Too Little Money And Too Little Time – Funding and Scale Issues

Products Mentioned:
Carbon Dioxide, Hydrogen, Biofuels, Deisel, Ethanol, Butylenes, Polyethylene, Polypropylene, PET, PHA, LNG, Ammonia

Companies Mentioned:
Shell, bp, ExxonMobil, Danimer Scientific, Gevo, Origin Materials, Newlight, Aemetis, Delta Air Lines, SABIC, Schlumberger, Dow, Amazon

Subjects Covered:
Recycling, Renewables, Carbon Capture, Emissions, New Energy, The Hydrogen Economy, ESG Investing

C-MACC Weekly “CRETER” (Climate etc.)

Too Little Money And Too Little Time – Funding and Scale Issues

There is not enough focus on the scale-up of technologies and processes to provide alternatives to fossil fuels – aviation fuel is one of the most pressing issues.
It is not only the production scale that could fall short, but it is also questionable where the money and expertise will come from – the same is valid with CCS.
A very immature carbon offset market will likely become increasingly important, and offset shortages would be one of the very few reasons to invest in DAC.
New incentives for CCS and possibly a virgin polymer tax in the US could drive step changes in investment around renewables, recycling, and carbon capture.
We also discuss a few of the consequences of Shell accepting the Dutch ruling.

First: Scale, Money, and Resource – the fundamental stumbling blocks ahead.

The focus of the first section of this report is scale – the scale of needed solutions, versus the ones currently being proposed, and the gaping funding and management holes around some necessary initiatives.

As a first example, Exhibit 1 shows how much bio-based aviation fuel would be needed by 2030 if all airlines were to adopt the 10% goal that Delta has discussed. The industry would need 800,000 barrels of renewable jet fuel a day – assuming that air travel recovers to the around 2019 levels and that growth is offset from there with efficiency. We use the Gevo Net-Zero 1 project for context, as it is one of the few biofuel projects for which there is cost and capacity data.

Exhibit 1: Aviation biofuels need in the context of the proposed Gevo Net-Zero 1 plant – assumes all output goes to aviation

Source: Corporate Reports, EIA and C-MACC Analysis

Exhibit 1 is an illustration. There are other potential sources of biofuels than Gevo, and not all of Gevo’s output will be suitable for jet fuel. Another supporting data point is Delta’s estimate (implied from a recent CNBC interview) that global aviation biofuels capacity would have to grow by more than 35x by 2030 just to meet Delta’s 10% goal. So either a lot of plants have to be built, or there has to be a breakthrough on the scale, but either way, a lot of funding is needed – close to $200 billion just to solve this one problem. On the scale front, the larger US refineries have a jet fuel capacity that is 15-20x the size of the Gevo facility – whether this would make sense from a scale perspective for fermentation is unclear but it might be achieved through running modules in parallel. The bigger question would be whether there was ample feedstock and whether it could be acquired without dislocating the corn or other feedstock markets.

So far we have only talked about investment in facilities and capital needed – other considerations would be:

The availability of the engineering expertise to maintain the level of design and construction needed
The availability of qualified workers both for construction and for operations – note that at least 10% and probably closer to 20% of this investment would need to be in the US.
Logistics – both for feedstock and for the finished product – one or the other (or both) will need to travel long distances and probably not over routes that are currently common – larger facilities might be needed to justify new pipeline infrastructure
Competition from materials – some of these newer fermentation processes have initial building blocks that can flow into chemicals and polymers easily (Gevo with butylenes, for example). While the credits available for low carbon fuels today make the initial investment for Gevo a no-brainer to target the fuels markets, increased incentives to make renewable polymers (taxes and/or customer willingness to pay more) could attract capital way from biofuels.

We struggle to see how the biofuels market is not one of the most obvious investments on the broad climate beachfront today. It is a rapidly growing unmet need, especially aviation fuel, the products are “drop-in” and require no logistic investments once the material hits existing infrastructure, and the potential demand growth is exponential over the next 10-20 years. Gevo is a more developed story than others and has plenty of cash – the challenge will be resources as the demand for projects 2-15 could come quickly.

Next, the CO2 example. We have seen a couple of high profile announcements around CCS in the US in recent weeks – one in the mid-west, focused on gathering the CO2 from corn ethanol facilities and (with a very long pipeline) sequestering in one or more locations in the region, and another from Aemetis focused on taking its CO2 and the CO2 of others and sequestering under Aemetis controlled land. Neither of these announcements was for the sequestration of more than 2 million tons a year – combined they would account for 0.15% of the emissions in the US – Exhibit 2.

Exhibit 2: The EPA summary of CO2 emissions by the industry for 2019 – the numbers in each state are the number of facilities reporting. This analysis does not include very small emitters.

Source: EPA

While there are some easy to get emissions (fermentation being one source) we estimate, based on multiple studies that have been done recently in several regions, that it will cost at least $100 per ton of CO2 to sequester a meaningful proportion of the CO2 emitted by those industries (or sub-industries) that are not likely to be easily rectified with new technology. ExxonMobil is talking about as much as 100 million tons of CO2 a year in one initiative in and around Houston – just under 4% of total US emissions and an annual cost of at least $10 billion (ExxonMobil’s cost estimates are much higher but involve more expensive off-shore sequestration).

To get at 20% of the CO2 emitted by the fossil fuel and industrial processes alone globally through CCS would require the capture and sequestration of around 7 billion tons – $700 billion of annual cost and more than that in the capital needed. Major scale advances are needed, but possible, but the same questions apply – where does the money come from, and is there enough expertise, labor, etc.

We have only covered a couple of objectives here and the costs are high and there are questions around resources and manpower availability, as well as where the money comes from.

The EU 2030 targets in the headlines below are worth highlighting and they are in part connected. The European targets are not coordinated with what is happening in the rest of the World and while we admire the ambition, we suspect that the goal is not achievable, simply because the challenges of replacing the power and fossil fuel associated with the emissions to be avoided are too great, given the timeline and in the context of what we have highlighted above. The level of additional renewable power generation, EV adoption, and hydrogen production needed to offset so much CO2 are extremely high, and it will be hard to get substantially more CCS offset than already announced because of land rights issues in Europe and logistics. To get the power, EV, and hydrogen, the EU will be competing with other regions that have their own targets and we see scare resources bidding up the price of power, impacting all of the elements, power itself, the cost of running EVs (see the chart below – Exhibit 3 – the EV carbon story does not work of you are using coal as a marginal source of power), and the cost of hydrogen.

The potentially misleading piece in Exhibit 3 is that it is focused on CO2 footprint and not power prices. If power becomes a scarce resource, pricing will reflect value not cost and even renewable power-based EV costs could be as high as fossil fuel-based costs.

The bp chart (exhibit 4) is also interesting as it shows not only an estimate of how much hydrogen is needed to get to net-zero, but how much of it needs to be blue hydrogen and therefore use natural gas and CCS. It is impossible (in our view) to chart an economic path to net-zero without growth in natural gas consumption at least for the next 20 years and the governments and other regulators around the world must recognize this and support the investments needed for CCS. The recently announced bill in the US Congress to raise the 45Q credit would be a good move, but as with many of the initiatives in Europe, the cost falls on the government (lower tax revenues in the US and higher subsidies in Europe) and will ultimately lead to higher taxes – finding bipartisan and equitable ways to pay for this will likely be easier in Europe than in the US.

Exhibit 3: Analysis: When do electric vehicles become cleaner than gasoline cars?. Per this report and commentary on the chart below in LINK, It takes a typical electric vehicle about one year in operation to achieve “carbon parity” with a gasoline vehicle. Although the production of EVs and batteries generates more CO2 before the first wheel turns, the total carbon “footprint” of gas cars quickly overtakes that of EVs after 15,000 miles of driving. However, if the EV draws electricity from a coal-fired grid, the catchup period stretches to more than five years. If the grid is powered by carbon-free hydroelectricity, the catchup period is about six months.

Source: Argonne National Laboratory GREET Model, Reuters, June 2021

Exhibit 4: BP Looking to Hydrogen Expansion to ‘Reinvent’ Natural Gas.

Sources: Natural Gas Intelligence, BP, June 2021

The math is overwhelming as are the expectations around available resources, and there is no chance of achieving any of the targets discussed above as well as renewable power needs to compensate without the right incentives to spur investment and without some step changes in scale, which may not be achievable within some of the emerging technology companies.

We have similar concerns concerning solutions for the plastic waste issue (see below), but the scale of investment is small compared to what is needed in energy transition and carbon abatement. A couple of related but key headlines are shown below. We show the Novozymes headline only because it is a distraction – it may an interesting niche process, but its impact on addressing the overall carbon issue will likely be negligible.

The Second Topic of the Week – Carbon Offsets

The Schlumberger net-zero goals, as discussed in the articles below and the presentation linked, set some aggressive but bold ambitions, especially as they are looking to solve problems that they share with their customers, methane leakage from oil and gas wells, and minimizing flaring. Schlumberger is a little dependent on collaboration from its customers here as the technology solutions are likely to be more expensive than current options and the oil and gas producers will need to pay up.

While Schlumberger’s plans are appropriately vague, given that customer acceptance, customer existence, and new technologies by 2040-2050 are hard to call, we want to focus on the offset bar in the 2050 projection in Exhibit 5. Almost every company looking at a net-zero goal reaches a point in their analysis where they conclude that all things being equal, they cannot go any lower in terms of CO2 equivalent emissions. At that point, they are assuming that they can get to net-zero through offsets – either with projects to consume carbon that they invest in themselves – note the direct air capture (DAC) project discussed for the UK in the headlines below, which would be a legitimate offset – or credits that they can buy from others who have achieved net-negative status. The original offset idea was reforestation, and many of the European oil majors have talked about, and are in the midst of, planting initiatives. But planting is unlikely to provide a large enough pool of offsets and the oil majors are looking to solve their specific problems and likely not expecting to create a surplus to sell. DAC projects are a way of creating offsets, but this is an expensive route and although costs are expected to fall the costs should remain at the top end of the carbon abatement curve – the CO2 in the air is in much lower concentrations than in furnace gases.

A risk here should be the problem of double-counting in company assumptions. We are already concerned that many of the hydrogen projects are planning on getting the same share of renewable power capacity as it is built over the next 20 years – “we only need 3% of the wind capacity likely to be built in 2027” – which will not work if 100 projects are making the same assumption. The same could be true of offsets. The offsets in Schlumberg’s plan may not look large, but if 1000 companies are banking on them being available and there are only enough for 500, prices could rise meaningfully, increasing the cost for the corporates of getting to that last mile or forcing them to walk back their targets. If this is the case, some of the more speculative DAC investments that we see today may make significant commercial sense.

Amazon (headline below) is a great example of a company that is likely to reach the limit of what it can do in-house to lower its carbon footprint and consequently will become reliant on some sort of offset – to get to “the last mile”, which is apt for Amazon.

Exhibit 5: Schlumberger Announces Commitment to Net Zero by 2050. This Exhibit highlights an investor slide from the Sclumberger CEO presentation that came alongside this announced commitment – see full presentation in LINK. We find many net-zero goals reliant on offsets, though the quantum of potential offsets is based on imprecise metrics.

Source: Schlumberger CEO Investor Presentation June 22, 2021, June 2021

Recycling and Renewable Materials

We have taken this section from our Sunday Thematic as it is equally relevant to our Chemical and our ESG and Climate clients.

Global plastics production has almost doubled since 2000 – Exhibit 6 – driven by increased consumer spending in general, but specifically, advances in food packaging and international and domestic trade – requiring more general packaging.

Exhibit 6: The chart understates some growth in plastic packaging growth (and consequently visible waste) as it measures weight rather than surface area. Advances in film strength have allowed for thinner films, and the growth in the surface covered by packaging has been much higher than implied below.

Source: Statista – note that 2020 is an estimate

We were recently quite critical of an FT article that singled out the large polymer makers around the world and implied that they were responsible for the plastic waste. While we would argue that there is a responsibility that the polymer companies share, the plastic waste problem has much more to do with what happens to the plastic after it leaves the polymer factors gates. The bulk of pure polyethylene, polypropylene, and other polymers are 100% recyclable when they leave the factory, it is what happens next that is the problem, and the activist and social pressure that stems from what happens next is, in our view, an existential threat to the polymer producers – making it very much their problem. Note that in Dow’s very good “INtersections” ESG report last week, the company talks about ensuring that 100% of its polymers are recyclable but is looking at application rather than production – this is not inconsistent with the 100% comment above. Today, roughly 20% of Dow’s polymer sales end up in packaging applications that create hard or impossible to recycle products – multilayer, where non-polymer or more complex polymer/chemical barriers are involved for example. Dow’s goal is to either redesign the polymer or the packaging in collaboration with the end-user either to make the material suitable for mechanical recycling or chemical recycling.

But the problem for the polymer producers is that they do not control what happens post the packaging solution and that is where the real threat comes from. Food and consumer products companies are not focused enough yet on their packaging from ease of recycling perspective. These are consumer brand-focused companies and marketing drives the bus. If the marketing department thinks that a particular product will sell better in an all-black polymer container with a different texture to the competition then that is what they will ask for, and while many companies are all making efforts on the packaging front there is still too much that is being messed around with and more than is necessary. Recycle-friendly packaging today is focused on the “environmentally friendly” range of products almost exclusively and while these sectors are growing they are a small part of the total.

However, the food, beverage, and consumer products companies all have big plans when it comes to packaging, and most of it involves reaching a recycled content goal, and in some cases, that goal is expanded to include renewable-based polymers within the target. The consumer products companies are currently making their publicly stated targets harder to reach by making many of their packaging solutions hard or impossible to recycle and they will need to move quickly to standardize and simplify what they do if there is any chance of a collection, sorting, and recycling industry evolving enough to meet their future needs. They cannot all rely on someone else to create the pool of recyclable materials that they will need. An evolution in packaging behavior can happen more quickly in Europe with product standardization as the infrastructure is largely in place for collecting and sorting, but in the US dramatic changes are needed, even if the pool of available recyclable material rises. The opportunity lies in the volume of plastic waste – Exhibit 7. We have all seen the idealized diagrams – as shown in Exhibit 8, but if only 10% of polymers is moving through this chain, targets will be missed.

Making matters worse (or potentially better) there is now a focus on the chemicals and other additives that are used in plastics and packaging processes that are potentially harmful – see headline below. Whether this concern becomes elevated beyond an academic study remains to be seen but it is another reason to simplify.

Worrying insights into the chemicals in plastics

Advanced recycling is being pushed by the polymer producers as a way to dispose of plastic waste and potentially create some circularity, but it unclear to us whether a pound of chemically recycled plastic at point A in the US will be seen as a recycled pound at point B. Most of the chemically recycled plastic is likely to end up in the fuels market in our view because it will not be close enough to ethylene facilities to make economic sense to transport, plus it does not convert back to plastics on a pound for pound basis. How the polymer producers see this working is illustrated in the bp/SABIC diagram in Exhibit 9.

Exhibit 7: Plastic waste per capita ranked by size

Exhibit 8: Kao ramps up sustainability strategy with use of recycled PET material. We highlight this diagram because it looks at every aspect of reducing plastic waste and virgin plastic use.

Source: TRbusiness.com, KAO, June 2021

We do not see an easy way out for the major polymer producers: Choice No. 1 is to work closely with the packagers on design to increase the pool of material suitable for mechanical recycling, but the larger the pool of recycled polymer the greater it will eat into virgin polymer demand. Choice No. 2 is to push for more chemical recycling, which almost guarantees that the consumer products company cannot meet their environmental goals with recycled material, and forces them to look elsewhere and at other ideas – which again will eat into virgin polymer demand.

Exhibit 9: BP and SABIC collaborate on new products from advanced plastics recycling

Source: British Plastics & Rubber Magazine, BP, SABIC, C-MACC, March 2021

Polymer diversity is likely not the key, as adding PHA and other biodegradable plastics to the mix just makes the whole collection and sorting problem harder. It makes more sense to reduce and simplify the polymers used – to improve the recycling rate. More likely, consumer goods companies look at alternative materials with easier to recycle pathways – like paper or they look at renewable-based identical polymers to what they are using now – so renewable PET, polyethylene, and polypropylene over PHA.

For now, we see consumer products companies flocking around the new ideas – bio-based existing polymers (Gevo and Origin) and biodegradables (Danimer and Newlight), and all of the companies mentioned either have joint initiatives with and in some cases investment from key food, beverage and/or consumer goods companies. This should not be surprising, as we would expect the major users of packaging to be exploring all options today as they have a fiduciary duty to their stakeholders to look for more environmentally friendly options, from a product design, process, and materials perspective. This is no different than the challenges facing the oil and gas majors and the inevitable transition away from fossil fuels – it is interesting to look at the list of potential new technologies that the oil companies have either investments in or R&D partnerships with.

A final and further wrinkle is the possibility of a virgin polymer tax – the US initiative is linked below, but there is a significant tax proposal for Europe on non-recycled plastic. Taxing virgin polymer or taxing non-recycled plastic has the same goal, to create a greater incentive to lower plastic use and increase recycling. Recycling is a fixed-cost business and so adding a fixed price/cost incentive, gives recycling projects some greater cash flow certainty. A 5 cent penalty in the US today would be small relative to the current very high virgin prices, but in a market that was more reflective of costs, would be proportionally much more significant.

Separately, the packaging design article below grossly underestimates the potential for cutting back resin demand in our view (especially if there is a tax, supporting higher prices) and we do not believe that we will see the real potential until the packagers backs are against the wall with the respect to both recycle and renewable plastic availability and cost. This will force innovation around how to minimize the use and the potential is likely closer to 15% than 5% over time. This is another reason why we think that the chemical and polymer industries should stop new capacity capital spending immediately – see our Sunday Thematic (One Last, But Possibly Long Hurrah!)

Carbon Capture and Emissions

Senator Cramer’s proposed Bill to increase the value of the 45Q carbon credits for sequestration and use as well as remove the annual cap could be a game-changer in many ways. The threshold removal is necessary regardless of the credit value. In our view, the cap creates a potential competitive disadvantage for smaller companies competing with larger ones, especially in the chemical space. Should the Bill increase the tax credit enough to drive real investment in abatement but not remove the threshold we would expect to see litigation from smaller disadvantaged companies. The chart in Exhibit 10 shows the current expectations for 45Q. To date, the only real investment activity we are seeing is around sequestering CO2 from ethanol production in the US. This is because the CO2 stream is easy to separate in a fermentation process and because some of the ethanol can benefit from the much higher LCFS credit if the fuel is sold into California.

There are projects in the planning stage around larger sequestration initiatives, but 45Q is generally an inadequate incentive at its expected 2026 plateau, and we are unlikely to see major investment unless the cost of capture and compression comes down, which it is doing incrementally, or if customers are willing to pay more for a low carbon product. This is a subject that we have covered in detail over the last 9 months. At the moment we believe that we will likely see LNG take the lead in CCS in the US, especially where the importing county has a strong carbon focus. The other possibility would be greenfield investment in the US to create blue hydrogen or blue ammonia aimed at the export market and targeting countries with higher credits for low carbon fuels – these investments, if they come, would not lower the CO2 footprint in the US.

If the credit is increased sufficiently we could see a step-change in investment in the US and billions of dollars of investment aimed at capturing and sequestering hundreds of millions of tons of CO2, with much of it focused in the US Gulf, where the carbon footprint is high and the sequestration costs relatively low. A higher credit could also boost other carbon use investments.

Exhibit 10 needs some updates as its definitions are likely no longer correct and some of the 45Q wording will need to be adjusted to create the playing field that is intended in the revisions to the legislation. First, “Aquifer” likely is the wrong definition for containment, as the EPA will be very focused on containment that guarantees long-term storage and minimal risk of seismic activity – the sequestration sites on land will need to be deep and in pore spaces that are very well capped. Second, the sequestration credit will need to be extended to other methods for permanently capturing CO2. This will be particularly important if the annual production cap is removed as some smaller volume emerging technologies could be important. These should qualify for the higher credit where appropriate. It will likely be beholden on the carbon capture technologies to show that what they are doing permanently storing the CO2 and, likely, some technologies might not hit the mark if the CO2 or some of it is ultimately released – these technologies should be evaluated on a case by case basis.

Exhibit 10: The current path of 45Q credits in the US has values peaking and plateauing at $50 per ton of CO2 sequestered in 2026.

Source: McCoy

Exhibit 11: The Carbon price in Europe has recovered to the 56-euro level, its multi-year high that reflects a ~66% increase YTD due to tighter European pollution rules.

Source: Bloomberg, C-MACC Analysis, June 2021

Renewable Fuels, Power, Hydrogen

Related to our main topic of the day, the renewable diesel headlines are also interesting, as we think they are a distraction. With the broader net-zero landscape, in the hard-to-solve column (at the top) is aviation fuel, as there are no obvious near or medium-term fixes other than biofuels. The aviation industry should be able to outbid everyone else for sustainable fuels for the next 20 years, and while some biobased, or renewable diesel may be needed, fuels cells, hydrogen, and ammonia may be the better fixes for this market.

Separately, the Japanese approach to ammonia use in power plants is very different from the ammonia projects in the planning phase that are seen as a means of transporting hydrogen – as in the large project planned for Saudi Arabia. Ammonia is not the easiest compound to combust, despite its heavy hydrogen content and the co-firing of burners in a coal plant is likely to be a challenging technology to get right. That said, it is one of the very few options for a Japanese power sector that is dependent on coal and LNG, and with nuclear out of favor. If the initial trials suggested in the article are successful, Japan could be one of the most significant sources of growth for ammonia demand from 2030, and with the expectations for global demand growth for hydrogen, support the need for blue hydrogen suggested in Exhibit 4.

The wind turbine additions in Exhibit 11 below show where the intersection of the right weather and the right incentives are the strongest in the US. Some of the more recent offshore moves may change the mix materially from here, but further additions where there has been a success already are likely.

Exhibit 12: Most U.S. wind capacity built since 2011 is located in the center of the country.

Source: EIA Daily, June 2021

ESG Investing

Dow raised the bar today last week with a comprehensive report on its ESG performance and targets. It is both comprehensive and detailed but aimed to play off some of Dow’s considerable progress on the S and G side of ESG as well as highlight its environmental challenges and progress to date. While there is plenty of historic data, there is not as much data as we would like on the environmental path from here, but we understand the challenges given that the regulatory landscape is unclear in most geographies and some of the technology advances that the company is looking at are in the early stages. However, we do not believe that Dow, Shell, BASF, or others can afford to wait and hope that electric furnaces for ethylene work or are economic and that all should be looking at some transition remedies that can impact the carbon footprints of their products more quickly and could become permanent solutions if the R&D initiatives do not pay off.

Otherwise, there is a lot of “green” lending going on, and it is unclear how accessing a green bond market can improve the ESG standing of a company with a significant carbon or plastic waste footprint unless the money is solely focused on projects that improve those footprints – i.e. can you produce an auditable trail that empirically shows the footprint or waste reduction that was driven by the deployment of the funds borrowed. We see opportunities for manipulation or misinterpretation in these markets and regulators will likely need to examine these investments as much as they will ESG equity claims.

Others Relevant News – Oil Again

This is fast becoming the oil and gas section as we again focus on some of the issues facing the industry. While the headline talks about the possibility of Shell dropping its appeal to the ruling in The Netherlands forcing the company to accelerate its goals concerning reducing its carbon footprint, Shell is already leaning in and has challenged itself to meet the goals, while keeping the appeal option on the table. Any Shell external advisor on the subject is likely advising that challenging the ruling would have negative ESG perception consequences for Shell, regardless of whether the imposed targets are reasonable or not. We see two consequences of Shell dropping the appeal and agreeing to the tighter targets. The first would be a higher likelihood that Shell will need to divest oil and gas assets to hit the goals, it may not be the first move, but it will certainly be something the company is examining as a contingency if other lower carbon initiatives cannot be ramped up quickly. There were a couple of stories this month suggesting that Shell is looking at divesting its assets in the Permian Basin – this would have a step-change impact on emissions but would lose Shell a significant revenue stream. That said, if you are going to sell oil and gas assets, the time to do so is now, with rising prices and with companies still interested in increasing holdings in the sector.

The second consequence is the precedent set, and the likelihood that it will be repeated (or at least attempts will be made) in other jurisdictions and targeting other oil majors. We have written extensively on the subject that climate change should ideally stay out of the courts, but if we cannot get sensible government-led progress that may be challenging. The risk is especially high in the US, where there is a stalemate in Congress on many climate measures and where litigation is often seen as the only way to get anything done. If we could get the modifications to 45Q and possibly a virgin polymer tax in the US, we might see a step up in capital commitments aimed at carbon emission reduction and a greater focus on plastic waste – both of which might help appease some of the more aggressive activists.