Shipping considers the doomsday scenario

July 24, 2019

It made the sort of headlines that editors dream about in the early days of summer, as the news agenda slows and decision-makers head for the beach. Tanker and bulker owners ‘could see asset values plunge’ with ships that carry fossil fuels becoming ‘stranded assets’ as the world transitions to a low carbon economy.

Its source, forecasting consultancy Maritime Strategies International, had been given the opportunity by the Europe Climate Foundation to model the radical change in demand that might occur if countries follow their commitments to the Paris Accords.

In fact, the headlines, while diverting, reflected a temptation to grasp the most downbeat aspect of the report as the most likely outcome, while ignoring the nearer-term challenge – how to put decarbonisation of shipping in place.

As has been pointed out frequently and by a number of interested parties, the IMO2020 sulphur regulations represent a ‘bump in the road’ compared to the challenge that decarbonisation poses to the industry in terms of its own carbon contribution. No-one had previously considered what would happen to the cargo base of crude and refined oils, natural gas and coal, if demand shrank rapidly.

The shipping industry has grown up alongside global trade and is itself a key driver of the growth in the world economy. A large part of growth in trade has been in raw materials including fossil fuels and until now there have been few periods when this upward trajectory has been interrupted.

A sustained move away from trade fossil fuel trade (which MSI accounts for about 28% of global trade in tonnes and estimates at 3.7 bn tonnes last year) would therefore represent a dramatic change.

To MSI, change of this magnitude has simply not been on the industry’s radar. But shipping is not alone in failing to fully recognise that real, sustained action on climate change was coming – or perhaps it seemed so far away as not to be an immediate priority. In the last couple of years there has been a sea change in awareness among the general public as well as in business that climate goals are there to be attained.

A decade of terrible earnings endured by the shipping industry which has put many companies under severe financial distress, coupled with waves of operational regulation have meant owners had the present rather than the future on their minds. But with IMO2020 set to come into effect next year, CO2 emissions are moving centre stage.

In fact, demand for fossil fuels – particularly from Asia – has provided the bulk of growth in cargo demand in most shipping sectors for many years and MSI expects this to continue, albeit at a slower pace. These nations though are not the only ones who will be affected by reduced demand, the impact will be widely spread across the industry.

If as MSI suggests, a fast-track move away from fossil fuels results in falling asset values for tankers and bulk carriers, a likely outcome might be consolidation or that smaller, less adaptable owners leave the market.

This is a plausible impact of the potential disruption but the complication here is that under such a scenario the industry will face a reduction to trade and vessel demand at the same time as investment is needed in vessels with new engine/efficiency technology to reduce shipping’s reliance on carbon-based fuels.

How this process will be made financially viable is difficult to predict – whether carbon-burning ships could be penalised at the same time as cleaner ships are rewarded with a premium, remains to be seen. The scale of the disruption created by decarbonisation certainly suggests the process will be better managed by larger, more diversified fleets, to the potential detriment of smaller players.

A related argument is that the deployment and efficiency of the spot or tramp-trading fleet needs to be optimised to reduce emissions – for example by improving communication between ship and shore so that speed can be adjusted to eliminate waiting times outside ports. This will reduce fuel consumption and free up capacity that would otherwise waste time waiting to for a free load or discharge berth.

This process will also arguably be best handled by larger fleets however, in theory, all companies are equally at risk from asset price depreciation if the result of decarbonisation is a sustained period of lower earnings.

But if this long term threat is existential, in the shorter term, MSI thinks many owners will be preoccupied with how to decarbonise their own operations – even though it is too early to know which technology will emerge as the clear winner.

In a recent study prepared for classification society, ABS, MSI observed that the potential for the adoption of alternative low carbon fuels will be greatest in regionalised shipping sectors. MSI assessed ships from very large bulkers and tankers, offshore vessels and ferries as well as short sea bulk carriers and feeder containerships in specific geographic regions including Japan, China, Northern Europe and Norway.

This regionalisation could provide the opportunity for government leadership in facilitating local market development and concentrated ownership that is heavily-oriented towards domestic/regional shipping companies. This cohesion, when allied with a greater integration with customers, provides a self-reinforcing environment for change.

By contrast, the fragmented and highly diversified nature of deep-sea shipping makes achieving the right environment to facilitate adoption a far more complex challenge. There is unlikely to be widespread adoption until multiple fuels have been tested in regionally-focused sectors.

In reality, better freight earnings (and hence asset values) will depend on the implementation of some reward/penalty scheme, so that those how invest early in new technology will ultimately have higher earnings. Otherwise, there will be no financial incentive to invest in new technologies, nor benefit in terms of asset values.