Overcoming Three Finance Dilemmas for US SAF Producers in 2024

According to project finance experts, US-based sustainable aviation fuel (SAF) producers will face three main dilemmas when financing commercial-scale projects in 2024: what feedstock to use, whether to get government loan guarantees, and how to de-risk operations.

If we are to decarbonize the aviation industry at the speed required, sustainable aviation fuel (SAF) must grow from 0.1 percent of global jet fuel to 10 percent by 2030, implying building 300 SAF plants globally within the next seven years. To meet US climate targets, the Biden administration has set a goal of 3 billion gal/year of SAF capacity by 2030 and 35 billion gal/year by 2050. The United States needs to add SAF capacity at an unprecedented rate. While US policy has fortunately tilted in SAF’s favor with federal and state-level incentives, building the first wave of SAF plants in the United States will nonetheless require project financiers to be flexible and creative.

SAF project developers may have little choice over some financing decisions: they’ll need to invest in community engagement, share returns with tax equity partners, and sign up a wide range of offtakers (including potentially sub-investment grade airlines). And yet there are at least three choices within their control — three choices that’ll go a long way in determining how much money they can raise and how cheaply.

Three finance-determining choices US-based SAF developers face in 2024 are: 1) what feedstock (and therefore technology) to choose, 2) whether to apply for a Department of Energy’s Loan Programs Office (DOE LPO) loan guarantee, and 3) how to cobble together insurance, construction guarantees, and equipment warranties in a way that’ll get past banks’ stringent credit committees. As part of our industrial decarbonization work with Mission Possible Partnership, RMI and SidePorch Consulting recently convened a SAF project finance roundtable with experts from banking, private equity, impact investing, venture capital, insurance, law, and public finance to consolidate perspectives from across the financial sector.

Here’s what SAF investors are saying.

The Feedstock Dilemma: Feedstock and technology choice will impact both debt and equity.

The strength of feedstock contracts and technological readiness (including lack of operating data) are different but deeply related risks for investors, which is why they must be addressed together. HEFA is a proven technology but has feedstock limitations. Investors are weary of short feedstock contracts (i.e., “recontracting risk”) and/or sub-investment grade suppliers who may not supply the project as planned. For e-fuels, on the other hand, renewable electricity is theoretically unlimited and is increasingly becoming more economical. Another feedstock — biogenic CO₂ — is limited and expensive but can support the development of e-fuels till DAC technology matures.

Infrastructure funds may favor e-fuels since it has more potential to win in the long term. A private equity-backed energy transition fund investing $100+ million will want to know there will be a market for the project/technology in 5-7 years when it needs to exit. On the other hand, lenders may initially favor HEFA because the technology has been widely used in commercial operations. The feedstock choice impacts LCFS revenues since LCFS depends on carbon intensity, whereas the 45Z federal incentive is more technology agnostic. Either way, feedstock contracts need to be as airtight — maybe even more solid — than offtake so that both debt and equity investors can participate. Investors will want contracts that protect their returns in case a project cannot source feedstock across its entire operating life.

Potential solutions: Equity investors and developers worried about losing out to long-term technology trends could diversify across both HEFA and e-fuels. State-level policymakers who want to attract SAF projects should incentivize feedstock production — both abundant green power as well as biogenic CO₂ for e-fuels and lipids for HEFA.

The DOE LPO loan guarantee dilemma — is it worth the time? 

Before private capital can finance billion-dollar scale SAF projects on its own, support mechanisms like a DOE LPO loan guarantee may be crucial for overcoming unproven technology and weak feedstock/offtake. The LPO review process, though, can take 6 to 12+ months and approval is uncertain. An LPO applicant’s competitors may gobble up limited feedstock by then. Therefore, it’s likely three financing archetypes will emerge: 1) government loan with government guarantee, 2) commercial loan with government guarantee, and 3) commercial loan with no government guarantee. While option 2 entails two rounds of due diligence (once by LPO and once by commercial banks) and is therefore potentially lengthier, experts suggest that commercial banks stand to gain long-term technology expertise by engaging and negotiating with LPO. Each financing archetype has different implications for cost of capital versus loan approval time.

Potential solutions: Given how uncertain the offtake may be, sponsors could try to get some form of loan guarantee, even if it’s from the USDA or a foreign ECA. To speed up DOE LPO approval times, borrowers should familiarize themselves with resources for borrowers before they apply. Federal agencies can continue improving loan guarantee processing times, while states like California (i.e., states with numerous projects in development) could provide temporary guarantees even for smaller amounts.

The Insurance Dilemma

Guaranteeing construction and performance will be crucial and banks may need to be flexible in how sponsors marry up partial-wraps from EPCs, less-than-ideal warranties from OEMs, and insurance. EPCs may not be able to provide full-wrap construction contracts, OEMs’ warranties may not be long/strong enough for lenders, and simply getting insurance to cover all project risks may be too expensive. Project developers will need to find the economical sweet-spot between those three (or more) sets of de-risking instruments. They’ll need enough risk coverage to placate bankers but at a price that doesn’t kill equity returns.

Potential solutions: Engage early and often with insurers, investment advisors, experienced lawyers, and Aviation CAF banks to determine what combination of guarantees is bankable.

Conclusion

The year 2024 could be a game-changer for aviation decarbonization if the first wave of SAF projects complete the LPO process and secure commercial financing. Many of these projects will be located in clean industrial hubs. Clean industrial hubs bring together policymakers, financial institutions, project developers, and community-based organizations to enable groundbreaking decarbonization projects in the hardest-to-abate sectors, like aviation. RMI and Mission Possible Partnership are working together to support stakeholders with the analyses and tools needed to advance zero-emissions trucking, low-carbon cement plants, sustainable aviation fuel, and decarbonized ports, by increasing the size, scale, and speed of critical climate investments that benefit the environment, the economy, and communities. This work is done in partnership with the Bezos Earth Fund, including convenings like the round table that led to these findings.

Sophisticated investors are evaluating projects and sponsors and pricing risk-return accordingly. According to SAF project finance roundtable participants, a private equity-backed energy transition fund may want ~15 percent levered equity internal rate of return for operating projects (and over 20 percent if there’s development risk), while venture capitalists may want north of 40 percent for pre-offtake projects with novel technology configurations.

LanzaJet’s pioneering 10 million gal/year Freedom Pines facility opened in Georgia in January, financed by a mix of strategic investors and climate-focused investors. Larger SAF plants may need private equity and debt investors too. Equity investors shouldn’t bet on just one technology, while lenders should explore loan guarantees, building relationships with clients while learning how to underwrite newer technologies.

And yet finance for clean jet fuel in 2024 will not flow as freely as it does for clean electricity: there’s no juicy 20-year investment grade offtake, there’s more demand for feedstock than supply, and investors are uncertain on which technology will win. So, for the first wave of deals, while the market works itself out, sponsors should seek government support to reduce both real and perceived risks for investors. It may be the only way to get this plane off the ground.