KBRA Comments on Decarbonization of Shipping
Increasing stakeholder pressure for the decarbonization of the shipping industry brings mixed credit implications for shipping companies and vessel financings.
The numerous stakeholders include regulators, financiers, investors, and customers, as well as the shipping companies themselves. There are now varied targets in place, such as the International Maritime Organization’s (IMO) current target to reduce total annual greenhouse gas emissions from the shipping industry by 50% by 2050 compared to 2008, along with more ambitious targets, including the Cargo Owners for Zero Emission Vessels (coZEV) initiative where major shipping interests have pledged to hit zero carbon by 2040. There are many options available for reaching these or any other decarbonization targets. However, the decision on which decarbonization path to take creates potential risks for shipowners given the many uncertainties regarding their efficacy as well as the cost of the various technologies. In addition, smaller ship owners may find themselves at a disadvantage, as they are exposed to a higher relative cost of cutting emissions than the much larger shippers.
There is a consensus on the need to reduce carbon emissions in the shipping industry but not on how to do it.
Most alternative fuels are not yet technologically viable or adequately available.
Efficiency improvements and lower sailing speeds also can reduce carbon emissions.
The primary regulatory target for reducing carbon emissions from shipping is formulated by the IMO 2050 requirements, and there are also lender requirements laid out in the Poseidon Principals. However, there is a growing stakeholder demand on the part of shipping customers, investors, and financiers to speed up the transition to greener sources of energy. This dynamic is illustrated by large corporations like Amazon, Ikea, and Unilever recently indicating their desire to reach net-zero targets by 2040, 10 years earlier and more aggressive than the regulatory target date of 2050.
One of the most prominent options for reducing carbon emissions is alternative fuels. The cost of yet-to-be-developed fuels like hydrogen and ammonia remains to be seen, but existing fuels such as liquefied natural gas (LNG), liquefied petroleum gas (LPG), and methanol are still marginally more expensive than ubiquitous fuel oil. In addition, designing ships to use alternative fuels adds another layer of cost for shipping companies that do not have the required infrastructure.
Ocean-going ships may sail for weeks at a time, and they rely on a global infrastructure for refueling. Any fuel choice requires a supply chain for bunkering. Ships must be able to refuel, and the fuel needs to be widely available across geographies. High demand for low-carbon fuels that depend on limited feedstocks (such as bio-LNG) could drive up prices to prohibitive levels, while others such as hydrogen or ammonia are still in the development stage, and only tangible demand would increase the fuels’ scale and lower prices. Overall, there is a lack of consensus on what direction the industry should move in. That said, higher fuel costs are unlikely to limit the transition to a greener industry or have a material credit impact on the shipping industry in the long term, as most of the expense will likely be passed on to shippers and ultimately consumers. In that regard, stakeholders are increasingly focused on a process of decarbonization, which includes some form of cost-sharing among governments and shippers.
Increased efficiency measures can also lower carbon emissions and will likely lead to the largest emissions savings in the near term. Various hull coverings (such as paint) are being developed that can decrease the resistance that the ship hull experiences as it moves through the water, thereby increasing efficiency. Improvements in hull shape can also lower fuel requirements and increase efficiency, as can improvements in propeller design. These fixes are a credit positive for shipping companies and vessel financings because they reduce costs and address stakeholder preferences for greener transportation.
Slow steaming is another way to lower fuel use and carbon emissions. These measures positively impact asset values as more ships are required to ship the same amount of goods. However, that same increased need for vessels could have a negative impact on shipping company operations, as they will need more assets to generate the revenue to move the same amount of goods.
For the shipping industry, the long life of vessels (typically 25+ years) is a serious impediment to the full adaptation of any given alternative fuel because the global infrastructure does not yet fully exist to utilize these fuel types. Dual-fuel engines or engines that can be readily converted to use a different fuel can help in the interim. This setup enables newly built ships to switch to a lower-carbon fuel if it becomes more widely available without committing the vessel to the risk of early obsolescence. Retrofitting can be very expensive, and premature fleet renewal will also not be a palatable option. Although dual-fuel technology increases building costs, it will also increase the probability that the ship will not lose value due to technological obsolescence.
In our view, higher initial costs could have negative credit implications for the industry; however, we also believe stakeholder demand is gaining momentum beyond regulatory pressure. In that respect, shipping companies that quickly address demand for lowering carbon emissions will benefit from better access to capital, which should eventually mitigate the higher initial costs. KBRA believes that overall, investments that consider the global transition toward a low-carbon economy can be credit positive.
While the industry at large is uncertain about which path to ultimately take, there is no question about the consensus for the movement toward reducing carbon emissions. The more readily available methods to reach that goal include improvements in ship and propeller design, along with better hull coatings and more fuel-efficient speeds. The uncertainty around alternatives for lower-carbon fuels will continue to drive credit uncertainty until the technologies and infrastructure are more evolved.
 Poseidon Principals provide a global framework for assessing climate and decarbonization in regard to lending decisions related to vessel financing.
Michael Labuskes, Senior Director
+1 (646) 731-3355
Marjan Riggi, Senior Managing Director
+1 (646) 731-2354
Coronavirus (COVID-19): Winners and Losers in the Face of an Oil Storage Crisis