Do you hear that hissing sound? It’s California emissions leaking into Texas 

Kinder Morgan and P66 have announced open season for bidding on the new Western Gateway Pipeline. As part of this project, KM intends to reverse the SFPP west pipeline, which moves product from California to Arizona. If it’s built, for the first time there will be direct pipeline connectivity from Texas to the West Coast.

Western Gateway Pipeline: A new corridor for American energy – Phillips 66

The reversal of the SFPP has me thinking a lot about the stability of the LA refining system, California regulatory environment, and Bakersfield through LA well to wheels value chain. I’ve seen a few well-written discussions on the impacts to the refineries directly, but I wanted to take it a step further. So for my first post here I’m going to cover my thoughts on Cap-and-Invest impacts, but for the next one I want share some thoughts on impacts to Upstream producers when the Refineries are pressured by this pipeline reversal. I have some thoughts on how regulators could handle these issues which I’ll get to as well. Anyway, without further ado:

Why the Arizona product outlet matters for California’s climate budget, not just the refining system.

California’s climate budget quietly depends on LA refineries being able to export surplus gasoline to Arizona. That outlet keeps refineries running full and keeps refinery emissions inside California’s Cap-and-Invest system, where they generate steady compliance revenue.

California’s refinery system is responsible for major emissions, but those emissions have declined over time:

Source: California Air Resources Board (CARB)

Proof that Cap-and-Invest is working? Not really. The refineries are still emitting just as much carbon per barrel processed, there’s just less refineries than there used to be. (Note the spike in 2020 associated with low utilization during Covid).

Source: CARB, California Energy Commission, EcoCira

Demand has declined, but mostly this is just a case of refineries shutting down or converting to biofuel operation. Since the product demand is still there, the crude refining and its associated emissions just moves outside the state. And when emissions move out-of-state, Cap-and-Invest revenue goes with them. At today’s prices and free allowance levels, the state is already losing about $100 million in revenue per year.

With the SFPP pipeline reversal in 2029, the Arizona outlet disappears and up to 175,000 barrels per day of product will flow into California instead of being refined here. LA refiners will be forced to move excess gasoline and diesel to Latin America, switching the market to an uneconomic export netback. Crude utilization declines and eventually one of the LA refineries shuts down to rebalance the market with pipeline product deliveries.

That means emissions that used to be in California and regulated by Cap-and-Invest permanently leak to Texas, where there are no carbon regulations.

How Much Revenue Is at Risk

Using reported emissions for the entire refining sector as a basis, displacing ~170,000 barrels/day of refining out of California removes roughly:

~3-4 million metric tons of in-state refinery emissions per year.

Refineries receive free allowances — but the effective coverage falls over time. By 2029, free allowance allocation is only ~59%, meaning that for ~41% of those emissions an allowance credit would be paid. So the net compliance emissions lost is roughly:

~1.5-2 million metric tons per year leaving the system.

How much money is this? It depends on what you believe about the carbon price forecast. There are a lot of price forecasts out there, but let’s use the UC-Davis model (CARB ultimately dropped this forecast from their SRIA for the last rule making, but the analysis remains public).  The UC-Davis modeling shows carbon prices likely in the $75–$150+/ton range in the early-to-mid 2030s under realistic rule tightening. Put that together:

Starting around 2029, California loses ~$150M to $300M per year in Cap-and-Invest revenue, depending on where carbon prices land.

What This Means

This is not really a “refinery economics” problem anymore. It is a Cap-and-Invest stability problem. Each refinery closure that isn’t coupled with demand decline is a hit to Cap-and-Invest effectiveness and revenue. California’s climate spending — transit electrification, wildfire prevention, utility rebates, equity investments — assumes a steady revenue stream from these refineries.

Pipeline reversal and refinery exits introduce a structural leak in that stream

If Texas barrels start moving into Los Angeles, California loses:

• Up to 4 million metric tons from its emissions base without any associated reductions
• Up to $300 million from its Cap-and-Invest revenue stream
• And the ability to drive emissions reductions in that sector

This is the setup where Cap-and-Invest fails: emissions aren’t reduced, instead they leak to other states as refineries or other industrials choose to exit. All without reducing fuel use or vehicle emissions in any real way.

So what can California do about it? There needs to be more focus and research on carbon leakage and the point of carbon obligations. The goal of Cap-and-Invest shouldn’t be to shift emissions to someone else’s state or someone else’s country, but to ensure that the production and combustion of the fuels have an associated carbon compliance cost. California figured this out for electricity—importers are subject to MRR and Cap-and-Invest—and it needs to do the same for fuels.