Partner Sydney
"For the aviation sector, the message is clear: energy resilience is no longer optional."
The impact of the closure of the Strait of Hormuz on the supply of oil, gas and jet fuel has highlighted our continued dependence on fossil fuels, notwithstanding decarbonisation goals and initiatives and the increasing role of renewable energy sources. As oil and jet fuel prices surge, airlines have been forced to deal with an almost doubling of the cost of jet fuel since 28 February. For the aviation sector, the message is clear: energy resilience is no longer optional. Will this make Sustainable Aviation Fuel (“SAF”) a more acceptable and accepted alternative to jet fuel and more critical, central and relevant as a fuel source for the aviation sector?
Even if the conflict is resolved to the point where vessels have safe and unobstructed access to the Strait of Hormuz, restoring the supply of jet fuel will take several months for it to return to pre-28 February levels. This reflects the impact of the closure of the Strait of Hormuz on vessel sailing schedules and positioning, restarting operations at oil and gas fields shutdown since 28 February and damage to loading and refining facilities and capacity in the Middle East. Jet fuel prices will continue to directly respond to supply disruptions and uncertainties in real time. Airlines should anticipate and plan for higher and more volatile jet fuel prices – even after the Strait is reopened allowing for the resumption of oil shipments through the area.
The fragility and vulnerability of supply chains passing through the Strait of Hormuz have again focussed attention on the role of SAF and the extent to which it can address and moderate the supply chain concerns and risks for jet fuel.
SAF price differential
Although jet fuel prices have almost doubled, SAF remains approximately 60% more expensive than jet fuel and will remain more expensive until production and supply increase. Mandates exacerbate the gap between supply and demand. Once the financial impact of the conflict in the Middle East and the surge in jet fuel prices can be assessed, airlines will need to focus on restoring routes and operations and addressing the impact of fuel costs on their balance sheets. For many airlines, it will also be necessary to stimulate demand, which will likely see significant discounting and fierce competition to attract passengers, particularly to fly to, from and through airports in the Middle East. Fuel represents 30 to 40% of an airline’s operating costs and is one of an airline’s more significant variable costs. Unless the cost differential between jet fuel and SAF narrows, airlines are unlikely to voluntarily expand their use of SAF in the short- to medium-term as they focus on the imperative of managing and reducing their costs and stimulating demand.
Supply side
A critical factor in reducing this cost differential is the supply of SAF. While the production, refining and supply capacities are increasing, the rate of increase does not meet current demand even before mandates, such as the EU mandate, are factored in. Even if airlines sought to increase their use of SAF, its availability does not currently allow for a significant increase in supply. Investment in SAF refining and production is limited by the low uptake of offtake agreements by airlines, which reduces the attractiveness of SAF refineries and producers as investments and credit risks. The fragility and vulnerability of jet fuel supply chains should now prompt consideration of whether domestic SAF refining and production capabilities should be considered critical infrastructure and essential for broader future national and regional economic development.
Key contacts
Partner Munich
Partner London
Partner London
Associate London
"Recent geopolitical shocks, coupled with the long-term decline of European refining capacity, have underscored the continent’s continued dependence on imported fossil jet fuel."
Supply Security
In Europe, the debate around SAF and e‑SAF is increasingly driven by questions of energy resilience as much as by decarbonisation objectives. Recent geopolitical shocks, coupled with the long‑term decline of European refining capacity, have underscored the continent’s continued dependence on imported fossil jet fuel. Disruptions to global fuel supply chains have immediate effects on aviation operations and price stability, with limited short‑term alternatives available. When availability becomes uncertain, the implications extend beyond balance sheets to trade, tourism and national competitiveness.
Governments of countries without domestic jet fuel refining capabilities that import most or all of their jet fuel, are now dealing with the consequences of dependence on foreign suppliers and market forces. For these countries, a domestic SAF refining capability and supply would reduce this dependence and the impact of external supply shocks on their aviation sector. The aviation sector and SAF stakeholders should take advantage of the current focus on supply chain fragility to persuade and pressure governments to support development of national SAF refining capability and capacity as a means of reducing dependence on imported jet fuel and vulnerability to external jet fuel supply shocks. More effective and beneficial government involvement would focus less on forcing the aviation sector to become more sustainable and more on financial and other incentives and support to encourage SAF refining. This should include government investment, use of export credits and other financial instruments and incentives and funds to repurpose decommissioned fossil fuel refineries as SAF refineries, incentives to promote domestic rather than offshore refining of SAF feedstock inputs and pricing mechanisms to reduce the cost differential to jet fuel and to incentivise airlines to enter into longer term offtake agreements. These steps and incentives could form part of the medium- to long-term government response to the current supply shock.
Countries with a secure long-term supply of feedstock for SAF and those with wind and solar power to generate e-SAF should see this supply shock as an opportunity to exploit these resources and develop national and regional markets for both SAF and eSAF. This could involve the use of cross-border ‘book and claim’ schemes and G2G agreements on the refining and distribution of SAF and e-SAF to develop and expand regional trade in SAF and eSAF. This can include waiving foreign ownership limits to enable investors and banks from a country without feedstock or renewable energy, to invest in SAF and eSAF refineries in a country which does.
Diversity of supply
"Once the supply of SAF reaches a more critical mass, a diversity of supply should contribute to reducing its cost as refineries and traders compete to supply it."
While not the result of a greater supply of SAF, the current divergence in jet fuel prices between the Americas and the rest of the world highlights the benefits of diversity of supply. A number of countries do not and will not have the financial or natural resources to develop a domestic SAF refining capability or to develop a long-term SAF refining capacity sufficient to meet domestic demand. This means they will need to rely on imported SAF. The key lesson from the current supply shock is to diversify the supply of fuel. Unlike jet fuel, SAF is not dependent on extracting fossil fuels from specific locations and then refining or transporting them to refining hubs like Singapore and South Korea before delivery to the importing country. SAF refineries require a supply of feedstock which can be sourced more widely than fossil fuels, allowing for a greater range of locations in which SAF refining capacity can be developed. If this capacity is properly developed, SAF importing countries will have a wider range of SAF sources than jet fuel sources. Once the supply of SAF reaches a more critical mass, a diversity of supply should contribute to reducing its cost as refineries and traders compete to supply it.
SAF versus hedging?
The relative stability of jet fuel prices in the last 12-18 months provided little or no incentive for airlines to hedge their fuel supplies. Typically, airlines that have hedged their fuel supplies have hedged 30-50% of their supply or for a further six to 12 months. The current supply shock and surge in jet fuel prices have demonstrated the challenges for airline fuel hedging strategies as they balance the benefits of stable fuel prices with the cost of hedging and the risk that prices will fall below the hedged price. As long as airlines continue to depend on jet fuel as their primary fuel source, hedging will continue to play a key role in airline fuel supply strategies. A greater supply of SAF could allow airlines to reduce their dependence on jet fuel with a corresponding reduction in hedging needs. If SAF becomes a greater part of airline fuel supply strategies, the market for hedged fuel will need to react and adapt. This may result in a more competitive fuel hedging market to the benefit of airlines.
Key contacts
Partner Sydney
Partner Munich
Partner London
Partner London
Associate London
