It's Not Enough, Part 2 - Sustainable Aviation Fuel Can Only Fly With More Incentives

It seems logical that shifting over time to aviation fuel with a lower carbon footprint would represent the most practical way for the global airline industry to reduce its greenhouse gas (GHG) emissions. But for that shift to happen, there needs to be an economic rationale for producing sustainable aviation fuel and, despite a seemingly generous production credit for SAF in the Inflation Reduction Act (IRA), that rationale is a least a little shaky when compared to renewable diesel (RD) credits available today. In today’s RBN blog, we conclude our two-part series on SAF with an examination of RD and SAF economics (which are remarkably similar), the degree to which existing SAF incentives may fall short of RD, and what it all means for SAF producers and production.

As we said in Part 1, jet fuel is the planet’s third-most consumed transportation fuel (after diesel and gasoline), and its considerable volume (7 MMb/d) is a meaningful target for carbon emissions reduction. Many airlines have set targets of “net-zero-by-2050” — which may be hard to fathom given the nature of an industry reliant on transportation fuels. If they are to have any degree of success in approaching their goals, lowering Scope 2 emissions through the increased use of SAF will be critical, particularly given the recent skepticism being heaped on the airlines’ other decarbonization strategy — carbon offsets.

Like RD, SAF is the chemical twin of its petroleum-based alternative and therefore can serve as a “drop-in” replacement for it. We also explained the processes most often used to produce RD — and from it, SAF. The most mature technology for producing RD from plant oils or other recycled fats uses hydrogen to remove oxygen (primarily hydrodeoxygenation, or HDO) to produce hydroprocessed esters and fatty acids (HEFA). This same HEFA process can be used to produce SAF (which contains the same molecules as petroleum-sourced jet fuel) by adding a hydrocracking processing step. SAF molecules are shorter chains of hydrocarbons; therefore, the diesel-sized molecules in RD must be broken (or “cracked”).

Further, we described the typical HEFA route to SAF, which has four steps: (1) Hydrodeoxygenation (HDO) and Decarboxylation (DCO), where renewable feedstock (such as vegetable oil) is reacted with hydrogen (H₂) at high pressure over a reactor filled with catalyst; (2) Separation, where produced water (about 10%-12% of the feedstock’s volume) is rejected, and gases are vented; (3) Isomerization and Hydrocracking, where diesel molecules are cracked in a hydrogen environment and transformed into lighter molecules, (jet fuel components); and (4) Fractionation, where the reaction products are separated into the key components of RD, SAF, naphtha, LPG, and fuel gas. (See Part 1 for details.)

Finally, we discussed the various government incentives provided to encourage the production of SAF (via the IRA, CORSIA, the state of Illinois, and the European Union) and described several U.S. SAF production facilities in operation or under development.

Today, we dive into RD and SAF economics, and whether today’s SAF incentives are sufficient.

Renewable Diesel Economics

The stacked-bar segments to the left in Figure 1 show the costs and returns associated with RD production and the stacked-bar segments to the right show the revenue generated by sales of RD. On the revenue side of the equation (green stack to right), which reflects selling RD into California, the value of the RD produced without any incentives is represented by the CARB diesel price (dark-green segment at the bottom). Stacked on top of the product price are various incentives for producing RD (feedstock CI = 54) that include (from bottom to top): the RIN (Renewable Identification Number) value, the federal government’s IRA Clean Fuel Production Credit (formerly the blenders tax credit, or BTC), California’s Low Carbon Fuel Standard (LCFS) value, and California’s cap-and-trade (a.k.a. “Cap at the Rack,” or CAR) credit.

CAR is a term used to describe California’s carbon cap-and-trade program as applied to diesel (and other fuels) sold at the truck loading rack. Conventional diesel suppliers must buy allowances to cover their emissions and can pass along these compliance costs — just under $0.30/gal for RD at the current CAR allowance price — into diesel’s price. Jet fuel is not included in the CAR program, and thus SAF is not able to capture this incentive available to RD.

As the green stack shows, the incentives (everything above the CARB diesel price) comprise much more than half of the revenue side of the equation. Without these incentives, an RD facility could not cover its feedstock and operating costs, much less provide a return on capital.

Those revenues must be weighed against the cost side of the equation (blue/gray stack to left in Figure 1 above). As indicated by the dark-blue segment, the recent cost of a representative renewable feedstock is slightly above $5/gal. An RD facility’s operating cost (thin gray segment above that) includes items that vary with throughput (hydrogen, energy, catalyst, and chemicals) and those that are the same regardless of throughput (i.e., fixed costs such as labor, maintenance, insurance, property taxes, and overhead). Not to be forgotten on the cost side of the equation is the required return on capital invested in the RD facility (medium-blue section), estimated at $0.50/gal for a 15% rate of return for brownfield projects. (The capital investment is very site-specific and, when considering a brownfield conversion, depends on the existing equipment and infrastructure available.)

Given the prices and credits used in the illustration, revenues exceed costs (indicated by the difference between the top of the blue/gray costs column and the top of the green revenues column). All told, this representative RD facility would reap a capital return of $1.35/gal in excess of the minimum required return. For perspective, that converts to $56.70/bbl and illustrates the current attractiveness of producing RD.

These cost and revenue components are estimates and vary depending on many factors, such as the type of renewable feedstock, the technology, and the markets for renewable products. The key takeaway is that RD has high feedstock, operating, and investment costs compared to fossil-based diesel and needs to capture relatively high regulatory incentives to cover them.

Sustainable Aviation Fuel Economics

As we discussed in Part 1, maximizing SAF production through the HEFA process requires extra hydrocracking processing and additional product fractionation capacity, both of which require additional capital investment. As noted previously, for RD, the capital requirement is very site-specific and depends on numerous factors. Operating costs for producing SAF are higher than RD due to increased hydrogen, catalyst, and energy requirements, and the additional hydrocracking equipment will naturally incur higher maintenance and sustaining capital investments.

The conversion of a molecule of RD to SAF results in an unavoidable increase in the production of low-valued LPG and naphtha as a result of the hydrocracking process. Even though these by-products are “renewable,” they earn lower incentives than either RD or SAF. Therefore, if SAF were priced equal to RD, a lower overall product gross margin would result.

So, what do increased capital investment, higher operating costs, and lower gross margins mean for SAF economics? The simple answer is that the producer needs to realize a much higher SAF price (or receive much higher incentives) relative to RD to make the economics work. But how much larger?

Figure 2 breaks it down and shows the additional SAF production costs ($0.58/gal; stacked blue/gray bar to left): including negative yield effects [$0.22/gal; dark-blue segment (negative yield indicates that the products produced from SAF are less valuable, on average, than RD)], higher operating costs ($0.08/gal; gray segment), and capital investment costs ($0.28/gal; medium-blue segment).

Compounding SAF’s increased production cost — and illustrated by the dark-green bar in the center — is the fact that it receives a lower RINs subsidy, is not directly eligible for California’s carbon trading program, and the process yields LPG and naphtha, which cannot take direct advantage of certain renewable incentives. The only offsetting subsidy is that SAF is eligible to receive a higher IRA credit than RD, dependent on feedstock CI (though the credit all but disappears after 2024 for a 54+ CI feedstock).

So, what does this all mean?

Whereas the RD example we showed first demonstrated an excess return of $1.35/gal, this SAF example implies it needs an additional $1.35/gal (medium-green bar to far right in Figure 2) due to the increased production costs ($0.58/gal) and lower SAF subsidies ($0.77/gal), just to cover capital costs. Note that the additional $1.35/gal is an illustrative estimate — the actual incentive for any project will vary depending on numerous factors — and that it is just a coincidence that the RD profit is the same as the SAF shortfall at $1.35/gal. Regardless, this example shows RD production is $2.70/gal ($1.35 + $1.35) better off, leaving little doubt that to overcome increased production costs and lower subsidies compared to RD production, SAF investments need additional financial compensation, whether through increased subsidies or a fuel price that is higher than RD. In regard to the former, additional government subsidies may be required over the long term to promote the use of limited supplies of plant oils and recycled fats for SAF and sustainable air travel. Regarding the latter, it does appear that the aviation sector is willing to contract SAF supplies at a price above RD to show that airlines are progressing toward their stated decarbonization goals. That would seem to make sense given airlines’ strategic goals for pursuing SAF versus the more immediate economic buying decisions of the RD market.

Given the current state of established SAF production technologies, it appears that SAF from plant oils and waste fats will be produced as an alternative to — not in addition to — RD. Therefore, incentives and/or the SAF market price must increase (to the tune of at least $1.35/gal, and probably closer to $2.70/gal) to encourage SAF production.

Note: The article was authored by Kevin Waguespack of Baker & O’Brien and published on RBN Energy’s Daily Energy Post on June 23, 2023.

“It's Not Enough” was written by Pete Townshend and Rachel Fuller and appears as the eighth song on The Who’s 11^th studio album, Endless Wire. It was released as a digital download single from the album in October 2006. Personnel on the record were: Pete Townshend (guitars, keyboards, backing vocals, drums, drum machine), Roger Daltry (lead vocals), John “Rabbit” Bundrick (organ, backing vocals), Stuart Ross (bass), Billy Nicholls (backing vocals), Peter Huntington (drums), Jolyon Dixon (acoustic guitar), and Rachel Fuller (keyboards).

Endless Wire was recorded between December 2004 and May 2006 at Pete Townshend’s home studio in London and Eel Pie Oceanic in London. Produced by Pete Townshend, Bob Priddle, and Billy Nicholls and released in October 2006, it was The Who’s first new studio album in 24 years and the first since the death of bassist and founding member John Entwistle.

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