The aviation industry contributes about 6% to total global warming annually, with the overwhelming majority of its negative environmental impacts stemming from the industry’s reliance on conventional jet fuel.1 While sustainable aviation fuel (SAF) currently appears to be the only viable solution to decarbonizing aircraft travel, the pace of SAF uptake has been remarkably slow. This means that many airlines—already facing headwinds from rising labor costs and volatile commodity prices—are likely to fall well short of their publicized decarbonization goals. Missing these targets may carry credit consequences and significant implications for inclusion in ESG-oriented portfolios.
Sustainable aviation fuel (SAF) is an alternative to conventional jet fuel that is produced using feedstocks derived from non-fossil fuel sources, typically organic materials, like food and plants. SAF is often referred to as a “drop-in” fuel, meaning it’s chemically similar to jet fuel, i.e., it can be used as a direct substitute in a typical jet engine. While it still emits greenhouse gases (GHGs) when burned as a fuel, SAF can reduce lifecycle GHG emissions by up to 94% relative to jet fuel.2
To illustrate SAF’s environmental benefits, plants later used as feedstock to make SAF remove carbon dioxide when they initially grow, resulting in negative emissions. Once the SAF is burned as fuel, roughly the same amount of carbon dioxide is then released back into the atmosphere, creating a mostly closed carbon cycle. Since the majority of the carbon dioxide emitted by burning SAF was initially absorbed during the SAF’s production via plant growth, many types of these organic-based fuels are almost “carbon-neutral” over their lifetime (Fig. 1).3, 4
Figure 1
SAF Lifecycle Emissions Reductions Relative to Jet Fuel (%)
Source: EASA, as of 2024. LCA emissions reductions for CORSIA eligible SAF pathways and feedstock compared to a fossil fuel reference value (89g CO2e/MJ).
Net Zero or Bust
Without reducing dependence on fossil energy, it’s almost certain the 300+ members of the International Air Transport Association (IATA)—a consortium of the world’s largest airlines representing 85% of total air traffic—will not achieve the industry’s goal of reaching net zero carbon emissions by 2050.5 The IATA’s plan expects SAF to account for 65% of pledged emissions reductions.6
In the near-term, airlines are aiming to reduce emissions by upgrading aging fleets to be more fuel-efficient and improving the efficiency of their flight operations. But longer-term, SAF is the only viable answer to reach net zero fast enough. Other future options, such as electric and hydrogen-powered commercial airliners, likely will have long safety lead times, especially due to recent high-profile aircraft failures, and will require enormous investment to design and scale. In line with the IATA’s expectations, the U.S. Department of Energy expects SAF to account for more than two-thirds of the total decarbonization gains should the airline industry reach net zero by 2050 (see “Decarbonisation: Theory vs. Reality” for additional context on reaching net zero).7
Grounded
While global SAF supply must reach 8 billion liters by 2025 and 23 billion liters by 2030 in order to achieve net zero by 2050, only 600 million liters was produced in 2023, representing just 0.2% of total jet fuel use.8 Although SAF supply is expected to triple to 1.875 billion liters by the end of 2024, production does not appear to be on pace to reach the IATA’s near-term 2025 target.9 Some estimates project under an aggressive policy scenario where most policy mechanisms currently under consideration are fully implemented, global SAF demand will exceed supply by 2029 (Fig. 2).
Figure 2
SAF Supply Lags Forecast (Billions of gallons lhs; million barrels per day rhs)
Source: BNEF, as of March 2024.
Some have pointed to regulatory incentives, particularly in the United States, as being too little too late. The 2022 Inflation Reduction Act (IRA) offers a $1.25 credit to SAF producers for each gallon produced that meets a minimum reduction of 50% in lifecycle GHG emissions. The credit increases by $.01 for each additional percentage point the reduction exceeds 50%, creating a maximum possible credit of $1.75.10
But, as of this writing in May 2024, the spot price for kerosene jet fuel is $2.50 per gallon, while estimates peg SAF at $9.70 per gallon.11, 12 Even assuming the credit fully translates to lower market prices, SAF still remains more than three-and-a-half times as expensive as conventional jet fuel.
Additionally, while the IRA’s production incentives may help further catalyze SAF production and bring prices down, demand-side policies to encourage SAF uptake are lacking in the U.S. as there are currently no mandates requiring the supply of SAF by U.S. airport refuelers. By contrast, the European Commission recently mandated that 2% of fuel at EU airports be sustainable by 2025 and 6% be sustainable by 2030.13 However, since this mandate only applies to flights departing airports located within the EU, its impact on the costs for U.S. airlines will likely be limited.
Furthermore, we expect a similar demand-side policy instrument by U.S. regulators to face significant political and industry pushback. The IATA has stated that a mandate is not its preferred policy option for advancing the commercial deployment of SAF, saying it may result in unacceptably higher expenses for airlines.14
Investment Implications for U.S. Airlines
Our base case is that policy action in the U.S. will remain more “carrot” than “stick.” Political gridlock, the popularity of flying, and industry opposition make passage of a mandate similar to the EU’s unlikely in the U.S. The scope for individual states to implement mandates is also uncertain, as the majority of air travel in the U.S. is inter-state and statewide mandates would likely face legal challenges. Moreover, individual state action may also prove ineffective, as airlines will have flexibility to adapt their operations (e.g. reduce the number of flights to first-mover states where refueling with SAF would be required).
Separately, fuel expense is the second largest cost item for an airline behind labor expense, typically accounting for 20% of an airline’s cost structure. While airlines generally view fuel as a pass-through expense, with the airline recovering the increased cost of fuel through an increase in ticket pricing, volatility in fuel prices often translates to earnings volatility. Assuming SAF prices remain high, absent a pass-through to the consumer, SAF adoption is expected to negatively impact airline profit margins by significantly inflating airlines’ second largest cost bucket.
According to research published by the IATA, 43 airlines have committed to SAF uptake levels ranging from 5% to 30% by 2030, with most committing to 10% of total fuel use.15 We remain skeptical that aggressive pursuit of these targets will take place given the current and projected future economics of SAF. Should airlines follow through on their well-publicized 2030 SAF uptake targets, significant EBITDA margin erosion is likely (Fig 3).
Figure 3
Projected Impact to EBITDA Margins Using SAF for 10% of Total Fuel Mix
Source: PGIM Fixed Income as of March 2024. *Assumes no increased costs are passed onto the consumer through higher ticket prices.
In the near-term, absolute increases in fuel expenses for airlines are likely to be negligible, as they will mutually struggle to include material quantities of SAF in their fuel mixes due to limited global supplies.
Unless airlines achieve their ambitious 2030 SAF uptake targets—a situation we find unlikely—impacts to fuel expenses in the medium-term are also likely to be negligible, limiting impacts to EBITDA margins and the credit profiles of most U.S. carriers.
If SAF’s share of the fuel mix does increase, either the airline, the consumer, or a mixture of both will be negatively impacted by higher SAF costs. As a result, we tend to view airlines which are implementing strategies to economically scale the availability and sourcing of SAF in the U.S. more favorably.
Lastly, budget airlines with more elastic demand and price-sensitive customers may be more adversely impacted by SAF adoption. Throughout 2023, the margin profiles of these lower-cost carriers were disproportionately negatively impacted by labor, maintenance, and other airline-related cost inflation. If they opt to aggressively pursue their SAF uptake targets, larger full-service carriers may be better positioned to pass on higher SAF costs as they have more exposure to more inelastic corporate and premium travelers.
Cloudy Skies Ahead
As we approach 2030 and beyond, we will likely see greater differentiation between the ESG performance of most major aircraft carriers. While a lack of SAF uptake is a universal problem plaguing the entire airline industry, carriers that are currently entering into long-term offtake agreements with producers to procure material quantities of SAF in the future may come closer to achieving their decarbonization targets. These airlines are most suitable for inclusion in ESG funds.
Due to the high cost of SAF, it’s not overly surprising that SAF uptake has been slow and supply of the biofuel remains limited despite recent regulatory interventions aimed at increasing its production. Regulatory mandates may negatively impact the airline industry by chipping away at the already-stressed profit margins of commercial airliners. However, due to SAF’s persistent cost premium compared to traditional jet fuel, limited global supply, and a low likelihood of future demand-side SAF usage mandates in the U.S., we do not expect the credit profiles of U.S. carriers to deteriorate as a result of increased SAF uptake over the near- to medium-term.
Instead, we expect the sustainability targets of the largest U.S. airlines, which include some of the world’s heaviest emitters, to be rolled back—or missed altogether. And that carries both credit and ESG-portfolio considerations unto themselves.
1 Source: European Federation for Transport and Environment, 2024. It is often reported that aviation contributes to 2% of CO2 emissions, which is true. However, it also emits other greenhouse gases and has further climate impacts via contrail effects (warming) and aerosols (cooling) that on net, lead to its overall net warming impact to be around 3x its share of CO2 alone. In this paper, references to “CO2” and “carbon dioxide” specifically refer only to carbon dioxide unless otherwise noted (references to “CO2e” include other GHGs converted to CO2 equivalent).
2 Source: U.S. Department of Energy, Alternative Fuels Data Center: Sustainable Aviation Fuel.
3 There are always still some residual emissions. The amount of carbon dioxide absorbed during the natural process of plants growing is roughly equivalent to the amount of carbon dioxide released when plant-based SAFs are burned for fuel. In the case of waste-based SAF, namely those produced from municipal solid waste, the carbon neutrality claim isn’t quite as clear cut. The production of these feedstock doesn’t remove CO2 from the atmosphere; it simply avoids emissions that likely would have otherwise occurred. As waste decomposes in landfills, it generates methane–a potent GHG. Although these GHGs are not avoided when waste is used as a feedstock, they are put to better use as SAF. Similarly, SAF sometimes includes e-fuels made from CO2 captured during industrial processes, which is another form of “avoided” emissions.
4 A particular concern centers around food crops being grown solely for use as a SAF feedstock. This can displace land area that would otherwise be used to grow crops for human consumption, leading to higher food costs and hunger.
5 Source: IATA, “Net Zero 2050.”
6 The remaining 35% of the IATA’s pledged emissions reductions are expected to be: 13% from new technologies (e.g. electrification and hydrogen), 3% from efficiencies, and 19% from offsets and carbon capture.
7 Source: U.S. Department of Energy, “SAF Grand Challenge Roadmap: Flight Plan for Sustainable Aviation Fuel Report.”
8 Source: IATA, “SAF Volumes Growing but Still Missing Opportunities,” December 2023.
9 Source: IATA, “SAF Volumes Growing but Still Missing Opportunities,” December 2023.
10 Source: Internal Revenue Service.
11 Source: U.S. Energy Information Administration
12 SAF price estimates vary considerably due to its fragmented production market and limited trading and production volume. Our estimate was provided by GlobalAir.com
13 Source: European Union Aviation Safety Agency
14 Source: IATA, “Fact Sheet: EU and US Policy Approaches to Advance SAF Production.”
15 Source: IATA, “Sustainable Aviation Fuel,” Hemant Mistry.
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Source(s) of data (unless otherwise noted): PGIM Fixed Income, as of 06/3/2024.
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