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Measures to limit the spread of COVID-19 are affecting industries across the world, from hospitality to retail, from manufacturing to distribution and from tourism to oil and gas. The sector most radically to date, is aviation. The International Air Transport Association (IATA) estimates that worldwide 420,000 flights will be cancelled between January and June this year. Combined with shocks on the supply-side, this has caused a dive in jet fuel prices of over 50% since January. To stay afloat in an already competitive market, airlines will cut costs wherever possible. In a bid to save national flagship carriers, governments too might show leniency towards the sector. Each of these factors would have a dampening effect on the nascent aviation biofuels market.
The price premium of biojet – under normal market conditions about 2 times more expensive than fossil jet fuel – has long been a barrier to the sector’s takeoff. After recent drops in crude prices, biojet now costs up to 4-5 times more than fossil jet fuel. Contrary to road fuel suppliers, airlines have little leeway in passing on such costs to consumers. In most countries, road biofuel blending is obligatory for each competitor operating on the territory, often mandated as a percentage of total fuel supply. Incentives for biojet blending are historically more indirect, still taking shape and due to the international dimension often simply weaker. Moreover, relatively stable fuel taxes generally represent a significant share of retail prices in the road sector. Fossil jet fuel on the other hand, is almost completely tax-exempt, meaning retail prices are a more direct function of production costs. Biojet’s competitiveness is less sheltered from drops in oil prices than road biofuels.
Traditionally, the biojet market was driven largely by individual airlines blending relatively small volumes to boost green credentials. Over the last 1-2 years however, producers have been announcing ambitious ramp-ups in biojet capacity in anticipation of stronger regulatory incentives. Norway became the first country in the world to implement a biojet blending mandate this year. Governments in Sweden, Finland and France announced the ambition to roll out similar mandates. Under EU legislation, aviation biofuels are exempt from the EU’s Emission Trading Scheme (ETS) and can be counted 1.2 times towards RES-T targets. Introducing an EU-wide fossil jet fuel tax has been a central focal point of the European Green Deal, while governments in Germany, Italy and France have started introducing such taxes domestically. Up until a few weeks ago, it thus looked like direct and indirect biojet support incentives were rapidly gaining momentum.
The corona crisis is cutting into an estimated USD 110 billion in aviation revenues, more than the total annual revenue of Delta, Air France-KLM and Lufthansa combined. Under these market conditions, airlines will cut costs wherever possible. It looks doubtful whether they will blend significant volumes of expensive biofuels voluntarily without strong legislative incentives in place. At this same time, legislators will balance the fact that airlines are a source of employment, connectivity and even national pride. Now that airlines are in trouble, calls for exemptions and leniency will resonate loudly. Some legislators did call for stimulus packages to be tied to environmental conditions. Overall, however, it looks uncertain whether the political momentum to regulate the sector can be maintained under these grim market conditions. It is likely that the introduction of climate legislation like the European Green Deal will be delayed to deal with a more urgent health crisis. After that, averting a short-term economic crisis could take priority over longer-term environmental legislation.
One global support mechanism for biojet uptake is the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). This UN-scheme aims for carbon neutral growth by obliging airlines to either blend alternative fuels or buy offsets for any emissions above the 2019-2020 average. Somewhat ironically, this means that the current drop in emissions could mean higher offsetting obligations for each of the subsequent years. After China raised this issue at last week’s ICAO summit in Montreal, the UN body is now performing an in-depth assessment of COVID-19’s economic impacts on CORSIA. Changes to the baseline seem likely, but this is complicated by uncertainty surrounding the length of the current crisis and whether it will lead to changes in air travel post 2020. It is possible that no clarity regarding this core parameter will exist until late 2022, when ICAO’s triennial summit is to take place.
Estimates about how long corona-triggered airspace restrictions will continue range from a few weeks to several years. Even after that period, downwards pressure on fossil jet fuel could sustain. Refiners have started stocking jet fuel offshore to deal with oversupply. The global economic recession that will possibly follow this health crisis could put a further lid on fossil prices. In such context, biojet blending can only be economic if strong legislative support mechanisms are in place. However, such legislation looks likely to be hampered by bids to save airlines and the broader economy. For these reasons, Stratas Advisors is sticking to a conservative medium-term biojet outlook.