The shift from fossil to renewable fuels is increasing. The renewable fuels market is estimated at US$160 billion in the US alone and is experiencing annual growth from seven to 39 percent – sometimes higher – in specific fuel types and regions.1
What’s more, dozens of projects to produce renewable diesel or sustainable aviation fuel have been announced in North America and Europe. These projects are set to produce over 12 billion gallons of combined capacity annually by 2025.
So, is now the time to invest in renewable fuels?
Drawing on our experience in over 37 renewable fuels projects around the world, we examine the investment horizon for renewable fuels to determine how operators and investors can enter the market, the pathways available to them and which financing options should be considered.
Investment horizon: higher returns and early adopter advantage
The renewable fuels market sits at a crossroads of two key industries: agriculture and energy.
The agriculture industry brings the expertise to process large quantities of biomass and biomass waste. While the energy industry brings the know-how to produce and distribute transportation fuels. These industries are working together to process bio-based feedstocks such as animal fats, used cooking oils, vegetable oils, and greases (FOGs), and biomass waste such as forestry residue or agricultural waste, into renewable fuels that can power the transportation industry.
Renewable fuels returns are positive and higher than historical returns from the agriculture and fuels industries. Tax credits and producer incentives are helping drive these returns. For instance, the Low Carbon Fuel Standard (LCFS) credit prices in the US have seen values at or near the legislative cap of approximately $200/metric ton since 2018.
Producers also benefit from renewable identification number (RIN) tax credits through the federal Renewable Fuel Standard (RFS) program. In Europe, the Renewable Energy Directive (REDII) sets a European target for renewable energy sources consumption by 2030. And while each country has adopted the directive in different ways, incentives and credits are available for trading.
In the US, producers must meet a target for the carbon intensity (CI) of fuels. If this target is not met, they‘re obliged to purchase credits. California implemented this approach with the LCFS for transportation fuel producers, which includes producers of gasoline, jet, and diesel. LCFS is also in place or under consideration in other US states.
Producing fuel using a lower CI feedstock lets producers earn emissions credits. These credits can then be sold on the open market to producers with a higher emissions footprint. In practice, this means that a relatively small production facility of 1,000 barrels of renewable diesel per day can generate a revenue stream from credits alone in the order of tens of millions of US dollars. In some cases, projects are forecast to breakeven in less than one year of production.
The takeaway
If the renewable fuel producer can export to a jurisdiction where carbon pricing is in place, an opportunity exists.
But investment opportunities are also available in regions without carbon pricing legislation. In 2019, only 12 percent of all liquid biofuels were produced in California. Other states or countries produced the remaining 88 percent.
Early adopter advantage is critical in the next several years.
Producers and investors who mobilize quickly will be rewarded with an early adopter advantage because carbon credits will remain at a high price when there are more buyers than sellers. Investing in production facilities will set up profitable businesses today and position these assets for more upside potential as future regulations come into effect.
