermore, 45Z is set to expire in 2027, leaving uncertainty for both farmers and biofuel producers. Investments to lower CI scores, such as CSA practices, would need to consider the risk of non-renewal of 45Z. What is known is that the federal tax credit for BBD looks very different than the past 20 years, with implications along the entire value chain.
[i] This formula is for biofuel plants that meet prevailing wage and apprenticeship requirements. The formula is otherwise $.35 - $.007 x emissions rate.
[ii] This formula is for biofuel plants that meet prevailing wage and apprenticeship requirements. The formula is otherwise $.20 - $.004 x emissions rate.
[iii] https://www.researchgate.net/publication/360637938_Life_Cycle_Greenhouse_Gas_Emissions_of_Biodiesel_and_Renewable_Diesel_Production_in_the_United_States
