California is replacing oil with cleaner-burning fuels in cars and trucks, thanks to a landmark low-carbon fuel rule, according to a recent report. But the rule’s fate is uncertain amid legal chaos and a shortfall in the production of clean biofuels.

The report, conducted by researchers at the Institute of Transportation Studies at the University of California, Davis, said California drivers saved more than two billion gallons of gasoline in the two years since the launch of the rule—about as much gas as the state uses in two months. The carbon emissions reduction is equal to taking half a million vehicles off the road.

Companies “are meeting and exceeding the standard,” said Sonia Yeh, the report’s lead author and a research scientist at the institute.

But the standard remains in legal limbo.

The California Air Resources Board (CARB), the state agency that regulates the program, is battling a lawsuit filed by oil and corn ethanol companies that want to void the rule. The suit charges that the fuel standard discriminates against crude oil and biofuels producers outside California. In 2011, a federal judge sided with opponents. CARB appealed the ruling in the Fresno-based Ninth U.S. Circuit Court of Appeals, which is considering the case but hasn’t said when it will rule.

A separate challenge is underway in California state court. POET LLC, the nation’s second-biggest ethanol producer, claims CARB violated the California Environmental Quality Act when it adopted the standard. POET says the rule unfairly penalizes ethanol producers by counting their indirect carbon emissions, including emissions that result from plowing pristine grasslands to grow corn crops. In a tentative ruling on June 3, an appeals court said CARB would have to fix certain procedural issues but that the standard “will continue to operate.”

At the same time, oil giants are waging aggressive public relations and lobbying campaigns to kill the rule. They say, among other things, that there won’t be enough clean fuel available—especially much-touted cellulosic ethanol—for them to comply with the law in future years.

Chevron, which helped design California’s program, is leading the charge. The oil company is the largest backer of the advocacy group Fueling California, which seeks to provide “a united voice on behalf of major fuel consumers” like Wal-Mart and UPS, according to its website. The firm spent $327,000 in 2011 and 2012 lobbying state officials to reevaluate transportation policies like the low-carbon fuel standard, Bloomberg News reported.

Chevron and ExxonMobil are also helping finance the Consumer Energy Alliance, which is leading efforts to keep the rest of the United States from following California’s lead. Already, a coalition of Northeastern states has shelved plans for a low-carbon fuel policy, in part because of California’s difficulties.

Supporters of the California rule are confident it will survive these attacks. But some worry that the rule’s vulnerability is making investors leery of clean fuel projects. “It’s undermining the clean fuel investment certainty in the market,” said Simon Mui, director of the California Vehicles and Fuels program at the Natural Resources Defense Council, an advocacy group.

Corn Ethanol Still Tops

California adopted the world’s first low-carbon fuel standard in 2007 as part of its ambitious global warming law, A.B. 32. The core of the rule is a requirement that petroleum producers, importers and suppliers  cut the carbon intensity of the fuels they sell in California each year, with the goal of achieving a 10 percent reduction by 2020.

Companies can comply by producing more low-carbon fuels, by buying cleaner fuels or carbon credits from other companies, and by cutting emissions along their fuel supply chain.  

The goal is to jumpstart the market for electric, hydrogen and natural gas-powered cars, as well as cellulosic biofuels made from algae, wood, switchgrass and other renewable feedstocks.  

According to the recent status report, fuel companies have used mainly corn ethanol—a fuel that’s been around for years—to comply with the mandate. Ninety-five percent of California’s non-petroleum fuel supplies come from corn or a mix of corn, sorghum and wheat. The rest is a combination of sugarcane ethanol, biogas—including compressed natural gas—and soybean biodiesel.

But ethanol is at a disadvantage under the rule, because one-third of the 35 corn ethanol blends CARB tracks have been assigned carbon intensity scores similar to or higher than conventional gasoline. The scores are based on a fuel’s “life cycle” carbon emissions—from extraction through to refining, transportation and combustion.

Yeh, the report’s author, said corn ethanol’s greenhouse gas impacts are “high compared to some of the better biofuels that we ultimately want to incentivize.” But she also said the report shows that ethanol producers are lowering the carbon intensity of their supply chains and adding other grains to their ethanol blends.

“There aren’t as many cellulosic fuels as we projected. There’s more LNG and CNG [liquid and compressed natural gas] out there than we projected. There’s probably a little more electricity than we projected,” Yeh said.

The lowest-carbon fuels ranked by CARB are renewable natural gas made from methane produced at landfills and biodiesels made from used cooking oil. Hardly any of these two fuels are available.

California’s low-carbon gasoline alternatives are about five percent less carbon intensive than they were at the program’s start. Diesel alternatives are six percent less carbon intensive, the report said.

Cellulosic Ethanol: None to Be Found

Cellulosic ethanol is much less carbon-intensive than corn ethanol and has long been billed as the biofuel of the future. But only about 21,000 gallons of cellulosic ethanol were produced in the United States last year, a tiny amount compared to the more than 360 million gallons of gasoline Americans use daily. None reached the California market.

A handful of cellulosic ethanol plants are ramping up this year and production could cross the million-gallon mark. But at the same time, the oil industry is abandoning or scaling back its cellulosic projects. Chevron, for example, has dropped plans to spend $400 million on new commercial cellulosic plants by 2014, citing higher profit potential from oil exploration projects, according to Bloomberg News.

The Western States Petroleum Association, a trade group that opposes California’s low-carbon fuel standard, cited the shortfall in cellulosic ethanol as a key reason why companies won’t be able to comply with the mandate’s stricter reductions in coming years.

“Cellulosic ethanol development has not proceeded at a rate that people thought it would” when the rule was developed, said Tupper Hull, a spokesman for the group.

Hull said his organization believes the fuel standard’s goals are achievable—but not within the 2020 timeframe called for in the regulation.

“The argument is not about whether or not we will diversify our fuel supply, or whether or not we’ll be transitioning to a lower-carbon future,” Hull said. “It’s about timing and the potential harm that this regulation could cause if the timing isn’t right.”

Mui of the Natural Resources Defense Council said that kind of thinking has to be reversed. It’s a “self-fulfilling prophecy,” he said, in which oil companies’ pessimism about cellulosic ethanol and other alternative fuels perpetuates the industry’s lag—and undermines the low-carbon fuel policy they oppose.

The fuel mandate “does require the oil industry to make investments,” Mui said. “You can’t comply with a program if you don’t invest and try.”

‘Marginal Improvements’

There are small signs that clean biofuels are beginning to enter the California market.

Neste Oil, a Finnish oil refining company, recently told a state Senate committee that it expects to supply California refineries with 100 million gallons of renewable diesel made from vegetable oil this year. Texas oil refiner Tesoro announced in March that it will buy 84 gallons a day of algae-based biofuels from San Diego-based Sapphire Energy for the rest of 2013—a tiny but meaningful step, advocates say, given that it’s the first such deal between an algae producer and a major oil refiner.

Electric cars could also play a bigger role in the low-carbon fuel standard once state regulators determine how utilities can generate credits from the electricity they sell to battery-powered cars. An estimated 5,800 electric cars were sold in California in the last three months of 2012, compared to nearly 233,000 gas-powered cars, according to the California New Car Dealers Association.

Yeh said proponents and regulators are “happy with the marginal improvements” revealed by the report, the second since November to track results of the low-carbon policy. But marginal progress is “not going to cut it to meet the stringent standards,” she said. “The industry will definitely need to have a better strategy in order to reduce these carbon intensities.”

Correction (6/17/2013): An earlier version of this article suggested that California’s low-carbon fuels have achieved about a three percent reduction in carbon intensity. The correct reduction is five percent.