The Cost of Net Zero

Note: This is an article highlight from the Summer 2023 Issue of Jetrader. To view the full magazine, including past issues, please visit the?ISTAT website.

By Jeni Stanley and Stuart Hatcher

We may feel that the drive toward decarbonization is a relatively new bump in the road but, in reality, the threat has been trying to burst through for decades. In fact, the International Civil Aviation Organization (ICAO) has been on the case to stamp out one form of emission or another since the early 1980s yet kept CO2 until last. So, we knew it was coming. If that is the case, why aren’t we better prepared? Surprisingly, we have already been moving as fast as our sector allows us, hence why the carrot is being removed by those on the outside, leaving us with just the stick.

Until fairly recently, decarbonization messaging has been conveyed within our industry with a large focus on appealing to demands for more consistent airline profitability. OEMs, lessors, banks, MROs, etc., are there to serve the airlines, which are striving for optimal operating cost metrics. Engine and airframe OEMs have for years been pointing the finger at one another as a reason for not tackling this issue fast enough, but that is a fundamental problem with a “balanced” duopoly. R&D is expensive and not always efficient, and when coupled with pressure coming from the finance side of the business to maintain steady depreciation, the incentive for change only really dominates every couple of decades. One only has to look at the changes across the 737 family since the late 1960s to visualize this evolution driven by pressure from the airlines and duopolistic behavior to cut operating costs while expanding networks. We can call that the carrot in this scenario.

Helping change along are regulations, which can be considered the stick. As new technology developments are driven by market forces, regulatory pressures wade in to drive out old technology through retirement or maintained with retrofittable upgrades. Consequently, since the advent of the Council on Aviation Environmental Protection (CAEP) standards in the early 1990s, engine OEMs have successfully complied with mandates to reduce NOx, smoke and other particulates via technical changes that would appear invisible to the layman to ensure conformity and maximize residual?value.

I think it’s fair to say that many of us (if not most) have become ever more cynical on what asset technology can do to address the problems we face. Sure, unit fuel burn has been steadily declining, but opposing that is the rising cost of maintenance and decreasing reliability. Those “outside” our industry have lost patience, too, hence why the stick is out?to beat us and all emitting transportation industries. Airlines, therefore, now have to reduce emissions in line with the EU’s requirements rather than at their own pace. The EU continues to remain deaf about aviation’s contribution to economic growth. From a technology standpoint, the problem we face is that propulsion technology that serves shipping, trains, trucks and cars doesn’t translate all that well to aviation. We are limited to technologies that must be both faultless and?lightweight.

The problem we face is that propulsion technology that serves shipping, trains, trucks and cars doesn’t translate all that well to aviation.?

By the end of this decade, several large European countries will potentially be able to serve their entire population’s domestic electricity requirements using sustainable methods like wind, solar and nuclear, provided there is sufficient infrastructure. For air transport, however,?we are decades away from reaching that point. Sure, battery and hydrogen technology may get to a point where it is used for short low-volume missions (due to its poor energy/volume ratio), but it wouldn’t be much use beyond ~3,500nm. We are therefore left with a mixture of market-based measures (MBM) and sustainable aviation fuel (SAF) pathways allowable by regulatory bodies until carbon capture technology can make enough progress.

The primary MBM options, namely the EU Emission Trading Scheme (EU ETS) and the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), both have airlines surrendering ever-decreasing allowances against verified flight emissions. The allowances can be traded and purchased, with their limited nature likely resulting in small amounts of tradeable value. The urgency, however, is centered on all free allowances being phased out by 2027, leaving operators no option but to buy into MBM schemes, scientific-based carbon capture programs and SAF. Penalties are 100 euros per tonne of CO2, which for a 2-class A320ceo operating within Europe is around €10 per seat per flight. This may seem reasonable, but pricing is expected to rise, deadlines will change and treatment remains inconsistent?globally.

Mitigation strategies vary notably between North America and Europe. While North America leans toward incentives, Europe has opted for mandates. Initiatives such as the California Low Carbon Fuel Standard uses a framework that puts a value on any carbon reductions generated from renewable fuels and generates credits. These can then be sold to other regulated parties, thus incentivizing SAF use and its production. The current U.S. administration’s goal to increase SAF production to at least 3 billion gallons per year by 2030 includes SAF tax credits and continuous funding opportunities for SAF projects. In Europe, mandating SAF will be via ETS and CORSIA. EU fuel suppliers will be required to blend a minimum amount of SAF with standard jet fuel. The current proposal requires a minimum share of 2% in 2025, increasing in five-year intervals to ultimately reach a minimum of 63% in 2050. Although not directly linked to SAF, the proposed REFuelEU scheme aims to eliminate tankering and, therefore, increase operational efficiency. It mandates that all airlines departing from the EU uplift fuel for the planned flight only and that at least 90% of the yearly aviation fuel required be uplifted from EU airports. Fines will be imposed for failing to do so.

While SAF alone is not the panacea to decarbonization, it’s the hand we’ve been dealt and unsurprisingly the focus of where most non-scientific groups are pinning their hopes. SAF benefits from its ability to be blended with jet fuel and fits into the existing fuel infrastructure with minimal changes to aircraft. To date, there have been more than 450,000 flights across 50 airlines utilizing SAF. The problems, however, are cost and scalability, and although costs have declined appreciably, the least expensive SAF costs approximately 2.5 times more than conventional jet fuel. Approximately 240,000 tonnes of SAF were produced in 2022, three times the amount produced in the previous year, yet still accounting for less than 0.1% of jet fuel. By 2050, the estimated requirement is close to 1,700 times that of 2022.

Currently, SAF is created primarily through the processing of cooking oils, plant oils, algae and tallow (HEFA). It’s the least expensive to make; however, feedstock availability hampers the ability to satisfy demand across all industries that wish to utilize it. Catalytic hydrothermolysis jet fuel (CHJ), which uses the same feedstock, would potentially allow for a non-blended fuel but is more expensive. Currently, more expensive processes, in order of increasing cost, utilize a multitude of raw materials, such as sugarcane and hydrocarbons (HFS-SIP), molasses and corn (ATJ), and forestry/agricultural residues and hydrogen (Fisher-Tropsch). Each has its pros and cons.

The proposed EU 5% SAF by 2030 mandate covers specified feedstocks that are available for producing SAF. The chart on this page shows the level of CO2 emissions for feedstocks that are permitted under this mandate. It illustrates the airline net emissions produced by twenty-five 5% SAF fuel blends against Jet A in a month, highlighting the efficiency variances that exist between allowable options under the mandate.

Many feedstock options under the proposed EU mandate don’t appear to be viable, particularly palm and corn oil, whose production generates more CO2 than Jet A. The ATJ process requires large quantities of land and water and performs poorly when assessing the net benefit against Jet A. The Fisher-Tropsch process stands out, as the net benefit of a 5% blend can exceed 5% and takes us into the power-toliquid methodology, whereby hydrogen is chemically combined with CO2 to produce fuel. While the traditional Fisher-Tropsch process is more reliant on external fuel prices, the life cycle benefit of utilizing this biomass material in conjunction with the rapid expansion of renewable energy within Europe could help to revolutionize SAF production from the perspective of scalability and cost. Initiatives from both airlines and OEMs to buy up large quantities of SAF (>1.2m tonnes) are well underway, alongside investment initiatives and lobbying to rationalize the process to combine renewable energy and SAF?production.

Cost Implications

The potential cost impacts of net zero are far and wide, but if we just look at the cost per seat, in IBA’s worst-case scenario, MBM costs could push ticket prices up by 39%, assuming all other costs remain constant (see chart) and the price of carbon reaches $150/tonne. The scenarios assume higher fuel taxation allowing governments to claim they are doing something while generating revenues. Based on responses to historical price hikes, we could see changes in flying habits, seasonal flying, tactical aircraft use and an accelerated shift toward more fuel-efficient aircraft.

Similarly, we may also open old wounds relating to the aircraft economic-life debate. Naturally, economic life impairment is part of a balanced equation that appears to be heavily impeded right now by the sheer panic on the production and maintenance sides of the business as to knowing accurately where aircraft supply is consistently coming compared to a normal re-fleeting process. That aside, taking lessons from the past, regulation change coupled with last-off-the-line effects have had a catastrophic effect on some aircraft types, whereby economic lives were reduced by up to 50% for the MD80. While the effect of last off the line versus the new technology aircraft can be assessed by discounting the cost of fuel over time, applying additional levies based on fuel consumption would further adversely impact last-off-the line aircraft. Even if aircraft supply takes another decade to recover and demand remains intact, the operating cost differences that emerge between old and new-generation technology will likely firm up the price differences that should exist within the market. From a positive perspective, pricing and lease rates for new aircraft should better reflect the difference in operating cost than they do today. Applying an increased finance cost for last off the line triggered by green financing, this gap should widen further.

That being said, there is plenty of life in the old dog yet, and there is a cost gap whereby operators that are less sensitive to environmental pressure and more concerned about the shorter term and direct economic impact of rising costs. Even in the current high-cost environment, a mere $100k rental gap is enough to extol the virtues of operating an A320ceo over the neo when only considering lessee operating expense costs. It may not be as ESG compliant, or provide that new image, but you can’t argue against the?reliability.

To summarize, SAF and offsets are here to stay. Aside from developments in propulsion technology covering smaller aircraft, we are decades away from a mainstream option that will utilize a different source of energy from jet fuel. Despite our best efforts, SAF supply will continue to remain limited and, given MBM costs, fares will have to rise to cover them.

Jeni Stanley is an ESG manager at IBA Group.

Stuart Hatcher is a chief economist at IBA Group and an ISTAT Certified Senior Appraiser.