Clean Marine Fuel in 2020: An Opportunity for Biofuel?
September 1, 2019
by Mike Newman of Parhelion Underwriting
2018 saw the shipping industry take its first steps towards addressing the challenge of climate change when, at its 72nd session in April, IMO’s Marine Environment Protection Committee (MEPC) adopted an initial strategy to reduce greenhouse gas (GHG) emissions from shipping by at least 50% by 2050. The United Nations body charged with regulating shipping on the high seas adopted its first-ever strategy to blunt the sector’s large contribution to climate change — bringing another major constituency on board in the international quest to cap the planet’s warming well below an increase of 2 degrees Celsius (3.6 degrees Fahrenheit).
The international shipping industry emitted an estimated 812 million tonnes of carbon dioxide in 2015 — nearly 2.3% of the global total and the industry’s emissions are projected to double by the middle of this century. Yet, along with the aviation sector, GHG emissions of the shipping sector are not covered under the Paris climate agreement and thus not addressed in the nationally-determined contributions of countries.
Ironically, the matter is made more urgent by the decision of the IMO to reduce the amount of sulphur allowed in bunker fuel from 3.5% to 0.5% by 2020. Sulphur is nasty stuff. When burned, it forms sulphates, which cause acid rain and pollute the air. The trouble is that sulphates also scatter sunlight and help to form and thicken clouds, which reflect solar radiation away from Earth. As a result, shipping is thought to reduce rather than increase man-made global warming. But unlike desulphurization, which is both imminent and legally binding, the CO2 target looks fuzzy: the IMO’s April resolution set targets for emissions reductions and lay the groundwork for future regulations but won’t finalize the regulatory framework until 2023.
It is still early days in the process and progress will not come without its challenges but, as is often the case, the challenges come with opportunities.
Let’s start with the fuel that powers the maritime industry – bunker fuel, heavy oil that is so dirty that on land it’s classified as hazardous waste, releases a lot of carbon dioxide. It is also expensive and a big concern to shipowners in a sector with tight margins. Fuel costs have risen from a third of their spending a decade ago to half or more now—and are expected to rise further. Low sulphur bunker fuel, of the sort needed to meet the new IMO standard, is expected to cost $600 a tonne when its use becomes compulsory. The current price of bunker fuel is $450.
Fortunately, there are plenty of ways for the industry to increase fuel efficiency, from simple changes like optimizing routes and reducing speeds, to technological ones like wind-assist systems and performance-management software that monitors data from sensors and from records of a ship’s past voyages and adds in weather reports. Another way to cut fuel consumption is to reduce drag by redesigning hulls and propellers and by smoothing hulls by stopping barnacles and other creatures growing on them. A drag-reducing technique on offer is air lubrication. Carbon efficiency can also be improved by looking at the total transport chain. Waiting time at anchorage outside ports is one element which increases the total CO2 emission from ships and finding ways to eliminate waiting time.
For shipping to decarbonize, current fuel oils would have to be replaced by alternatives and there are several options such as biofuels or switch to low-carbon fuel systems such as diesel-electric propulsion. Liquefied natural gas (LNG) is another option. Burning LNG releases about a quarter less carbon dioxide than burning bunker fuel does. Nuclear propulsion also has its supporters. This releases no carbon dioxide, and shipboard reactors are an established technology. Some 140 icebreakers, warships and submarines are so propelled. A nuclear-powered fleet, capable of terrific speed, could move more goods with fewer vessels.
Enthusiasm for the goals, though, is uneven. The European Union and small island states are pushing for more aggressive action on greenhouse gas reductions but many developing countries fear that stricter rules will drive up the cost of shipping, harming their economies and an attempt to begin reconciling the differing views at a meeting of IMO member states in London in October, foundered. On the positive side, at the United Nations climate summit in Poland in December, as world leaders called on each other to pledge more ambitious climate action, the Danish shipping giant AP Moller Maersk took the opportunity to announce its own climate target: net-zero emissions by 2050.
The current plan is referred to as an “Initial Strategy.” From here, IMO is expected to move ahead with regulations for global shipping that will gradually require these carbon-saving changes to the industry. Those could include mandatory energy-efficiency requirements, speed limits or other measures. IMO is expected to start developing legally binding measures, which could include increases to ships technical and operational efficiency, a low and zero-carbon fuels implementation programme, national action plans and market-based measures. These would be in addition to existing measures on energy efficiency (EEDI and SEEMP). When the time comes, the IMO could accelerate that transition further with phase-out rules like the ones that required tanker ships to switch from single hulls to double hulls, which went into effect in 2001 to help prevent catastrophic oil and chemical spills.
The Strategy lists market-based measures as one of the measures in the long-term – an emissions trading scheme in which shipping companies could purchase emission allowances from other companies across flags or even from other industries – in the same way that carbon credits are currently traded in several successful markets.
The best climate policy – environmentally and economically – limits emissions and puts a price on them. Cap and trade is one way to do both. It’s a system designed to reduce pollution in our atmosphere. The cap on greenhouse gas emissions that drive global warming is a firm limit on pollution. The cap gets stricter over time. The trade part is a market for companies to buy and sell allowances that let them emit only a certain amount, as supply and demand set the price. Trading gives companies a strong incentive to save money by cutting emissions in the most cost-effective ways. Companies that cut their pollution faster can sell allowances to companies that pollute more, or “bank” them for future use. This market – the “trade” part of cap and trade – gives companies flexibility. It increases the pool of available capital to make reductions, encourages companies to cut pollution faster and rewards innovation.
In the European Union’s Emissions Trading System, capped emissions from stationary structures were 26 percent lower in 2016 than when the program started in 2005. In the United States, California’s climate policies have led to a steady decline of the state’s carbon dioxide pollution. The centerpiece is the cap-and-trade program and California’s emissions from sources subject to the cap declined 8.8 percent between the program’s launch in 2013 and 2016. Meanwhile, the state’s economy is thriving. Cap and trade makes even deeper cuts possible when countries cooperate, such as the United States and Canada. California and Quebec connected their systems in 2014, building a strong market that shows great potential.
Trading in the climate finance market – the systems designed to reduce greenhouse gas emissions – sometimes create areas of uncertainty. The risk of invalidation of credits worry market participants – but insurance risk capital can be used to mitigate these concerns and in fact, already works successfully in several markets. One example of this is in the California Cap-and-Trade program where “buyer liability” has created a price differential between carbon offsets depending on the level of risk associated with them. By removing this risk from both offset buyers (typically refineries and utilities) and sellers (project developers), insurance adds certainty and therefore liquidity to the market because it’s a guarantee with investment-grade A+ security.
Risks often act as barriers to investment in innovative changes in commerce and it takes the huge pool of global insurance and reinsurance capital that has traditionally taken the risks that other forms of capital (debt and equity) can’t or won’t take, to ensure liquidity in new markets.
Mike Newman is a Director of Parhelion Underwriting Inc, a risk finance company specializing in risks impacting investment in climate finance markets and clean energy. He can be contacted at [email protected] or (323) 459-5346.