By Brian Carey, Cleantech Advisory Leader, Alex Payne, Director, Deepak Dugar, Senior Associate, PwC
Special to the Digest and ABLC 2014
Aviation industry trends
Aviation is projected to have a faster growth rate than other modes of transport, with demand expected to grow at 4.5% annually to 2050. Asia and the Middle East, both with a growing middle class, are key drivers of this demand. Along with this market growth, greenhouse gas emissions are also expected to rise to 3% of total global carbon emissions by 2030, exposing the sector to additional policy risk.
The aviation industry is very sensitive to fuel price and price volatility. Petroleum-derived jet fuel accounted for 30-50% of the operating cost of airlines in 2013, with costs expected to rise over the next decade. While fuel costs impact the entire industry, fuel price volatility has an especially significant impact on financial planning in the defense sector. For example, from 2000-10, the US Department of Defense faced an average budget overrun of $1.8 billion, with a standard deviation of ±$3 billion in fuel expenditures, underscoring the challenges of fuel budgeting in an uncertain fuel pricing environment.
Biofuels continue to garner significant interest from the aviation industry as a solution to reduce emissions, fuel costs, and fuel price volatility. However, biofuel suppliers have yet to reach sufficient commercial volumes and have not come far enough down the cost curve to be economically viable.
The figure and table below provide an overview of the projected economics of various fuel technology options. As illustrated, biomass fermentation route is projected to have higher overall costs than traditional crude oil refining today, but as the industry scales and drives down capital and operating costs, biojet fuel has the potential to be the low cost solution.
Note: The fermentation route considered here represents an optimistic scenario and assumes jet fuel-like molecules can be produced by modified microbes with the same conversion efficiency and economics as ethanol on an energy basis. Nth plant economics are assumed to model the cost of biomass (lignocellulosics) based processes (i.e., the initial plants built are expected to cost much more). The capital investment and processing economics numbers are based on reports by EIA, ISU, and NREL. The feedstock costs reflect the average price of the respective raw materials from 2008-2013. These weekly time series of prices were gathered from FAO and EIA databases. A biomass price of $59/dry ton was assumed, per NREL report. Depreciation costs are based on a 10 year straight line approach.
The case for biofuels
Based on current economics, it would seem that natural gas to liquids (GTL) is a clear winner. But the inherent uncertainty in capital cost overruns for large GTL facilities and high long-term volatility in natural gas-crude oil price spreads makes such large multi-billion dollar projects very risky and hard to execute on a merchant basis. A major oil company recently shelved development on a multi-billion GTL plant due to the financial risk of the project. While the risk of high capital investment is also a challenge for biofuels, it is at a relatively smaller scale, approximately a $500 million investment.
Another area of differentiation for biojet fuels is emissions. Most biofuels are low in sulphur, leading to lower sulphur oxides emissions. Biodiesel blends also claim to lower nitrogen oxides and particulate emissions. Therefore, if more stringent regulations are passed, biojet fuels can be used to complement petroleum-based fuels. And for greenhouse gas emissions reduction, biojet fuels remain the only option apart from purchasing credits.
In addition, biofuels can be produced locally, providing a logistical cost benefit in remote locations such as islands or mountainous regions. And compared to crude oil, with its price volatility and business risk, biofuels have the potential to provide energy security and price stability.
Finally, co-products can help overall project economics. Low value co-products like electricity and animal feed are critical for profitability and are already being exploited for sugarcane and corn-based ethanol respectively. Also, electricity is projected to be a major co-product for lignocellulosics-based fuels in the future. Other co-products, like higher value chemicals, cosmetics and nutraceuticals, are also worth exploring.
Interestingly, alternatives which don’t look economically attractive today may become feasible in the future. For example, oil sand regions would not have made much economic sense 15 years ago; however, today they are top oil-producing locations. Similarly, a scenario which would include increasing agricultural productivity, improving conversion technologies, rising crude oil prices, and tighter emissions norms could lead to the wider adoption of biofuels.
The challenge ahead
High capital requirements, long gestation periods, and technological, operational, and regulatory complexity are some of the key challenges facing biofuels companies. In that sense, they are very similar to bio-pharma companies working on the next blockbuster drug. As such, the successful business models developed by such companies may provide lessons for biofuels ventures trying to commercialize new technologies.
In the interim, ventures trying to commercialize the next generation of biofuels should seek alternate sources of revenue by developing a portfolio of products and applications rather than just fuels. This requires a new business model and different operational capabilities compared to a standalone fuels play. The debate on whether such a strategy would indeed help the industry come down the cost curve or be a distraction restricting them to “co-products” remains a reasonable question, but few other options exist.
Ultimately, the aviation industry stands much to gain by diversifying jet fuel supply. Not only is there an acute economic need, but the industry also has experience with large capital investments. These two factors make them prime candidates to support the further development and commercialization of biojet fuels.
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