Airlines Demonstrate the Benefits and Challenges of Getting to Net Zero

Flying is one of the larger contributors to climate change. The International Energy Agency estimated it comprised two percent of all global carbon emissions in 2022, and the sector’s greenhouse gas output has grown faster in recent decades than rail, road or shipping. The United Nations warned that airplane emissions will triple by 2050, and the industry is under pressure to reduce its carbon footprint; according to the IEA, it is currently far behind schedule. 

Sustainable aviation fuel (SAF) is basically the airline industry’s entire bet on reducing carbon output and getting to net zero emissions by 2050. Emissions from jet fuel comprise nearly all of the industry’s direct emissions, and SAF is attractive in that it is a direct replacement for jet fuel. Planes do not need to be outfitted with new technology to accommodate SAF, and because of this ease of transition, it has become both the industry’s and the Biden Administration’s primary hope to decarbonize air travel.

There are a lot of big promises being made around this newer source of energy. The United States Department of Energy believes SAF can eventually reduce greenhouse gas emissions by ninety-four percent and Airbus claims SAF can currently reduce emissions compared to jet fuel by eighty percent. Twelve, an SAF producer, asserts that their fuel can lower emissions by ninety percent versus jet fuel.

There is no one kind of SAF. There are many different methods to make biofuel that can replace jet fuel, and not all of them are sustainable. In fact, there is plenty of evidence that ethanol and vegetable oils actually increase net emissions versus jet fuel, and the Biden administration greenlighting a tax credit supported by the ethanol industry is likely counterproductive to their stated goals of getting to net zero by 2050.

Additionally, it takes a lot of land to grow all these crops, and many scientists believe that scaling this technology could take up so much farmland that it winds up increasing food prices while ratcheting up emissions through deforestation and excess water usage, as the International Council on Clean Transportation (ICCT) explained:

Increased demand for biofuels made from crops grown on dedicated cropland, such as wheat or palm, may displace commodity use for food and feed and increase the total agricultural area needed to meet demand. The conversion of high carbon-stock forests, natural lands, and pastures to agriculture to meet increased demand would release carbon from disturbed biomass and soil and thereby would generate indirect emissions attributable to those biofuels.

The World Resources Institute estimates for the United States to reach its SAF target just with ethanol, it would require 114 million acres of corn to be planted—an area larger than the size of California. What a lot of these analyses centered around that eighty percent figure miss is that just measuring SAF emissions versus jet fuel in planes does not come close to telling the entire SAF story. There are a lot of second- and third-order effects of producing certain kinds of SAF which can dramatically increase emissions.

This complexity around SAF’s second- and third- order effects can generally be boiled down to a basic dynamic that ICCT detailed: “it is evident that oilseeds may have [indirect land-use change] emissions that increase their emissions above the petroleum baseline, whereas starch and sugar crops have lower [indirect land-use change] emissions.”

SAF Is a Good Investment: A Delta Case Study

Even though SAF is still very much a work in progress and there is no standardized version, the economics around it make sense as a replacement for jet fuel. I took a sustainable finance class in my master’s program, and what I learned doing my final project on Delta’s SAF goals blew me away. We often hear about the immense up-front costs of decarbonization programs, and this is no different, but even factoring in the gargantuan price tag, this still would add economic value to Delta in the next ten years.

Finding exact figures for the investment needed to meet Delta’s fuel demand was tricky, but I found a good proxy in the Finnish sustainable energy giant Neste, who Delta has an agreement to purchase SAF from. Neste opened a plant in 2022 that cost $2 billion to construct and is supposed to yield roughly 430 million gallons of SAF per year.

That figure comprises eleven percent of Delta’s annual fuel consumption. Delta’s market share is a little over seventeen percent, which means that a two-billion-dollar investment won’t even make a dent in the entire airline industry’s fuel demand. SAF comprises just one percent of one percent of all airplane fuel use today, so the industry will have to aggressively scale up production.

The scope of the problem is immense. Standing from where we are now, pinning this as the hope to get airlines to net zero seems farcical. The cost to scale up to meet the demand necessary is just bonkers.

But there clearly is some belief by industry players and the Biden administration that SAF production can scale in a cost-effective manner. Delta has targets of ten percent SAF fuel use by 2030 and a hockey stick-growth-like thirty-five percent by 2035. There has been and continues to be, a lot of investment in SAF, so judging its economic potential from this nascent moment in time seems imprudent.

Part of the problem, but also the benefit of the current dynamic is that high SAF prices incentivize firms to build more SAF plants (SAF costs nearly two to four times as much as jet fuel). It’s a tricky situation since the goal is to get the cost of SAF down below jet fuel to create economic incentives for the industry to transition on its own, but lower SAF prices make SAF investments less profitable assuming production remains the same.

My proposal was that Delta accelerate its 2035 SAF target of thirty-five percent of its jet fuel to fifty percent by investing in additional SAF refineries. Using Neste’s new plant as a proxy for the costs, revenues and fuel output, the total investment needed today to meet fifty percent of Delta’s fuel demand by 2035 is a little over $9.1 billion dollars.

Wait Where Is Everyone Going?

The sticker shock on the up-front cost just to meet Delta’s targets is immense, and extrapolating that to the rest of the industry makes this plan seem completely hopeless. However, Neste wouldn’t be building new plants if they didn’t think they could make money from them, and for my final project I built a discounted cash flow model demonstrating that this kind of investment is actually very profitable (with the government’s help) even if you factor in declining SAF prices.

Argus Media provided SAF price data to Reuters, and as of November 2023, SAF cost $6.69 per gallon. If you assume that figure remains unchanged and the annual increase in revenues is six percent, over the next ten years, the net present value (NPV) of this investment is $9.5 billion, and the internal rate of return (IRR) is a whopping sixteen percent. Even at one percent annual revenue growth, the IRR is fourteen percent and the NPV is $7 billion.

For those not versed in finance-speak, that means that the investment is very profitable, and you would be a fool not to jump at fourteen to sixteen percent low-risk returns in a world where standard venture capital IRR’s for high-risk investments are twenty to thirty percent.

The current government tax credit between $1.25 and $1.75 per SAF gallon is the key part of this dynamic. Bringing the cost of SAF down below jet fuel with the $1.75 subsidy would require SAF to cost $4.59 per gallon, and $4.09 with the $1.25 subsidy.

Even at a thirty-one percent reduction in SAF price and thus revenues at the $1.75 subsidy used to beat jet fuel, the NPV of the project is $1.6 billion and the internal rate of return is a little over seven percent. If you take the six percent assumed annual revenue increase down to one percent, this still has a positive NPV of $171 million and a five percent IRR.

At a $1.25 subsidy necessitating a thirty-nine percent reduced cost of SAF to undercut jet fuel, the NPV is still $1.6 billion, and the IRR is seven percent assuming a six percent growth rate. Again, taking that assumption down to an extremely conservative one percent growth rate still yields a positive NPV and about a five percent IRR.

The math just works almost no matter what kind of situation you want to throw at it, assuming the government is providing an SAF subsidy. If SAF on its own has to cost less than jet fuel, then these NPVs turn negative. 

Investing in SAF refineries and pressing the pedal to the metal to hit fifty percent SAF usage would add to Delta’s long-term value. All they have to do is scrounge around in the couch cushions for the annual GDP of Tajikistan to get it started. The most feasible way find $9.1 billion tomorrow would be to finance it with green bonds, where investors will loan Delta money today and receive semiannual coupon payments supported by project revenues over the next ten years. There is healthy demand for these kinds of bonds, as Blackrock, the largest asset manager in the world, owns $16 billion in green bonds, and they are an attractive method for firms to improve their ESG scores.

Delta could also add the equivalent of about ten percent of 2023 net income back as profit because of the stupid government rule which says that interest expense is tax deductible, but dividends aren’t, which allows the Mitt Romney’s of the world to load up on the debt that other people have to pay en route to running good companies like Toys ‘R Us into the ground. 

There is a uh, slight drawback to this plan of issuing $9.1 billion in green bonds, as it would increase Delta’s long-term debt by fifty-three percent. 

However, Delta could still pay a very competitive coupon rate (five percent) and once the project began generating revenue in year four, it could easily pay for the coupon payments with plenty of profit left to spare. The big hurdles to clear are making the roughly half a billion dollar annual coupon payments the first three years while the plant is still being built, and then repaying the principal $9.1 billion balance in year ten once the bonds expire.

As it currently stands, the subsidy is the most important thing the government can do, as it bridges the gap to where SAF makes economic sense for airlines to purchase and for SAF refineries to produce. Given the incredibly large up-front investment needed, the next biggest assist the government could provide the industry is through either grants or loans. Outside the subsidy, there are very few things you can throw at this model that will have a larger impact on the feasibility of this plan than reducing the up-front cost of it, even if loan payments cut into annual revenues. So long as the cost of SAF remains relatively high, this project will generate more than enough revenue to cover loan payments on a billion-dollar loan.

However, should the price of SAF decrease substantially while output remains the same, then it becomes more important for the government to issue annual subsidies to help buttress revenues for SAF refineries. There is no one-size-fits-all kind of governance here, and it requires active government management and being responsive to industry changes. Additionally, there is evidence that taxing jet fuel would help push airlines towards more sustainable alternatives. The fact of the matter is that without government help, this project doesn’t really work.

Quarter-to-Quarter Outlooks Are Killing Us

A very common theme that arose in my sustainable finance class is how from a pure finance standpoint, a lot of climate projects are winners. So much of the focus is on decarbonization and trying to move us off our current apocalyptic track, but there should be more attention paid to the fact that some of these initiatives are more attractive investments than the old 20th century energy technologies that are leading us down the path to climate hell. If the government kicks in to help, with innovations like SAF it’s not even a question which path to take against burning dead dinosaurs (assuming the kind of SAF they choose is not on the path to climate hell).

If the so-called “rational” market acted the way so many capitalists believed it to operate, it would have been investing in a lot more climate projects a long time ago. Instead, we are stuck with outdated technology largely because of regulatory capture by Big Oil standing as a barrier to both economic and societal progress.

So long as we live in a world where the primary function of publicly traded companies is to constantly increase their stock price from quarter-to-quarter to further enrich their executives paid through stock compensation, the oceans will swallow us whole. If we could transition to a world where ten-year corporate investment horizons were the norm, the proposal I made to load Delta up with long-term debt (which would disappear in year ten) would not feel like such a pie-in-the-sky dream.

Despite how far behind the climate change curve we find ourselves, all hope is not lost, especially with new climate investments. When it comes to innovating a decrepit 20th century product, we often have the money on our side—and in this country, that’s all you need.