When will alternative fuels take off?

Will Farrell, Manager – Engagement and Michael Yamoah, Director – Engagement, Federated Hermes

Note: The views expressed on these pages are the opinions of their respective author(s) only and do not necessarily reflect the views and opinions of UKSIF.

This website should not be taken as financial or investment advice or seen as an endorsement or recommendation of any particular company, investment or individual. While we have sought to ensure information on this site is correct, we do not accept liability for any errors.

When will alternative fuels take off?

Will Farrell, Manager – Engagement and Michael Yamoah, Director – Engagement, Federated Hermes

Biofuels, hydrogen, and sustainable aviation fuel have been mooted as potential low-carbon alternatives to fossil fuels. However, although they increasingly feature in company transition plans and government policies as an attractive opportunity, there are drawbacks that must be addressed.

The International Energy Agency (IEA) expects an expansion of low-carbon fuels (renewable or alternative fuels) from a 1% weight in global final energy consumption in 2022 to almost 5% in 2030 under its Net Zero Emissions by 2050 (NZE) scenario. However, most low-emissions fuels are likely to remain more expensive than their fossil counterparts. For example, SAF is currently twice as expensive as conventional jet fuel. This means that any discussion of the role of low-carbon fuels should focus on credible emissions savings, particularly for those emissions-intensive segments of the economy where the technological and commercial feasibility of electrification remains unlikely or impossible.

Companies are increasingly exploring the potential of low-carbon fuels, seeing them as an attractive ‘plug in’ solution to some of the challenges associated with the energy transition. On the surface, alternative fuels appear to help companies continue with business as usual, sometimes without the need to wait for the build out of costly new supporting infrastructure. For example, biomethane can be injected directly into gas grids. However, a push into low-carbon fuels, even as an interim solution, is not without risk, such as competition for supply, or regulatory reversals.

For investors, there are also unintended consequences to consider. The expansion of biofuel crops, such as palm oil and sugarcane, has been associated with land grabbing, forced displacement, and labour exploitation in developing countries. These human rights violations raise ethical concerns, disrupt supply chains, and create reputational risks for companies. Land use change can also have severe environmental and social consequences, including biodiversity loss, increased greenhouse gas emissions from forest and soil carbon release, and the erosion of food security.

The production of advanced low-carbon fuels, such as green hydrogen, also faces technological constraints. Competition for biomass resources between biofuel production, food, feed, and other bio-based industries can lead to price volatility and supply shortages. The lack of adequate infrastructure for the production, distribution, and use of low-carbon fuels presents another supply constraint.

On the demand side, there is uncertainty surrounding long-term policy support for low-carbon fuels, which can dampen investor confidence and limit demand growth. For example, the EU’s Renewable Energy Directive II (RED II) has set sustainability criteria for biofuels, including minimum greenhouse gas savings thresholds. These thresholds can limit the demand for certain types of biofuels that fail to meet the required emissions reductions. The US EPA and Department of Agriculture are considering policies that focus on increasing the demand and supply of low-carbon fuels.

Demand for alternative fuels

In the aviation sector, the use of sustainable aviation fuel (SAF) in the near-term is expected to drive emissions reduction, as a fully commercially-viable electrification option is not yet well developed. In the near-term, SAF penetration is supported by targeted regulation, including the ReFuelEU’s requirement – from 2025 – that EU airports’ aviation fuel supply reaches 2% SAF, increasing to 70% by 2050. Similarly, the UK’s SAF Mandate also requires 2% of total UK jet fuel demand in 2025 to comprise SAF, increasing to 22% in 2040. However, in a business-as-usual demand scenario, 50% biofuel penetration by 2050 would require almost 20% of global cropland to be dedicated to aviation biofuels. Land use, food security, and price concerns associated with such a significant displacement of agricultural markets strengthen the economic case for exploring alternative technologies over the longer term. Gas distribution infrastructure also represents a hard-to-abate segment, and the blending of low-carbon gases, such as biomethane, has been mooted as an intermediate solution. We have engaged Engie, the French utility, on the viability of its plans for its biomethane sales to reach 30TWh by 2030. This has included challenging business leaders over the risks of relying on scarce waste feedstocks at a meeting at its headquarters in 2024. We continue to engage on the delivery of this strategy and its consistency with the company’s longer-term vision for a hydrogen grid.

In some easier-to-abate sectors, such as power generation, low-carbon fuels can support a lowest-cost energy transition. The co-firing of biomass in coal-fired plants would support near-term emissions reduction in countries where the existing coal fleet is unlikely to be phased out in the near-term. In India, Adani Power – which we have engaged on the transition-related financial risks faced by its fleet of coal-fired power plants – is piloting green ammonia and biomass co-firing. It expects these solutions to reduce coal use by up to 30% over time. However, we do not expect co-firing to be a long-term solution given supply constraints and the cost competitiveness of renewable solutions.

Green hydrogen may also play a role in connecting locations with abundant renewables to centres of high energy demand. This could improve the efficiency and reliability of a net-zero energy system without the significant transmission losses. In the UK, National Gas’s Project Union is pioneering this approach to build a hydrogen ‘backbone’ for the country. It is proposing to repurpose 2,000km of gas transmission pipelines to carry hydrogen to connect large-scale offshore wind assets in Scotland to industrial clusters in England.

Implications for engagement

There are several economic and social consequences associated with low-carbon fuels that need to be considered and addressed. These include:

• • Justification of why a low-carbon fuel is a significant and competitive emissions reduction lever for the particular intended application, timeframe, and systemic context.
• • Feedstock risk management, including:
  • • Minimising any negative impacts on biodiversity and water
  • • Upholding high human rights standards, including respecting indigenous group and community engagement, and fair labour practices throughout the company’s supply chain
  • • Addressing potential food security issues, particularly when sourcing food crops for biofuel production.

• • Proper board oversight of the strategy on low-carbon fuels and how companies are evolving financial and strategic risk management systems to identify and manage such risks, including when purchases are a regulatory requirement, plus the effectiveness of supplier selection and monitoring processes.
• • Addressing technological and infrastructure limitations associated with some low-carbon fuels (where these are reasonably expected to be competitive for the intended application), including through commercial partnerships and public policy.

 

EOS generally adopts a technology-agnostic approach but routinely inspects transition plans for their robustness and credibility. Where low-carbon fuels are referenced, EOS probes the assumptions being made. We encourage companies to develop capabilities to deliver decision-based climate scenario analysis, and to address their alignment with a transition scenario, capturing system effects. This improves investors’ understanding and enables them to play a role in influencing the policy environment. EOS also encourages companies to outline their advocacy efforts for relevant policies supporting low-carbon fuel adoption.

 

Note: The views expressed on these pages are the opinions of their respective author(s) only and do not necessarily reflect the views and opinions of UKSIF.

This website should not be taken as financial or investment advice or seen as an endorsement or recommendation of any particular company, investment or individual. While we have sought to ensure information on this site is correct, we do not accept liability for any errors.