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Jun 06, 2024
By Scott Gerlt • ASA Chief Economist
Federal tax credits for biofuels are poised to take a new direction. The Inflation Reduction Act was enacted in August 2022 and restructured biofuels tax credits (for more information on the IRA, read this previous Economist’s Angle). The legislation extends the Biodiesel Blenders Tax Credit, establishes a sustainable aviation fuel tax credit and transitions future biofuel tax credits to a carbon intensity (CI) basis.
Sustainable aviation fuel[i] is a renewable replacement for fossil fuel-based jet fuel. SAF can be produced through multiple pathways, and one such pathway is already approved for uses fats and oils. This pathway is similar to the process used to produce renewable diesel and uses the same feedstocks, such as soybean oil, canola oil, corn oil, tallow, used cooking oil and so forth. Producing SAF requires more capital expenditures, feedstocks and energy than producing renewable diesel.
Due to interest in reducing carbon emissions generated from aerial transit, interest in SAF has skyrocketed. For instance, the president issued the SAF Grand Challenge in 2021, which established an interagency taskforce to work on solutions that would supply 100% of U.S. aviation fuel demand with SAF by 2050[ii]. To help overcome the enhanced costs of producing SAF, the IRA instituted a tax credit for SAF known as 40B, named for the section of IRA where it can be found.
The 40B credit is available to domestic SAF producers for calendar years 2023 and 2024. The credit amount depends on the carbon intensity of the fuel’s production, including the feedstock that is used to produce it. In practical terms, this results in a higher credit for any SAF that generates lower greenhouse gas emissions in its lifecycle. The credit value is equal to $1.25 per gallon of SAF plus $.01 for each percent of lifecycle greenhouse gas emissions reduction below 50% compared to petroleum-based aviation fuel[iii]. For instance, SAF with a 70% GHG from standard aviation fuel would receive a tax credit equal to $1.45 gallon. If SAF does not achieve at least a 50% reduction in carbon intensity, the fuel does not qualify for the 40B credit. The maximum credit per gallon is $1.75.
The Department of Treasury has several options for determining the carbon intensity of SAF under the IRA[iv]. A SAF plant may utilize the most favorable result from any of these options.
Table 1 shows the SAF GHG reductions using various fats and oil feedstocks with the different models. The ICAO-CORSIA model gives SAF made from U.S. soybean oil a 27% decrease in GHG emissions, which is below the 50% threshold. Canola, likewise, falls below the threshold. However, both would qualify under the RFS option with a 50% reduction. In fact, all fats and oils have a 50% reduction under the RFS option. The last option, 40BSAF-GREET, estimates that soy has a 55% reduction.Table 2 shows the corresponding tax credit amounts from the modeling results. For soy, the GREET model provides the highest credit amount. The CORSIA model would not provide a credit. The RFS option is the only one that provides a credit for canola oil. The difference between using used cooking oil (UCO) and soybean oil as a feedstock results in $.29 per gallon of credits under the 40B.
SAF producers can further reduce the CI score of their fuel through several means. One is by utilizing renewable energy at the SAF plant. Soybean crushing plants cannot receive credit for renewable energy in the 40B program. The other way is by utilizing climate smart agriculture (CSA) practices to produce soybeans or corn. While specifics for corn are outside the scope of this article, farmers who utilize both no-till and cover crops for soybeans can generate CSA certificates for the production from those acres. SAF plants that wish to use these certificates must contract directly with the farmers. The farmer does not have to deliver the soybeans directly to the SAF plant, but every stage of custody must record the amount of soybeans that are CSA beans versus others. Comingling of the two types is allowed. However, recording of the amounts of each type ensures CSA volume claims at the SAF level will match the volume of practices at the farm level.
SAF producers that have CSA certificates for soybeans receive a further 5% reduction in their CI score if the 40BSAF-GREET model is used. Given the 40B tax credit formula, this is worth an extra $.05 per gallon in credits. Using national average numbers, this would be worth $3.46 per acre of soybeans if all the credit went to the farmer. Realistically, the SAF plant and other stages of the supply chain would likely capture part of the credit to cover their administrative costs plus any economic rents. This means, bottom line, this credit amount is much too small to incentivize adoption of these practices. Cover crops alone cost about $37 per acre to utilize and can require multiple years to realize returns[vi]. The other reality is that, since SAF production is limited and the rules about CSA practices were just released on April 30, the timing will likely result in almost no generation or utilization of CSA certificates under the 40B program.
This information does, however, provide clues about the next stage of SAF credits. On January 1, 2025, the 40B program and 40A BTC expire, and the 45Z begins. The new program will run through 2027 and provides tax credits for SAF and other biofuels. For SAF, the new credit formula will be $1.75 - $.035 x fuel emissions rate in kg of CO2e per mm BTU so long as the emissions rate is below 50[vii]. Table 3 shows the new SAF credit values under 45Z if the modeling is not changed from 40B, which likely will not hold true[viii]. Notice that the credit for SAF using soybean oil goes from $1.30 in 40B to $.28 in 45Z. However, waste feedstocks (UCO, tallow and corn oil) generally experience a much smaller drop in credit values.
Agencies are working to expand the list of potential CSA practices that qualify fuels for further CI reductions. However, for illustrative purposes, consider the 5 gCO2e/MJ reduction for soybeans produced using no-till and cover crops in 40B. In the 45Z formula, that reduction would equal an extra $.18 per gallon instead of the $.05 in 40B. The steeper slope for CI in the 45Z equation means CSA practices have greater marginal value. Instead of $3.46 per acre value for the CSA practices, the same practices under 45Z would have a value of $12.79 per acre.
45Z also establishes a tax credit for non-SAF biofuel producers. Biodiesel and renewable diesel historically received the biomass-based diesel tax credit (BTC) at $1.00 per gallon. SAF produced from fats and greases could also receive the BTC. However, that credit was often discontinuous and applied retroactively[ix]. The IRA extended the credit through 2024 for the same fuels as long as they do not also receive the 40B credit. Instead of the $1.00 per gallon credit for biodiesel and renewable diesel, starting in 2025 under 45Z biofuels will receive a tax credit equal to $1.00 - $.02 x fuel emissions rate in kg of CO2e per mmBTU for fuels with emissions rates less than 50[x].
The IRA specifies that the GREET model should be used for 45Z non-SAF biofuels. The requirement for compliance with the Clean Air Act is not required in this section of the IRA. Therefore, it seems the ANL-GREET model would be a candidate for the scoring. Table 4 shows the corresponding 45Z amount for various biofuels with the ANL-GREET model (BD is biodiesel and RD is renewable diesel). Also note that the 45Z credits are indexed to inflation, both for SAF and other biofuels, meaning the credit amounts should increase over time.
The potential 45Z credits are all below the level of the BTC, and soy biofuels are in the low $.30 range. Most renewable diesel is sold in California and also receives the state’s Low Carbon Fuel Standard (LCFS) credit. This credit also depends on the CI of the biofuel and can be stacked with 45Z. Table 4 also shows the current LCFS credit amounts for the same gallon of biofuel. Once 45Z begins, soybean oil biodiesel and renewable diesel will receive $.45 to $.50 per gallon between the two credits compared to about $.90 to $1.00 per gallon for waste feedstocks.
While the 45Z values shown here are only speculative, several observations are relevant. First, the current BTC for SAF produced from agricultural lipids is likely to be significantly better than the corresponding credit under the 45Z. Even for waste-based feedstocks, the credit amounts are only likely to be marginally better than under the BTC. While agricultural feedstocks make up most of the potential feedstocks, there is not much incentive to produce SAF using them.
Second, the incentives to produce renewable diesel and biodiesel from waste-based feedstocks grows much larger when 45Z begins. California’s LCFS has incentivized large amounts of UCO imports to levels that are much higher than anticipated, which has slowed soybean oil demand. 45Z will likely further increase this trend by providing a much larger differential than currently exists. A couple of caveats apply here. The 40BSAF-GREET model assumes that UCO is domestically collected, so the CIs for imported UCO may be higher than used in this analysis. Additionally, shifting from a blenders credit in the BTC to a producers’ credit in 45Z will encourage fewer biofuel imports while potentially increasing the demand for feedstock imports.
Many of the details of 45Z are still unknown. Further, the 2027 expiration date leaves uncertainty for both farmers and biofuel producers. The agencies are currently working to develop guidelines, including expanding CSA practices that can be adopted to generate certificates. This could help reduce the credit discrepancy between agriculture and waste-based feedstocks. 40B is the first step in the transition to 45Z. This first program will likely have few gallons produced during its lifetime, but it provides the initial look into how 45Z might develop. The programs are a departure from traditional federal programs that considered not only GHG emissions, but also rural income, energy security and air quality, among many other things. This change will likely affect not only the volume of biofuels but also the feedstocks from which they are produced.
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[i] For a primer on the types of biofuels made from soybean oil, read https://soygrowers.com/news-releases/economists-angle-renewable-diesel-explained/
[ii] https://www.energy.gov/eere/bioenergy/sustainable-aviation-fuel-grand-challenge
[iii] Emissions reduction percentages are rounded down to the nearest whole number when calculating credits.
[iv] https://www.congress.gov/bill/117th-congress/house-bill/5376/text
[v] https://www.irs.gov/pub/irs-drop/n-24-06.pdf
[vi] https://www.sare.org/wp-content/uploads/Cover-Crop-Economics.pdf
[vii] This formula is for biofuel plants that meet prevailing wage and apprenticeship requirements. The formula is otherwise $.35 - $.007 x emissions rate.
[viii] https://home.treasury.gov/news/press-releases/jy2307
[ix] https://www.eia.gov/todayinenergy/detail.php?id=42616
[x] This formula is for biofuel plants that meet prevailing wage and apprenticeship requirements. The formula is otherwise $.20 - $.004 x emissions rate.
