Andrew Lui | Consulting Process Engineer, Monrovia | 18 November 2021
As legislation and technology for low-carbon energy industries converge, the technologies needed to produce renewable fuels have reached technical and commercial readiness. This is creating a booming renewable fuels market.
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.
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.
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.
While profitable, renewable fuel projects come with a cost. The key to implementing a successful renewable fuels strategy is to de-risk potential investments as much as possible. This involves using the knowledge of industry leaders and technology suppliers for quick and efficient project execution with little to no re-work.
Project financials can be evaluated using a robust financial model and tools such as probabilistic risk analysis, sensitivity analysis, and business model selection. And technical risks can be reduced by developing supply chain or business partnerships with companies that have existing assets in refining, agribusiness, renewable fuels, etc.
Operators and investors have several investment options to enter the renewable fuels market:
Co-processing – favored as the lowest cost option, co-processing limits capital risk exposure. However, it requires an existing production asset (refinery) and may be limited by existing equipment constraints.
Revamping an existing unit – a great combination of low-medium capital cost while still producing a sizable amount of renewable fuels. In some cases, projects can leverage up to 80 percent of an existing unit’s processing equipment.
Developing a new unit adjacent to an existing facility – a medium-high capital cost option but enables more capability and higher reliability. This option is practical in cases where it’s more efficient to build a new unit and retrofit only some of the existing infrastructure.
Constructing a new standalone unit – generally the highest cost option, constructing a new standalone unit allows for maximum flexibility and reliability. Reliability is important. For many investments, minimizing unplanned downtime makes a major difference, especially within the first few years of investment.
All these options come with trade-offs. For example, paying higher capital costs tends to buy more processing capacity as well as feedstock flexibility. However, location and logistics costs impact the availability of feedstock. Various other factors such as available assets and capital, and risk tolerance may also sway companies towards different investment options.
Government guaranteed-loan programs and grants are available in some countries to help finance the required upfront costs and capital for studies and projects. This, along with the ability to claim credits, can generate a portion of the initial investment. Selling the credits later to the market can also help offset investment.
As for business model options, the traditional engineering procurement and construction (EPC), joint venture (JV), or build own transfer (BOT) models have different advantages that can strengthen investments in renewable fuels. To date we’re seeing multiple JVs around the world –in the form of multi-party consortiums and two-party arrangements – particularly in North America and Europe.
On the partnership front, proper structuring of junior and senior debt, and fair equity retention for resource contribution, can impact project finances. Pain-share/gain-share agreements can also strategically improve the investment outlook while mitigating risk for all parties.
It’s early days and there’s no clear market leader. But those who can take quick and strategic action in the short term, identify the right technology options for their assets and navigate the legislation will emerge as a dominate player in this new market.
Read our full article Counting the cost of the shift to renewables published in International Biofuels.
Contributors
1. “ADVANCED ENERGY NOW 2019 Market Report: Global And U.S. Markets By Revenue 2011-18 And Key Trends In Advanced Energy Growth". Info.Aee.Net, 2019.
