LOS ANGELES, CA – JANUARY 13: United Eco-Skies Boeing 737-924ER arrives at Los Angeles international … [+]
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Airlines for America, a trade group representing leading U.S. airlines, announced last week a commitment by its members to reach net-zero by 2050. Accompanying the announcement was a wishlist of policies and support programs to enable the transition to a net-zero future built around sustainable aviation fuels, or SAF for short. Although the release identifies climate change as the motivating factor, the commitment by the airlines and the associated asks of policymakers are proactive steps meant to protect and bolster the industry’s bottom line. It’s yet another example that what’s good for the climate is also good for business.
Airlines have always operated in a precarious space, with multiple business risks baked in to their models. Airlines have a misalignment between their multiyear planning and airplane procurement cycle and their sometimes fickle and unpredictable demand. They additionally suffer from outsize exposure to oil market volatility, with approximately 15% of operating costs dedicated to fuel purchases. In short, the aspects that drive the profit or loss of an airline have complex interconnections with geopolitics and the macroeconomic environment, with a history of sudden volatility when unforeseen global events, such as a terrorist attack or wedged container ship, disrupt economies, supply chains, or fragile alliances. The impacts of these exposures can be severe: the list of U.S. airline bankruptcies is a who’s who of the industry, with every major U.S. carrier (save Southwest
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On the demand side, SAF solves a key problem for airlines by providing a pathway to guilt-free flight. Just before the pandemic hit, airlines were contending with a small but vocal activist campaign aimed at getting fliers to shun air-travel. The argument was straightforward: flight, which represents 2.5% of global CO2 emissions, is a luxury product that kills the planet, and virtual alternatives make trips unnecessary. Although the campaign had no measurable impact on demand, there is no guarantee that a larger movement couldn’t take hold. Financial crisis and recessions tend to quickly erode demand for air travel (especially among the high paying business fliers), to say nothing of the impact of an event such as the coronavirus pandemic. With business’s everywhere now comfortable with remote-work arrangements and virtual meetings, climate impacts provide a ready rationale to delay a return to the skies. Providing cover to fliers to return without shame is important to rebuild demand. Unlike cars or trucks, however, there is no viable technology to decarbonize medium- and long-range flights. Measured by passenger-mile, most flying is out of reach of electrification or similar alternatives. SAF provides airlines a credible technological solution to enable net-zero flight without the need to reinvent airframes, propulsion systems, maintenance plans, and supply chains.
On the fuel side, SAF provides a new mechanism to guard against cost fluctuations. In the past, airlines have engaged in a variety of schemes to protect against swings in the price of oil. One strategy, for which Southwest is perhaps the best example, involves fixing prices for a portion of fuel needs through the purchase of fuel hedges. Delta pioneered a different hedging strategy in 2012 by purchasing an actual refinery in Pennsylvania in an attempt to gain upside for itself in times of high oil prices. The problem with a hedge, however, is that you can find yourself on the wrong side of a trade when prices drop. Nearly every airline, including Southwest, saw losses from hedging operations when oil prices plummeted in 2016, and Delta’s gambit in to oil refining was a bust. In a world where all airlines hedged equally, such incidents would move the needle the same for everyone, but in reality each airline enters hedges at different times, prices, and proportions. Carriers can find themselves locked in to operating costs significantly higher than a competitor, with little ability to alter the situation while hedging arrangements stay in place.
SAF provides a new, different hedging mechanism, by enabling airlines to vertically integrate and buy in on the ground floor of a new and potentially enormous market. Airlines have been aggressive in seeking to purchase SAF and benefit from its deployment. Southwest contracted with Red Rock Biofuels to purchase SAF produced by biomass, United is an investor in Fulcrum Bioenergy, which is building a trash-to-fuels plant outside of Reno, and Delta has invested in Northwest Advanced Bio-fuels and has committed to purchasing SAF from Gevo. Airlines stand to benefit from the deployment of SAF through direct equity participation in the companies making and selling the SAF itself. For the first time in their histories, airlines have a pathway to control their own fuel production. By making an industrywide pledge to move to net-zero SAF, the major carriers provide each other cover to make proactive investments in SAF developers, many of whom are working towards projects with an expectation of future regulations incentivizing SAF production.
The downsides to betting on SAF are relatively small compared to the risk mitigation SAF provides. At best, airlines reinvent their image, make enormous profit on their SAF bets, reduce their exposure to market volatility, and become a net neutral climate participant. At worst, carriers are out a small chunk of change and have to move towards a different solution. In the end, the only real surprise from this announcement is that the carriers set the bar so low: 2050 is a long way off.
