Regulators have yet to force the sector to decarbonise, but larger shipping lines and operators are planning for a low-carbon future
Decarbonisation was front and centre at London International Shipping Week (LISW) in September 2021. There were many sessions considering the decarbonisation of shipping as the global climate emergency becomes increasingly clear to all. This contrasted with the same gathering in 2019, where decarbonisation was at the margins and shipping was largely either in denial or pessimistic as to the ability of the industry to change.
The conversation is no longer about whether change is needed or if it will come: the question is how rapidly can shipping change in response to the climate emergency and what this change will look like.
As shipping lawyers, we are usually asked to deal with immediate problems. Covid has been a huge challenge, particularly for seafarers, but it is testament to the resilience of the sector that the maritime supply chain continued largely uninterrupted. The issue of decarbonisation, in contrast, is not one affecting shipping today but rather an issue that looms over the decades to come and beyond. The challenge is in foreseeing the future and calculating the likely long-term consequences of decisions being made now about investment in new tonnage and propulsion systems.
It has always been the case in shipping that decisions made today will impact on the future operations and profitability of a fleet for many years to come. However, one of the challenges of decarbonisation is that there is a larger range of options available to shipowners and it is difficult to foresee not only which will be the best solution (or range of solutions) in order to make shipping sustainable, but also which of all of the green options will gain traction with the industry. These are strategic long-term and enormously challenging problems to address, and the cost of getting it wrong could be significant.
What is driving the need to make these decisions? Some of the talk at LISW in September concerned the developments that would follow Cop26 and the 77th session of the Marine Environment Protection Committee (MEPC), both in November.
Would the regulators show their teeth and force shipping to accelerate its progress down the decarbonisation path? The answer was largely no.
Shipping (and aviation) remain firmly at the margins of the efforts of those involved in the UN Framework Convention on Climate Change. Although there were many useful maritime sessions at Cop26, and the International Maritime Organisation (IMO) representatives—including the secretary general—made impressive efforts to be seen and persuade the conference that it was serious about regulating and decarbonising shipping, the conference was not focussed on this sector; shipping was a sideshow. The IMO was invited to accelerate its goals to reduce greenhouse gas (GHG) emissions from shipping in order to reach zero emissions by 2050, but there was no real understanding in the main conference as to whether the industry could practically do this or any interest in how it might.
That is not to say, for those who were listening at Cop26, that the IMO was not promoting this issue: one example of progress has been the four Maritime Technology Cooperation Centres (MTCCs), based in Africa, Asia, the Caribbean and the Pacific since 2017. The project supports regional MTCCs and, while it is implemented by the IMO, it is in fact funded by the EU. While this is a positive step, the scale of the initiative is small and is due to wind up this year.
There were useful conversations about future fuels; one session considered the potential of developing states with plentiful green energy—particularly solar energy—to make the green fuels of the future: methanol, hydrogen and ammonia. Speakers stated that, at a stroke, it would be possible to provide those developing countries with an income and infrastructure from producing, distributing and bunkering ships with green fuel while at the same time solving the problem of how green fuel can be economically produced in the quantities required. Much vision and investment will be required for this to come to fruition but, on the face of it, it seems a more sensible plan than trying to produce green fuel in the developed world where energy is expensive as demand is high.
After Cop26 dispersed, the industry waited to see what would come out of MEPC 77 meeting in response. But the session did not result in the regulators baring their teeth significantly. The differences in approach of the various groupings at the IMO made decisive progress difficult. The meeting did not adopt the proposal for zero emissions by 2050 put forward by various small island nations, or the proposal for net-zero by 2050 put forward by the International Chamber of Shipping. For some, such a target is too conservative—for others it is too fast. Although some technical progress was made, no final decision was reached on finalising guidelines relating to the design (Energy Efficiency Existing Ship Index) and operational (Carbon Intensity Indicator) measures that are due to come into force later this year and into effect on 1 January 2023. We must wait to see what comes out of MEPC 78 in June 2022, with a possible result that the goal will be fixed at a 40pc reduction of carbon intensity by 2030.
Fit for 55
The EU, long critical of the pace of change at the IMO, decided that faster, unilateral measures are required. The European Parliament, as part of the EU’s ‘Fit for 55’ proposals, voted to include CO₂ emissions from shipping within its Emissions Trading System. The scheme will include emissions from all voyages by vessels 5,000gt and above within the EU and 50pc of emissions from extra-EU voyages that start or finish within the EU.
Recent discussions at the EU have seen proposals for 100pc of the voyages to or from the EU to be subject to the legislation. The proposals will require vessel operators to purchase and surrender carbon allowances to cover emissions of the relevant voyages. This is not uncontroversial: effectively applying a levy for emissions from ships on the high seas may well bring legal challenges along the lines seen in the past from the aviation industry.
The other proposals from the Fit for 55 package also include the FuelEU Maritime Initiative, which sets an increasingly stringent limit of GHG emissions from ships calling at EU ports to promote the use of sustainable maritime fuels and zero-emission technologies. The UK has yet to make a decision as to whether shipping should be included in its version of the ETS.
The industry’s reaction to these developments is mixed and ranges from outright resistance, particularly to the EU ETS proposal, through to active engagement with change. There is a sizeable minority of shipowners who are frustrated by the lack of clarity in the proposed regulations that hinders planning for the future. Many would prefer clarity now on what the rules will be so plans can be made to design compliant ships and operate them with the required reduced levels of carbon emissions—but particularly on a level playing field which requires the compliance of all.
Despite this uncertainty, we have seen a recent surge in the larger shipping lines and operators deciding that the time for waiting has passed and that action is needed to start to plan for a low-carbon future. One of the drivers for this is that such companies see a competitive advantage in being first movers in this area. As Jack Welch of US multinational GE once said: “Change before you have to.” There are increasing examples of shipping companies doing just that, whether it is building dual-fuel ships, investing in the use of green fuels or adopting energy saving devices onboard. The competitive advantage comes principally from not just complying with IMO technical standards but in responding to the pressure being applied by the other parties involved—namely the customers and stakeholders who use shipping in their supply chains.
To that extent, the measures being adopted at Cop26 have an indirect effect on shipping. Shore-based industries have to decarbonise and are looking to their supply chains as one of the areas in which they can improve. Beyond scope one and two emissions, a company such as a supermarket has to look at its logistics network, including carriage by sea, to reduce its scope three emissions, which often dwarf the combined scope one and two figures. As a result, stakeholders have little choice but to demand the supply chain cuts its emissions. There are signs of increasing demand for more efficient ships and ports; calls for reductions in delay and congestion; and suggestions that initiatives such as ‘cold ironing’, as set out in the FuelEU proposals, can be used to reduce carbon footprints. There is an increasing focus on the use of technology and big data to help in this drive.
Despite ‘eco ships’ having been around for some years, the additional cost of these ships has not been rewarded by higher charter rates in comparison with unmodified ships with poor GHG ratings. But as stakeholders require their supply chains to reduce emissions, so more sustainable ships with better GHG ratings should become more valuable and provide better returns on the owner’s investment in green technology. The number of stakeholders requiring improved environmental performance is increasing: initiatives such has the Sea Cargo Charter and the Getting to Zero Coalition are examples of the pressure now being brought to bear to decarbonise the supply chain. The financing of ships will be affected in a similar way through the Poseidon Principles, led by the European banks, while leading insurers have now agreed to use the disclosure framework provided by those principles to report on progress towards net-zero insurance.
Maritime companies also face the risk of shareholder activism and lawsuits similar to those brought against ‘big oil’ companies, which may require them to make deep cuts to GHG emissions on the basis of human rights legislation. Activist groups now complain to financial regulators that listed companies are not reporting these sustainability issues accurately in annual reports and demand that action is taken by regulators.
Shipping has long been targeted by activists on the basis that it is a ‘dirty industry’ and that it has failed to take effective steps towards decarbonisation. The intensity of this sort of campaign is only likely to increase in the future. Any ‘horizon scanning’ of future risk has to consider these issues, and there has to be a plan to meet these challenges. As ESG increasingly makes an impact on shipping, it is the ‘E’ that will take the longest time and incur the largest cost to address.
The technical challenges of achieving the goals set at Cop26 are immense and will require huge investment. Which of the competing technologies will prevail is not yet clear: as would be expected, every evangelical proponent of a sustainable shipping solution promotes their favoured solution over all others. This leads to concerns that investors in shipping may make the wrong choice when choosing the best way to decarbonise their fleet.
It is tempting to compare the current dilemma with the competing VHS and Betamax video cassette recorder systems in the 1980s—in the end the better system did not prevail. But in shipping the choice is less clear cut: there are three or four possible fuel solutions and there are a multitude of other paths such as the use of batteries, onboard carbon-capture or fuel cells, which might be a solution in the medium term. Some sectors, such as short sea, are potentially more straightforward to decarbonise and aggressive targets of fleets being carbon-neutral by 2030 are being voluntarily set. However, at this time, there is no single magic bullet and incremental reductions using a number of different technologies seems the most likely way of meeting the new targets and demands.
But in any analysis of prospective risk and reward it is vital that the risk horizon scanning includes all the elements of future shipping. There are many factors to consider: the result has to be a significant decarbonisation of the fleet over a relatively short timescale; future fuels have to be green otherwise the problem is simply moved from afloat to ashore; the investment in producing and distributing such fuel has to be manageable as shipping must remain a relatively cheap and efficient way to move goods and to avoid hampering the global economy.
Additionally, future fuels should not take up unacceptably large amounts of a ship’s total space; investment in what may become stranded assets has to be avoided or limited; the change to low-carbon shipping has to be both financially efficient and timely so as not to require unfeasibly large investments in new infrastructure as well as new ships. Ultimately, though, safety has to remain paramount in any consideration of future technology. Ships must continue to be seaworthy and safe in all conditions, and the fuel has to be safe enough to handle ashore, while bunkering, and in day-to-day operation at sea.
The efforts being made to decarbonise the industry and avert a serious degree of global warming and climate change are undoubtedly necessary, but in the rush to decarbonise, it is vital that day-to-day safety of ships, cargo and most importantly seafarers is not compromised. Scanning the horizon and assessing risk is as important as ever as the industry starts to make real progress in charting a route to a sustainable future.