As countries around the world seek to limit
their carbon emissions, sustainable fuels will play an important role. This
category consists of a broad range of low-carbon fuels, including biofuels, eFuels
and chemical byproducts. Because sustainable fuels can fill gaps in
decarbonization and complement electrification, demand is expected to triple
over the next 20 yr, reaching approximately 600 MM metric t by 2050 (FIG. 1).1 Today,
completed advanced-biofuels projects and the announced investment pipeline in
sustainable-fuel capacity have reached $100 B.2
The sustainable-fuel market
is still mostly nascent, characterized by complex regulations and
interdependencies across sectors. Physical and regulatory constraints on
feedstocks have resulted in price volatility, supply chain and infrastructure
bottlenecks, while varying pricing across regions and import and export rulings
have added to this volatility. The mix of fuel types will evolve through 2050. Road
fuels have represented most of the demand and growth to date, but in the 2020s
categories such as sustainable aviation fuel (SAF), renewable natural gas,
synthetic natural gas and bio- and eMethanol will make up a larger share.
During the 2030s, technological advancements could spur growth in new advanced biofuel
pathways and eFuels, complicating the global market while injecting much-needed
capacity and liquidity.
With such complex market
fundamentals, sustainable fuel traders should seek to understand which markets
will increase in liquidity, which arbitrage plays to explore across products,
which storage hubs to invest in, and which offtakes to secure to gain access to
supply. Winning traders will build and enhance selected capabilities to keep
pace with the market’s evolution.
Current
market and development factors. A fascinating but challenging aspect of the sustainable
fuel market is the broad range of categories it encompasses (FIG. 2). Biofuels
account for the vast majority of the market, but drop-in sustainable fuels and
hydrogen (H2)-based eFuels could reshape the landscape in the coming
decades. The development of these fuels will be nonlinear—they will mature at
different paces, and their specific uses could replace fossil fuels at
different rates.
The rise of eFuels. In the coming
years, constraints on sustainable biomass feedstocks are expected to create a
gap between supply and demand for fuels with existing technologies. Although
biomass feedstocks (notably lignocellulosics) have significant potential for
energy production, practical constraints on their collection mean the
global community will likely be unable to achieve net-zero targets without a
shift to eFuels and dedicated biomass production on marginal lands or surplus
agricultural land (FIG. 3).3
The
eHydrocarbon market could still emerge in the late 2020s, but volumes will
likely not become significant compared with bio-based production until the
following decade. In addition, the cost competitiveness of different production
pathways continues to be uncertain given the limited adoption and potential to
reduce production costs of some of the pathways over time (FIG. 4). European
Union (EU) regulators have taken the strongest long-term view on the role of eFuels,
introducing proposals to mandate the use of renewable fuels of non-biological
origins (RFNBOs).4,5
The business case and
location choices for eFuel production are affected by access to affordable
renewables, the availability of sustainable carbon (eAmmonia, which does not
contain carbon, is an exception) and integrated production costs of H2
derivatives (which are affected by rules such as temporal correlation,
requiring electricity storage or H2 to produce compliant fuels).
Classifications vary by the H2 type (e.g., the carbon intensity or
whether the electricity source includes nuclear in addition to renewables) and
carbon (e.g., carbon derived from fossil, biogenic or direct air capture
sources) and can affect a product’s market value. Future producers are
concentrating primarily on non-fossil carbon sources such as ethanol, pulp and
paper, and waste-to-energy plants.
Production can provide
opportunities in regions with a high potential for renewables and
biogenic-carbon availability, such as Latin America, North America and parts of
Asia and Europe. Africa, Australia and the Middle East could be major producers
of eAmmonia and potentially eHydrocarbons for markets that allow the use of
fossil carbon in eFuels. The high cost of direct air capture must fall
dramatically to be competitive with carbon capture from industrial sources.
Competing policy approaches to support market development. Multiple countries and regions are active in the global
sustainable fuel market. The EU and North America are at the forefront in
drop-in sustainable fuels. Meanwhile, an established significant market for
conventional biofuel has experienced growth over the past 30 yr, with
bioethanol in Brazil, China and India and biodiesel [fatty acid methyl ester (FAME)]
from palm and soybean oil in Latin American and Southeast Asian countries.6 Asia–Pacific,
Australia, China, Japan, India, Singapore and South Korea are emerging as
potential demand hubs for drop-in fuels such as SAF, eMethanol and eAmmonia to
serve as energy carriers or fuels for the marine sector.
An examination of the EU and
U.S. markets highlights the complex and varied landscape across regions as well
as different approaches to spurring sustainable fuel’s adoption.
EU. The EU has set ambitious targets for
reducing carbon emissions and is using legislation to support demand. For
example, the “Fit for 55” package of legislation aims to decrease the EU’s
greenhouse gas (GHG) emissions by at least 55% by 2030, establishing targets
for renewable energy use in the Renewable Energy Directive amendment (29% for
the transport sector by 2030) and specific feedstocks (5.5% for advanced
biomass and RFNBO by 2030, of which a minimum of 1% must be RFNBO).7 Proposed
legislation would lay the foundation for SAF demand, mandating a 2% share of
SAF supply in 2025, 6% in 2030 and 70% in 2050 (of which 35% would be RFNBO).8 By
providing long-term demand signals, including compliance mechanisms, EU leaders
have sought to create prerequisites for investment decisions.
On the supply side, the EU
and its member states have imposed bans and restrictions on feedstocks that can
be used for biofuels. The region is shifting from food crops (such as palm, soy
and corn) to waste and residue streams for advanced biofuels.9 In
addition, it is defining sustainability criteria for eFuels, favoring biogenic
or direct air capture carbon and green or low-carbon H2 that meets
stringent criteria (as laid out in the RFNBO delegated act).10 A
recent proposal to allocate some EU emissions trading system (ETS) funds from
aviation to support SAF adoption could also introduce incentives similar to
those found in the U.S. Inflation Reduction Act (IRA).11
North America. The passage of the IRA in 2022
signaled a dramatic shift for the U.S. The act features $370 B in tax credits
for the renewable energy industry, including a credit of $1.75/gallon (g) for
SAF through 2026 and a production tax credit of $3.00/kilogram (kg) of H2
that contains GHG emissions below 0.45 kg CO2 per kg of H2 (such
as onshore wind or nuclear). By attracting investment, the IRA seeks to scale
up SAF production to at least 3 Bgpy by 2030, with the goal of 100% blending by
2050.12
These tax credits could
significantly boost manufacturing capacity. However, a high share of projects
have yet to clear the final investment decision (FID) stage. Twelve major North
American passenger and cargo airlines have made SAF commitments through 2030,
but their offtakes are still far from meeting future demand, and few of those
offtakes can be considered fully binding.
The North American market
also has several policies to support the use of sustainable fuels. For example,
the U.S. Renewable Fuel Standard (RFS) and the state-level Low-Carbon Fuel
Standard (LCFS) programs affect pricing and create markets for credits.
Aligning market supply and demand. The different policies and approaches could lead to supply-and-demand
imbalances across regions in the medium term. The market could snap back into
balance in multiple ways, including:
Outlook on global
trade flows through 2050. The
development of sustainable fuels will proceed at different paces depending on
category and region. However, based on trends to date, a few observations can
be made about how global trade flows could play out through 2050. A significant
share of production and consumption takes place within regions, shaped by
various mandates, incentives and trade rules. Some inter-regional trade also occurs,
notably of feedstocks and fuels—for example, from Asia-Pacific hubs to Europe and North
America. Producers outside the U.S. are increasingly looking to the EU as a
potential export market. Therefore, many feedstocks and fuels can be considered
as partially global commodities.
Although the recent IRA
package in the U.S. is intended to meet local demand, it is starting to attract
more investment to the region. This activity may be contributing to the
widening gap in pricing among regions. Some demand patterns are also shifting:
for example, airlines refueling with SAF have access to cheaper prices in
California than in the EU. Furthermore, proposed book-and-claim schemes could
lead to global or regional optimization of demand volumes based on local
incentives.13
Looking toward the future,
long-term scenarios will likely be shaped by high demand growth beyond the EU
and U.S., the increased interest in securing supply, regional and local
feedstock constraints, greater market complexity and the partial
commoditization of markets such as renewable diesel and SAF. On one hand,
feedstock shortages could lead to the adoption of more expensive or
capital-intensive production pathways, such as the conversion of
lignocellulosic feedstocks. Differences in sustainability criteria across
regions may result in the growth of regional markets and product differentiation
based on that sustainability criteria.
Conversely, the rise of eFuels
combined with a scarcity of the biomass needed to support 2050 net-zero
scenarios may lead production to concentrate in the global south, depending on
the cost of direct air capture and requirements for non-fossil carbon sources.
As an alternative, production could be more regional, with sustainability
criteria differing by region. The resulting long-term outcome will likely be a
mix of global commoditization and local fragmentation, creating opportunities for
a range of feedstock, technology and fuel combinations.
How traders can
win in sustainable fuels. The
sustainable-fuel market is poised to ramp up significantly in scale and
complexity. Five interdependent areas will shape the market in the coming years
(FIG. 5). To
better identify value creation opportunities and risk, market participants must
understand how these areas influence one another and how to keep pace with
advances. For example, traders that have a good grasp of the shifting market
balances but lack an understanding of the pace of investment in new technology
platforms could be at a disadvantage.
Build
a regulatory intelligence team. The regulatory
landscape varies dramatically among countries and regions and is evolving
rapidly. Traders that develop a deep understanding of local market regulations,
credit qualifications, future trends and potential changes will be better able
to shape their trading strategies and secure offtakes or supply arrangements.
The economics of sustainable
fuels such as renewable diesel, which has relatively high production costs, are
highly dependent on regulatory incentives and vulnerable to regulatory
uncertainty. For example, the cost of SAF from HEFA-used cooking oil (UCO) in
Europe without incentives was recently about $2,200 per metric t, 100%–150%
more than the cost of producing fossil-based kerosene today.14 That
means users either rely on substantial credits [such as the LCFS, Renewable
Identification Numbers (RINs), Blenders Tax Credit, or the new IRA credit
stack in the U.S.] to break even or customers pay the required price for
mandated volumes and pass those costs on to customers (the primary mechanism in
the EU).
The outlook for many of these
programs could be affected by regulatory changes, which will influence the
price of subsidized fuels in the years ahead. For example, multiple IRA credits
will expire after several years. The RFS program has also historically been
volatile, with the price of RINs often driven by legislative outcomes and
market perception of new targets set by the U.S. Environmental Protection
Agency (EPA).
Develop
global trade flow models. Gaining an
understanding of global trade flows will be far more difficult in the coming
years given the level of uncertainty, lack of transparency (including the
dearth of trade categories for some products) and complexity in the sustainable
fuel market. Optionality is especially critical in this environment. Winning
traders will model how fast each commodity will grow and in which market it
will likely clear (including within-year demand dynamics), as well as
anticipate shifts and monitor key changes in logistics capability and access
within regions.
Enhance
origination capabilities. Traders will
need robust origination functions to secure offtakes or supply agreements for
specific feedstocks and products that offer competitive flow advantages.
Successful traders will structure these agreements to balance price, volumetric
flexibility and logistics to enhance optionality and derisk volume flows if
market dynamics change. Traders also have opportunities to rent or buy blending
facilities, acquire sustainable fuels (including certificates) and fossil fuels,
perform blending, and detach sales of molecules and credits—essentially creating a
secondary market in a given country for the certificates.
Commodity trading
organizations attracted to sustainable fuels by their dynamic nature and growth
could try to anticipate how the market will evolve and identify inconsistencies
in pricing across products or over time, offering opportunities for market arbitrages.
Successful traders look for areas of greatest transactional volume and seek to
build scale around these opportunities. Often, they will use scale to continue
to capture value when margins collapse as the gaps start to close.
Strengthen
the trading team. The interdependencies of feedstock, fuel and
credit prices within sustainable fuels and across other sectors are complex.
Successful traders must model correlations among products and explore arbitrage
opportunities across specifications, locations and timing. For example, as
demand grows for second-generation feedstocks for drop-in fuels, the prices of
advanced waste and oils could become more volatile. Through 2021 and part of
2022, soybean oil prices exhibited high volatility in response to intensifying
competition from renewable diesel and FAME producers in the U.S. amid limited
supply from export markets. Feedstocks with limited or scattered availability
and competing demand for alternative uses are at the greatest risk of such
volatility.
The trading team must have a
broad level of expertise across various commodities and understand the
interplay of those commodities in different markets and products. Specialist
trading across high-volume commodities will still exist, but because each
market will be influenced by a growing array of factors, traders will need far
broader commodity knowledge to be effective.
In
the coming decades, the sustainable fuel market will be transformed by
increased demand, substantial investment, disparate policies across regions and
technological advancements. Despite the many factors that will shape the
market, rapid growth and volatility could offer enticing opportunities to
capture value. Winning traders will develop new capabilities to track
regulatory changes, monitor global trade flows, improve origination and build
out their trading teams to navigate this complex trading landscape. HP
LITERATURE CITED
TAPIO
MELGIN is a partner
in McKinsey’s Helsinki office.
AGATA
MUCHA-GEPPERT is
a solution manager in McKinsey’s Warsaw office.
XAVIER
VEILLARD is a
partner in McKinsey’s Paris office.
ANDREW WARRELL is a partner in McKinsey’s Washington, DC office.