How ‘historic’ decarbonisation deal could inflate future shipping rates

How ‘historic’ decarbonisation deal could inflate future shipping rates

Hellenic Shipping News — 2023-07-17

Maritime and Ports

Decarbonizing shipping is like herding cats, and that herd, otherwise known as the International Maritime Organization (IMO), unveiled major new global emission-reduction targets Friday.

From a future freight rate perspective, it was a win for tanker and dry bulker owners. The uncertainty over future regulations that has stymied newbuilding orders was not only kept in place, it was exacerbated.

Ultimately, the result is a much more aggressive ‘where’ target, without much additional clarity on the ‘how’ part of the equation,” said Stifel shipping analyst Ben Nolan in a client note on Sunday. “That ‘how’ ambiguity should keep new ship ordering limited.”

For shippers of containerized cargo, Friday’s agreement theoretically increases the risk of much higher freight costs in the future.

Despite pushback from China and other countries, the final IMO agreement included a timetable to develop a global carbon levy. There was “consensus on the need for a GHG [greenhouse gas] emissions pricing mechanism,” said ship brokerage BRS on Monday.

If a global carbon levy is ever enacted, container lines should have a systemically easier time passing the cost along to shippers than bulk commodity vessel operators would. In bulk commodity shipping, there is already a game of hot potato over who gets stuck paying for environmental rules. In the highly consolidated liner business, ship operators could just tack on another customer surcharge.

What the IMO decided

The final agreement is ambitious — the International Chamber of Shipping (ICS) called it a “historic deal” — but it’s peppered with vague language. “The language … is ambiguous,” said the Environmental Defense Fund. The Clean Shipping Coalition dubbed it “a wish and a prayer agreement.” The new plan calls for:

• An “indicative checkpoint” to reduce shipping’s GHG emissions by at least 20%, “striving for 30%,” by 2030 compared with 2008 levels.
• A “level of ambition” to use “zero or near-zero GHG-emission technologies, fuels and/or energy sources to represent at least 5%, striving for 10%, of the energy used by international shipping by 2030.”
• An indicative checkpoint to reduce GHG emissions by at least 70%, striving for 80%, by 2040 compared with 2008 levels.
• For the shipping industry “to reach net-zero GHG emissions by or around 2050, taking into account different national circumstances.”
• For GHG emissions to be measured on a “well-to-wake” basis, i.e., not just emissions from ship operations but also from fuel production.
• For the IMO to develop a “maritime GHG emissions-pricing mechanism,” i.e., a carbon levy. The timeline calls for approval by 2025 and implementation by 2027.
Switch to methanol could triple fuel costs

The carbon levy is the one to watch for cargo shippers.

Container lines ordering new ships have focused on two alternative-fuel types, both of which are much more expensive than traditional bunker fuel: liquefied natural gas and methanol.

The vast majority of container ships ordered over the past two years are dual-fuel, with methanol emerging as the preferred alternative-fuel choice. The latest shipyard contracts came Tuesday, with Evergreen ordering 24 dual-fuel methanol newbuildings.

Existing vessels are being retrofitted, as well. Hapag-Lloyd and Seaspan announced Thursday that they will retrofit 15 vessels for methanol use, with an option for 45 more.

Methanol is triple the price of very low sulfur fuel oil, said Hapag-Lloyd. Consultancy Drewry estimated that a switch to “green” methanol — methanol produced from biomass or by other means to reach carbon neutrality on a well-to-wake basis — would increase fuel costs by 350%, equating to an additional cost of over $1,000 per forty-foot equivalent unit for containers shipped from Asia to Europe.

For competitive reasons, dual-fuel vessels capable of burning LNG or methanol are widely expected to continue burning mostly fuel oil until the playing field is leveled by a carbon tax.

Because the cost differential is so big, governments and policymakers will have to adopt stronger or even more compulsory rules to force the change if they want to achieve green shipping,” said Drewry.

The new decarbonization targets “can only be achieved if the IMO rapidly agrees to a global levy on ships’ GHG emissions,” said Simon Bennett, deputy secretary general of the ICS. “A majority of governments now support a levy for shipping involving flat-rate contributions by ships per ton of GHG emitted,” he said.

A global carbon levy would equate to a large tax on shippers of commoditized goods and bulk commodities, and ultimately, on consumers.

EU ETS: A taste of things to come?

It remains far from certain that the herd of cats — the 175 member nations of the IMO — will agree to a global levy by 2025. Some major importing and exporting countries could block the levy if they believe it would cause too much harm to their economies.

But regardless of what happens at the IMO, vessel owners and their cargo shipper customers will face carbon pricing soon: The phase-in of shipping’s inclusion in the EU Emissions Trading System (ETS) begins January 1 2024.

The EU ETS coming into force next year is going to be much more impactful [than other existing environmental regulations],” warned Carlos Balestra Di Mottola, CFO of product tanker owner D’Amico, at the Marine Money Week conference in June. “Given the current prices for CO2 allowances and bunker [fuel] prices, it could lead to bunker costs on European voyages increasing by around 50%. That is quite a steep increase.”

On Thursday, consultancy Hecla Emissions Management published projections for added EU ETS shipping costs of €17.2b in 2024-2026 — or $18.9b at current exchange rates.

Container lines have already confirmed that they will pass EU ETS costs along to cargo shippers via surcharges. This will give cargo shippers a taste of what’s to come if a global carbon levy deal is ever reached.

Effect on new tanker and bulker orders

On the bulk shipping side of the equation, very few new tankers and dry bulk carriers are being ordered. The capacity of very large crude carriers (VLCCs; tankers that carry 2m barrels of oil) on order is now a mere 1% of the on-the-water fleet, according to Clarksons Securities.

Capacity on order of Capesizes — larger dry bulk carriers with capacity of 100,000 or more deadweight tons — is just 5% of the existing fleet. The lower the orderbook-to-fleet ratio, the better the prospects for future freight rates, assuming future demand outpaces inelastic vessel supply.

Uncertainty over allowable future fuels is one reason shipowners have not ordered new tankers and bulkers. Owners don’t want to pay for new vessels that will become prematurely obsolete, and banks don’t want to finance them.

If the IMO were to aggressively move forward with a clear strategy that gave shipowners comfort that their newbuildings would meet future regs, it would pave the way for orders, a headwind for future rates. If the IMO consensus were to completely break down, it would also pave the wave for new ships, convincing owners that they could safely build conventionally fueled vessels, likewise negative for future rates.

Instead, there was a consensus at the IMO — and the takeaway for shipowners considering newbuildings was ambiguous.

Sticking to ‘wait and see’ approach

What the IMO is effectively saying is ‘you must dramatically cut your emissions, you figure out how, but if you don’t there will be serious repercussions,’” said Nolan.

Consequently, we expect most owners are likely to continue to take the most prudent step of ‘wait and see’ before betting on a new fuel type for new ships.”

According to BRS, “There was hope among [tanker] owners that last week’s meeting would have provided a roadmap on exactly how shipping would decarbonize, with clear guidelines on how alternative fuels would be incorporated and promoted going forward.” Instead, “there is the distinct impression that the unveiling of the nuts and bolts of the strategy has been kicked farther down the road.

The tanker orderbook remains anemic and it appears unlikely that last week’s meeting will provide tanker owners with the clarity that they require to make future investments.”

This could ultimately backfire on the IMO’s decarbonization plans, said BRS. “If there is not an influx of newer tankers … older, thirstier units will remain in service for longer,” which would be “contrary to GHG targets.”