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Decarbonising Shipping: Going Flat?

This week, the IMO is holding an informal online meeting for its members (flag states and industry associations) in which they can discuss progress towards the IMO’s decarbonisation goals. In particular they are discussing the measures that the IMO has proposed to cut shipping’s carbon emissions by 40 per cent in 2030 compared to 2008.

That 40 per cent figure is in itself contentious because who was reliably and accurately measuring shipping’s carbon emissions in 2008? The first half of that year was the height of the freight market superboom when ships were racing around as fast as possible to optimise earning days. The second half of the year was painful for many, with freight markets collapsing, pyramids of charters tumbling, operators going bust, and trade credit lines evaporating.

Even today, emissions go up and down as ships accelerate and decelerate depending on market conditions. Electronic engines have made variable operating speeds easier to achieve and control without overly stressing the engines. So long as laycans can be met, ship operators have more flexibility than they used to. In the liner markets this is even more the case than in tramp markets, as liners seek to optimise per-ship utilisation days in order to protect their operating results.

According to several sources such as Refinitiv and Vessels Value, crude oil tankers have been speeding up this year to their fastest operating speeds since the firm market of 2017. Low bunker prices help too. Many ship owners and operators have argued that the best way to cut ship emissions (and to maximise utilisation rates and earnings) is to impose speed restrictions.

Back in 2014, the IMO published a study on shipping’s greenhouse gas emissions including an estimate of 921 Mn Tonnes of greenhouse gas emissions for the year 2008. But that number in itself has little value. It needs to be qualified by quantifying demand and / or operating speeds. With the advent and development of AIS data, it’s now easier to quantify shipping demand and operating speeds – indeed many firms including my own model markets using these and contextual data. But the quality and quantity of the data have changed (improved) over time. Is 2008 a reliable or practicable baseline year?

Still, on the basis that the 40 per cent figure and its 2008 baseline have been agreed in good faith, IMO members can enjoy a good conversation this week about the difficulties in meeting the 2030 target. The IMO will publish a note about the meeting and I don’t want to try to predict what they will say. But I can confidently say that one main issue will be what decides whether the 2030 target is met or not.

That issue is: Who Pays?

Ship owners have had a lacklustre time since the global financial crisis. Average earnings in the 10 years to 2019 are below the average for the 10 years before then. Average ship values are generally lower. Lower prices for newbuildings have not even generated much interest as newbuilding volumes have been falling for the last three years, indicating a lack of interest in fleet renewal amongst owners whose bank balances have become anaemic after years of chronic oversupply.

We cannot then expect independent ship owners to pay out of their own pockets until there is no alternative. And finance is getting harder to come by – witness the Poseidon Principles, the demise of the traditional vanilla mortgage from a western relationship bank, the rise of leasing as a means of operating ships which separates the capital risk from the operating risk.

To meet the costs of decarbonisation, the operating model for shipping will have to change. The freight market, with its volatility and uncertainty, provides no reliable expectation of being able to pay for the presumed much higher cost of developing a fleet of ships that run on renewables, methanol, hydrogen, ammonia, batteries, fairy dust or fresh air.

It is perhaps more likely that something like the traditional LNG model could be introduced. For decades, the only way to find finance for a USD 200 Mn LNG tanker was to attach it to a long-term LNG sales contract and include it in the project finance. The ship was operated as a floating pipeline. If ship owners can contract with charterers to provide this kind of industrial shipping – still a common practice through contracts of affreightment or consecutive voyage contracts – then all parties might agree on building a ship running on non-hydrocarbon fuel. The buyer of the cargo would have to accept the higher costs – which might only be possible through some form of carbon taxation with rebates for using non-hydrocarbons.

And then that regime would have to be policed. In our Coronavirus world of today we are becoming used to greater oversight and supervision from the State, even as many people bristle at the requirement to wear masks or write down their address as they enter a public building. But independent ship owners have had to get used to all sorts of agencies demanding data and will have to endure even greater levels of surveillance in the future. All of which costs.

The cargo buyer will then have to pass on as much cost as possible to the end user, even if they can absorb some of the higher delivered materials cost through productivity gains in their own industrial process. In the end, the end consumer will have to pay the full environmental cost either directly through the cost of retail goods, or indirectly through carbon taxation and policing schemes, or indirectly through the environmental costs of inaction.

But from where I sit the end result for shipping is the same – greater capital costs, greater regulatory costs, more intrusive surveillance, leading to consolidation by default, fewer independent ship owners and a smaller spot market. I wonder if those themes will appear in the IMO’s summary document next week.

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