In the era of "Net Zero", much legislation has evolved from the EU with respect to the imposition of mandatory decarbonisation targets and the composition of lower-carbon fuels.

One area of focus has been the aviation sector, which accounts for approximately 2.5% of global CO₂ emissions.

The ReFuelEU Aviation Regulation seeks to decarbonise the sector by imposing obligations on fuel suppliers, certain EU airports and aircraft operators to respectively supply, facilitate access to and lift sustainable aviation fuel (SAF).

Financial institutions also have greater internal mandates to support the development of sustainable projects.

However, notwithstanding the regulatory requirements for SAF production and usage, and the appetite in the market for projects to be developed, the number of project-financed SAF projects that have reached final investment decision remains low compared to the scale-up of the industry required to meet the EU's regulatory targets.

Many major airlines have also announced voluntary targets in terms of the proportion of SAF they are looking to incorporate into their aviation fuels mix.

This article considers certain key challenges that have emerged with respect to the project financing of the early SAF projects in Europe or which are targeting export to Europe.

How does the EU define SAF?

SAF is a "drop-in" fuel, meaning it can be blended with conventional jet fuel to reduce the carbon intensity of the aircraft's fuel batch.

It can be safely used by all aircraft and engines that are certified to operate with jet fuel, meaning SAF can already be used in the majority of operational aircraft, giving it a strategic advantage over other clean fuels which require aircraft to be fitted with different engines.

While SAF still contains carbon, and therefore emits CO₂  when combusted, if the SAF is produced using certain sustainable pathways, it is not considered to be as carbon-intensive as conventional jet fuels.

The ReFuelEU Aviation Regulation defines SAF as:

• an aviation biofuel – liquid fuel produced from prescribed biomass sources such as cooking oil, animal manure or palm oil mill effluent which are not excluded sources (such as food and feed crops);

• a synthetic aviation fuel, or e-fuel – fuels (such as e-SAF) made by synthesising green hydrogen with captured CO₂ that fulfil the criteria for renewable fuels of non-biological origin (RFNBO) under the Renewable Energy Directive III; or

• a recycled carbon aviation fuel – produced from waste streams of non-renewable origin that meets the requirements of RED III (e.g. jet fuel made from synthetic crude oil derived from municipal solid waste).

Regulatory mandates for SAF usage

Given the cost differential between conventional jet fuel and SAF (in particular e-SAF), regulatory intervention is required to stimulate demand.

An example of this is the EU's ReFuelEU Aviation Regulation which imposes the following targets:

• aviation fuel suppliers must supply fuel to aircraft operators at EU airports containing an average minimum SAF share (2% from 1 January 2025, rising to 6% by 2030 and thereafter in increments to 70% by 2050);

• SAF should contain a minimum amount of RFNBO (1.2% by 2030, rising in increments to 28% by 2050);

• applicable aircraft operators are required to uplift at least 90% of their annual fuel requirements from an EU airport (to avoid tankering at airports outside the EU to avoid lifting SAF); and

• airport managing bodies must facilitate access to aviation fuel containing the minimum SAF blend (for example, by having the required infrastructure for SAF storage and transmission to aircraft).

The effectiveness of this regulation in promoting the evolution of the aviation fuel market is due to be reviewed by the European Commission by 1 January 2027.

Key challenges of project financing SAF projects

Offtake

While the airline travel industry has in many respects recovered from COVID-19 travel lockdowns, many are not in the financial position to commit to a long-term offtake agreement for SAF, while prices are significantly higher than conventional jet fuel.

Airlines (the end-users of SAF) do not typically forward-hedge their fuel requirements beyond two to three years, making a long-term, fixed-price offtake agreement (that project finance lenders typically require) difficult to secure for a SAF project.

Even if an environmentally-conscious airline can agree to stretch their SAF purchase commitment to, for example, 10 years, this would still leave a large, uncontracted tail for a long-term debt tenor of perhaps 20-25 years (which producers will try to achieve to lower their production costs for the larger SAF projects).

Lenders will struggle to lend to a project with significant uncontracted exposure at the back-end. A potential solution to bridge the gap would be to interpose an intermediary (aggregator) of sufficient creditworthiness between the SAF producer (selling long term) and end-customer(s) (buying short/mid-term).

Trading houses may find this risk profile attractive as it allows potentially lucrative upside if SAF demand surges as the reality of regulatory compliance becomes clear.

Larger projects may also find it difficult to secure one offtaker for the entirety of the plant's production and a sole offtaker's balance sheet might not be sufficiently strong to underpin a large-scale financing.

These projects may therefore enter several offtake arrangements with different buyers (potentially from different sectors) to spread the credit risk.

Bullish SAF producers may seek to have an uncontracted portion of their production sold on the spot market, to capitalise on forecasted demand as the SAF mandates ramp up.

As discussed above, lenders will be reluctant to take significant merchant exposure for a new sector and any limited merchant offtake strategy will need to be supported by detailed marketing analysis and considered implications for debt-sizing.

SAF valuation

The long-term valuation of SAF is currently impossible as the premium for SAF is too uncertain to establish a reliable value.

The SAF price will be a function of demand, largely driven by uncertain regulatory drivers, and supply which combines feedstock costs and production costs.

Levelised cost models may provide some price guidance for the various production pathways, but can only reflect the current understanding and costs base, not a guarantee of future project economics.

In the absence of any well-established pricing index for SAF, project finance lenders will likely require offtake to be on a fixed-cost basis (or by reference to another commodity index with which lenders are familiar and comfortable).

Feedstock supply and pricing

For SAF produced from biogenic sources, there are concerns around competition for feedstock supply in light of other EU-mandated targets that also require the use of biogenic feedstocks for other fuels.

This competition for feedstock also adds a greater level of uncertainty to its cost and value in SAF production. As is customary, lenders will expect a long-term feedstock supply arrangement from a credible and reliable source (meeting the EU's strict eligibility criteria) and a back-up plan in case of critical feedstock unavailability.

For e-SAF requiring CO₂, sources of eligible CO₂ are also limited by regulation. Biogenic CO₂ is most readily available. However, there may be project-on-project risk in the event a SAF project is relying on the delivery of a biogenic CO₂ from newly built processing facilities outside the project perimeter. There is an overall challenge around whether there will be sufficient biogenic CO₂ available for e-SAF production.

For both e-SAF and bio-SAF, the CO₂ supply and other biogenic feedstock supply, respectively, will need to comply with the greenhouse gas (GHG) reduction and sustainability criteria under RED III and the delegated acts (adding an additional layer of cost and complexity to these projects). Lenders will perform detailed due diligence and GHG modelling to ensure the SAF will meet the EU's regulatory requirements.

The route to market for SAF production into aviation supply to airports will also need to be considered, such as which market the SAF is best suited for, where it might be blended and what logistics are therefore required.

SAF technology

Uncertain and competitive production technologies make it more difficult to provide lenders with the certainty they crave to finance projects.

The most-proven technology for SAF production is the hydrotreated esters and fatty acids (HEFA) process, which uses bio feedstocks. This places production economics in direct competition with hydrotreated vegetable oil and bio-diesel.

While certainty of production costs makes for easier financing, European regulations limit the proportion of HEFA-based SAF in the mandates over time, in order to encourage development of other technologies.

Alcohol-to-jet (ATJ) has the advantage of access to large volumes of feedstock i.e. ethanol. A first-scale production plant started in the past year in the US, where ATJ is seen as a viable SAF pathway, subject to meeting carbon intensity targets. 

RED III, however, caps the amount of biofuels produced from food/feed crops that can count towards the EU's decarbonisation targets for the transport sector (currently at 7%). As most bio-ethanol is produced from starch-rich crops, SAF using bio-ethanol may have less value in the EU market.

Given the fluidity of the market and the number of competing technologies, lenders are likely to favour SAF projects using technology that has a wide product slate and which can pivot to produce an alternative clean fuel (such as synthetic diesel or gasoline), should market conditions change.

While the technology used for e-SAF production (including electrolysers for green hydrogen, Fischer-Tropsch for hydrogen and CO₂ synthesis) is proven at a smaller scale, additional risks are introduced when the technology is scaled up and integrated.

Lenders will undertake a rigorous technical due diligence and examine the robustness of the construction contractual arrangements (see below).

Construction

Given the integration of different technologies, SAF construction procurement may follow similar pathways to industrial downstream projects – whether to go down the single lump-sum turnkey engineering, procurement and construction (EPC) contract approach or procure the different components separately through an engineering, procurement and construction management contracting strategy (and lower construction costs and, ultimately, SAF costs).

Since the sector is nascent, lenders are likely to be more stringent in requiring an EPC contractor to provide a full technology "wrap" for the project.

Utilities access

SAF projects will need to consider any baseload power requirements not supplied by their dedicated renewable energy sources, such as any cooling and storage equipment requiring round-the-clock power.

Depending on location, using power from the grid may create issues in meeting the overall GHG emissions reduction requirements in EU legislation.

Lenders may be more comfortable supporting projects in locations where renewable sources are in abundance or where the average share of renewable energy in the grid exceeds 90% (in which case power can be taken directly from the grid and still be considered "green").

Non-HEFA SAF production is expected to be intense in terms of water requirements, meaning that this key utility needs consideration to determine plant and site feasibility.

Regulatory risk

The regulatory environment governing SAF is continuing to evolve and is extremely complex and uncertain. For instance, the pending review of the ReFuelEU Regulation in 2027 is creating apprehension on matters such as penalties.

More generally, given the extensive lobbying around the RED III sustainability requirements for clean fuels, projects can expect the change in law risk to feature prominently in lender due diligence.

Ideally, the costs of compliance with a change in SAF regulatory requirements (i.e. the further tightening of sustainability criteria for SAF) should be passed to the offtaker (SAF customer) under the offtake contract, as the end-user will ultimately only be interested in buying SAF to the extent it complies with the then-current SAF requirements in its market.

This article was authored by Colm Ó hUiginn, Partner, and Claire Hunter, Senior Associate, in the Projects team at Dentons; and Jonathan Martland, Head of Oil & Biofuels and Jason Rajah, Head of Infrastructure Services at Energex Partners.

A version of this article was first published by Project Finance International.