Europe Raises the SAF Mandate to Fight Against Climate Issues

1. Investment Research Services REPORT Europe Raises SAF Mandate to Fight Against Climate Issues

2. Europe Raises SAF Mandate to Fight Against Climate Issues Introduction With the introduction of sustainable aviation fuel (SAF) mandate, the European Union (EU) has once again demonstrated its leadership capabilities in climate issues. The European Parliament (EP) has voted on new regulation under ‘ReFuelEU’ strategy in July 2022, which will help reduce carbon pollution by the end of the decade. By 2030, the EU wants to reduce emissions by 55% from the 1990 levels. There is no global standard that can define how much emission reduction compared to fossil fuels is required for any fuel to be considered sustainable. In the US, the proposal is at least a 50% reduction. The ‘ReFuelEU’ mandate will be part of a bigger package of carbon-cutting programs known as ‘Fit for 55’. Under the mandate, the EU’s transport ministers have raised the proportion of SAF to 6% of fuel available in every European airport by 2030, which is 1% higher than what the European Commission (EC) initially suggested in 2021. The ministers also supported initiatives to increase SAF to 85% by 2050, of which 50% must be produced using captured CO2 and renewable energy. SAF: what does it have for producing companies? SAF differs in the amount of carbon savings received from different sources that include biofuels, or fuels made from cooking oil or excess biomass, and synthetic fuel, which is basically e-kerosene. Synthetic fuels are made by combining carbon and hydrogen renewable energy. Some of the biomass-derived SAFs are not as sustainable as they look if they are developed from feedstocks and add to other environmental issues such as deforestation. Investing in the right type of biofuels is important otherwise companies would lose their credibility with the customers. Neste, a Finland-based oil-refining company, claimed to be the biggest global producer of SAF. The company had been accused of using palm oil for SAF for which the suppliers had cleared large areas of forest land in Indonesia and Malaysia. This can be considered as an example of ‘greenwashing’ wherein the company promoting environmental sustainability has not been able to keep up with its supposedly clean image. EU lawmakers have thus decided to exclude harmful biofuels derived from palm and soy while permitting other fuels produced from animal fats to be used until the end of 2034. Apart from the fundamental metrics, ESG parameters have recently become major drivers of business valuation, and any misconduct by a company might risk its brand image and impact valuation. 2

3. Europe Raises SAF Mandate to Fight Against Climate Issues Primary objective of the proposed mandate The primary objective of the ReFuelEU mandate is to reduce carbon emissions and begin the use of alternative fuels that are sustainable in aviation. The mandate, although approved in the EP, needs to be approved across various branches of the EU government by January 1, 2023, when it will enter into force. IATA’s ambitious plan of carbon-neutral aviation by 2050 involves ~65% of the aviation fuel in the form of SAF. This means an annual production capacity of 449bn liters. Investments are in place to increase the annual production of SAF, and it is expected that by 2025 yearly production will be up to 5bn liters from its current level of 125mn liters. It is expected that by 2030 this level will reach 30bn liters. Currently, less than 1% of aviation fuel is SAF, according to International Air Transport Association (IATA). Meanwhile, SAF Requirement Timeline SAF VOLUME = EU SAF VOLUME 32 Mt = 83% of total kerosene volume 3 Mt = 6% of total kerosene volume 2018 2030 2050 -R&D -Pilots -First-of-a-kind -Upscaling of Production -Towards higher blending (up to 100%) -Long term policy framework TIMELINE JOINT AND COLLABORATIVE INDUSTRY AND GOVERNMENT ACTIONS REQUIRED Percentage of total fuel volume 6% 83% Average life-cycle CO2 emissions reduction 72% 98% Average CO2 abatement costs 312 €/tonne 640 €/tonne Source: centreforaviation.com The above chart clearly depicts the 6% SAF requirement by 2030 and above 80% by 2050, considering the possibilities of hydrogen and electricity in the overall fuel mix (the EC had earlier proposed 32% by 2040 and 63% by 2050). This translates into 3Mt and 32Mt of total kerosene volume by 2030 and 2050, respectively. By adhering to the new standards, the average CO2 emission reduction lifecycle is expected to improve to 72% and 98% by 2030 and 2050, respectively. This would finally help in reducing the average CO2 abatement costs to €640 per ton by 2030 and €312 per ton by 2050. 3

4. Europe Raises SAF Mandate to Fight Against Climate Issues Differing opinions by industry players European airlines agree that SAF is required to reduce emissions and that the EU needs to set policies to promote the use of SAF. In addition, airline companies believe that the EU should provide financial support for the development of SAF. However, the companies differ on the cap to be set on the supply of SAF. The Airlines for Europe (A4E) group that includes Air France-KLM and Lufthansa does not support the new 6% SAF requirement and instead supports the previous mandate of 5% by 2030. On the contrary, the International Consolidated Airlines Group (IAG) seems to be happy with the proposal and is already committed to using ~10% of SAF by 2030. In addition to the SAF requirement percentage, the type of SAF to be used is also up for debate. The Transport & Environment Group urged that from SAF mandate (6% of total available fuel at every European airports), at least 2% of the SAF should be synthetic fuels, basically e-kerosene, by 2030 that is higher than 0.7%, what EC had proposed. This could reduce emissions by a further 5Mt of carbon by 2030, which is equivalent to eliminating ~30,000 transatlantic flights. 2.0 Pledged e-kerosene production in Mt per year 1.83Mt 1.8 Projected development of e-kerosene production capacities 1.6 1.4 1.2 1.0 T&E suggestion 2030: at least 2% 0.8 0.6 0.4 0.2 Commission Proposal 2030: 0.7% T&E suggestion 2025: at least 0.1% 0 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Source: T&E Analysis Downside for travelers As per the study from PwC and Strategy, it is anticipated that the addition of SAF will increase the cost of fuel for airlines by up to 16% by 2038. In addition, kerosene will also become more expensive as a result of the CO2 tax. We believe, that using SAF will make flying expensive, and the additional cost will be fully passed on to passengers. 4

5. Europe Raises SAF Mandate to Fight Against Climate Issues Conclusion We believe, the EU’s sustainable fuel mandate is only the beginning in the government’s plan to back SAF and ultimately sustainable aviation. The US President, Joe Biden, has already mentioned that he backs tax credit for SAF, but agreement on the form of those credits has yet to come. In our opinion, the initiatives must be taken by the airlines and not the government; in fact, only a little help from the government will suffice. Though the penalty to be imposed on non-complying companies is not yet clear but we believe that every company will do its best to achieve the sustainability targets. Fulfilling these sustainability targets will help companies to improve their brand value and ESG rating. This helps in minimizing costs and increasing productivity and makes it easier for the business to comply with regulations. Ultimately, the company’s valuation rises, and it automatically becomes attractive to employees and shareholders. 5

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