Taking Wing: Renewable Aviation Fuel Could Have a Strong Investment Future

Art by James Yang

Those white jetliner contrails stitching the sky are lovely. Too bad they are an environmental blight.

Commercial airplanes and large business jets generate 10% of U.S. transportation greenhouse gas emissions and account for 3% of the nation’s total GHG output, according to the federal Environmental Protection Agency. Meanwhile, global passenger traffic is projected to expand by 4.3% annually over the next two decades.

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The good news: The race is on to produce sustainable aviation fuels, driven in part by EPA and other countries’ regulators, and because SAF could become a very profitable business. If so, these fuels would prove to be good investments.

“We see increasing focus across the value chain in both public and private markets for renewable fuels,” such as SAFs, biodiesel and renewable natural gas, says Jonathan Grabel, CIO of the Los Angeles County Employees Retirement Association, which is investing in them. A report shows LACERA has invested in three sustainable jet fuel makers, albeit amounting to a tiny fraction of the pension fund’s overall assets ($78 billion): $980,000 in Gevo, $2.2 million in Johnson Matthey and $1.5 million in Finnish energy giant Neste.

Demand Is There

The major U.S. airlines have set a 2050 target for cutting their carbon emissions to net zero by bidding goodbye to petroleum-based fuel. (With net zero, carbon output is severely reduced and any remaining emissions are offset by using sustainable energy sources and by other means.) Renewable fuel is a tiny amount of their usage currently.

While demand for green aviation fuel is surging, a lot of ramping up lies ahead. American Airlines, for instance, consumed 3.6 billion gallons of regular fuel in 2022 and just 2.6 million SAF gallons. Still, American has commitments to buy 620 million gallons of SAF from 2025 through 2030, or an average 110 million annually. Airlines United, Delta, Southwest and JetBlue are also among those dedicated to boosting their renewable fuel usage.

Admittedly, in its bid to employ renewables, the aviation industry is far behind autos and power plants, which are focused on converting to giant batteries, among other things. Inventing a battery strong and light enough to run an airliner is a lot harder than building ones for earthbound uses and may be impossible. Hence, the emphasis on SAF.

The goal is to fly planes powered by sustainable fuel made from corn, soybeans, sugar, trash, even rabbit droppings. Some new fuels will take years to develop. Right now, vegetable oil and animal fat are the easiest to convert to jet fuel.

There are potential downsides, though. Not enough fat and vegetable oil exist to cover the entire airline industry, so using a number of sources is the best approach, experts say. A second worry: increasing agriculture to serve as feedstocks for sustainable energy products could result of clearing forestland, which removes carbon from the atmosphere, and the new farm fields could release carbon lying dormant in the soil, noted Nikita Pavlenko, leader of the fuel team for the International Council on Clean Transportation, in a research paper.

Right now, the production cost of SAF is typically not economical, although a federal sustainable fuel tax credit, under the 2022 Inflation Reduction Act, helps—cutting the cost by $1.25 to $1.75 per gallon, about one-third of its retail price. Sustainable jet fuels are often triple the cost of petroleum-based fuel. So SAF is twice as expensive as traditional fuels. SAF’s “cost is higher but the tax credit at least keeps it in the ballpark” of commercial acceptability, says Rob Thummel, portfolio manager at investment firm Tortoise, who oversees $7 billion in energy assets.

Investing in Renewables

SAF research and production are concentrated in small pure-play companies or in large energy outfits, where they are a fraction of the fuel picture. For SAF-centric investors, the hope is either that the small players will take off or that, at the big companies, the renewable component will drive significant earnings. Still, SAF is a very speculative investment.

While renewable jet fuel is projected to be a large chunk of the market by 2050, a lot of unknowns remain on whether ambitious goals will be achieved. “The technology and the cost of capital are big questions,” points out Marcus McGregor, a managing director of investment research at asset manager Conning. And because government support is a vital part of SAF’s development, a second Trump administration could reverse the progress made during the Biden presidency, he observes, and the result could be “two steps forward, five steps back.”

To gauge the extent of aviation sustainability’s progress, let’s look at the situations at the three renewable makers in which LACERA invests. Colorado-based Gevo has seen a dramatic revenue expansion over the past year, thanks to sales of renewable natural gas, even as the company continues mired in the red. The stock has fallen deeply over its 13 years of public trading and now changes hands at less than $1 a share.

Johnson Matthey, located in Britain, traces its origin to 1817, when it assayed gold—a process of ensuring that the yellow metal was genuine. Now it manufactures chemicals to help with oil refining, but also has a strong renewables business. In 2021, it created a process to convert household garbage into airplane fuel. Earnings have fluctuated, with its March-ending fiscal year finishing profitably, up from negative results the previous year. The stock has dropped nearly by half since its last high, in 2021, and trades at a lofty price/earnings ratio of 30.

Finland’s Neste, with its $15 billion market cap, is a far bigger force in the energy sector than the other two. It is centered on traditional oil distribution and refining, is in the black and trades at an affordable 11 P/E. The company has entered the renewables business by partnering with McDonald’s 250 outlets in the Netherlands to recycle cooking oil used for making French fries. Using this source and others, Neste has become one of the world’s leading SAF producers.

Several energy giants are getting into renewable flight fuel, too. Most notable is Chevron, a P/E of 14, which in 2021 turned its refinery in El Segundo, California, to making SAF, using animal fats and cooking oil. Phillips 66 and Valero Energy also are converting refineries to process renewable fuels. For Tortoise’s Thummel, the better investment choice is to go with a major like Chevron, Phillips or Valero. Small “pure plays are ultra risky, and not competitive,” he says. “The larger companies have the R&D to make [sustainable fuels] competitive.”

In CIO Grabel’s view, “With more markets and companies aiming to fulfill low carbon commitments, there is an active search for cost-competitive, durable solutions in manufacturing, processing, and marketing of these fuels.” And for good reason: “We anticipate the opportunities to expand.”