What is the UK Government’s revenue support mechanism, and how can it be good for e-fuels?
One of the more obscure of the 40 bills announced in the King’s Speech last week was the Sustainable Aviation Fuel (Revenue Support Mechanism) Bill. What is a revenue support mechanism? Our Policy Officer Nuala Doyle explains how this financial policy could help get the UK e-fuel industry off the ground.
The hurdles ahead for e-fuels
To decarbonise aviation we desperately need more investment in green hydrogen-derived e-fuels, but the significant risks and high costs that come with such projects is a major barrier to investment. A commercial SAF plant can cost up to £2 billion to reach economical scales of production, and even then risk running at a loss for their first years of production. These risks are magnified where projects are a first of their kind and require innovation and demonstration before being ready to operate commercially.
Of primary concern to investors is the risk of diminished revenues. We currently lack clarity over the future cost of SAF and there is no defined market price. This leaves investors lacking in confidence over the revenue that SAF production will lead to.
This unpredictability is one of the reasons that as of last year no major e-kerosene projects in the European Economic Area (EEA) had reached final investment decision (FID).
The UK government has already implemented policies to stimulate SAF demand. The publication of the UK SAF mandate, coming into effect next year, marked a major milestone in helping drive the uptake of alternative fuels by setting a minimum SAF uptake, and some UK aviation emissions are priced in the UK Emissions Trading Scheme (UK ETS). Both of these policies can and must go further, as we made clear in our key asks of the new government.
What is the revenue support mechanism?
Despite these important policies, e-fuel is still stuck in a chicken-egg conundrum: we won’t see investment until we have some certainty as to the industry’s future, and we won’t get this missing clarity until we get investment. This is where a revenue support mechanism comes in.
In a nutshell, a revenue support mechanism is a way of guaranteeing investors that they will have stable revenues for a determined period even in the face of no clear global market price for SAFs and potential regulatory changes. Giving investors the confidence that they will enjoy returns on investment in e-fuel projects means that they will be more likely to get to FID.
This is not the first time such an approach has been used: in the renewables sector a contract for difference (CfD) scheme has already helped boost investor confidence. The introduction of a revenue support mechanism for SAFs will play the same vital role in incentivising their production in the UK.
But the success of the mechanism depends on its design. Last month we fed into a government consultation saying that to be a success, the mechanism must have the following features…
1. It must be industry funded
Currently, international aviation (beyond the European Economic Area) is not included in the UK ETS, and air passenger duty (APD) is not equivalent to VAT nor fuel tax. This means that the environmental cost of fossil fuel use in aviation is not adequately priced. The aviation industry must pay for its own decarbonisation rather than letting costs fall on the taxpayer. A revenue certainty mechanism must be funded by the industry, not the treasury.
2. Focus on e-fuels
Lowering barriers to investment is particularly important for SAF produced using green hydrogen. The nascency of e-fuel technology and higher costs associated with production present even higher barriers to entry for projects to reach FID. For this reason, the mechanism should focus on incentivising the production of e-fuels which have the greatest potential to lower emissions.
By the same token, the revenue support mechanism shouldn’t support the production of hydroprocessed esters and fatty acids (HEFA)-based SAFs. This is in part due to the fact that HEFA-based SAFs are at a more mature stage of development and don’t face the same degree of price uncertainty as other SAFs. However, it is also due to feedstock availability challenges and more limited emission reduction potential, which means they don’t offer as effective an alternative to fossil fuels as those derived from green hydrogen. Thus, any support for HEFA-fuels risks locking in investment into fuels that don’t offer a long-term sustainable pathway for decarbonising aviation.
3. Provide maximum certainty to the investment community
There are many ways to implement a revenue support mechanism, offering varying degrees of certainty to the investment community. We agree with the government that a private law contract between the producer and government or government-backed counterparty provided the best certainty for investors. This is because it provides more legal certainty to producers, especially with a government-backed counterparty where there is a degree of impartiality and less perceived risk that contracts could be influenced by government policy changes. Other options, like a mandate auto ratchet or mandate floor price, could be amended by secondary legislation which risks undermining investor confidence.
4. Target UK SAF production
A private law contract – in particular implemented through a guaranteed strike price (whereby a price per litre of fuel produced is agreed and producers included in the scheme receive – or pay back – the difference between the market price for SAF and the ‘strike price’) – is also the best option for ensuring that the mandate targets domestic SAF production in the UK. This is important as the UK is in good stead to enjoy a first mover advantage in aviation e-fuel production. The benefits of developing this industry go beyond just decarbonisation, supporting a just transition for workers, providing good jobs across the country, and inspiring growth.
The revenue support mechanism will be a crucial tool for helping decarbonise aviation, but to be most effective it must:
Be industry-funded.
Incentivise the right SAFs, green hydrogen-derived e-fuels.
Provide maximum investor certainty.
Promote domestic UK production.
We look forward to seeing the outcome of the consultation process. With the government announcing the Sustainable Aviation Fuel (Revenue Support Mechanism) Bill in this month’s King’s Speech, it’s promising to see UK SAF production being taken as a matter of priority. The question now is whether it will be designed to work to its full potential.
Read more about our revenue support mechanism analysis in our response to the government consultation.
