Financiers, owners and stakeholders alike should be future-proofing investments and preparing to harness the new opportunities decarbonisation will create
With the onset of climate policies as soon as 2023 there will be a need for significant capital investment to keep vessels competitive, according to a joint report by Carbon War Room (CWR) and UMAS on stranded assets and climate risk in shipping.
By examining the outcomes of investment approaches in a range of future scenarios in the newbuild dry bulk fleet (60,000 to 99,999 dwt), the report, Navigating Decarbonisation: An approach to evaluate shipping’s risks and opportunities associated with climate change mitigation policy, assesses whether the industry is exposed to climate policy-driven risks and how to mitigate these.
The report takes two investment perspectives – short-term and long-term – in a number of scenarios to anticipate how vessels will compete in a range of potential futures, enabling it to incorporate uncertainty into decision making. Variables defining the scenarios include build year, carbon price, freight rate growth and market barriers.
In the short-term perspective scenario, the shipowner or investor evaluates the investment within a short time horizon. Market barriers to the adoption of energy efficiency technologies in this scenario are high. While, in the long-term perspective scenario, the shipowner or investor evaluates the investment within a long time horizon and market barriers are low.
“Actions taken now by financiers, owners, and shareholders will position both individual assets and the industry as a whole for greater long-term profitability, and will ensure that the first step of decarbonisation is a success.”
The report suggests that decarbonisation can still be a win-win on profit and climate for shipping companies, but as chief executive of CWR and Rocky Mountain Institute Jules Kortenhorst says, “they will have to be more proactive and live up to the green reputation that many of their institutions hold”.
Indeed, it appears that financiers should already be future-proofing investments and preparing to harness the new opportunities decarbonisation will create if the industry is to thrive in a decarbonised world.
The report highlights five key findings. First, for both lengths of investment perspective considered, an incremental deployment of energy efficiency technology was found to be a likely response to the onset of climate change mitigation policy. For the size range of bulk carrier considered in the case study, this included the introduction at certain points in the future of hull and propulsion improvements, machinery efficiency improvements and energy recovery devices and renewable propulsion.
Second, the report assumes that further regulation on CO2 emissions will occur at some point between 2020 and 2030. The results show that a ship built in 2020 that does not anticipate future operations under carbon pricing will either need to be operated at lower speed – and therefore lower revenue – or undertake retrofitting to be competitive. Hence, when adding operational performance to the comparison, an even greater divergence in productivity and earnings can be observed between ships specified in different years and under different investment perspectives.
Third, the short-term perspective scenario generally leads to a ship with a lower technology specification operating at a relatively constant speed over time, whereas the long-term perspective scenario leads to a ship with higher technical specification operating at a higher speed that increases over time. The total costs of operating the ship are lower in the long-term perspective scenario than in the short-term perspective scenario. The report attributes this to the lower voyage costs incurred by the ship in the long-term perspective scenario due to the better technical and operation specifications compared with the ship in the short-term perspective scenario.
Further, charterer revenues for the ship in the long-term perspective scenarios are mostly higher than in the short-term perspective scenarios due to higher technical and operational specifications which can increase its speed and, therefore, its productivity or transport work.
Fourth, the report finds that long-term scenarios with lower barriers imply a greater amount of fuel cost savings passed through to shipowners, while short-term scenarios with high barriers imply lower cost savings passed through to shipowners.
Finally, the report reveals that ships in the long-term scenarios typically generate higher profits for the shipowner over their lifetime, except in the case where low freight rates coincide with a low carbon prices. These ships generally have a higher internal rate of return (IRR) and may, therefore, be considered more resilient to climate change-related risks, it says.
Moreover, the shipowner profits in the short-term perspective scenarios are more stable and fluctuate less than in the long-term perspective scenarios, but they are also generally lower than in the long-term perspective scenarios.
The improved profit performance of ships built under long-term scenarios is a result of a variety of effects, says the report, but the driving factor is generally the operational cost advantages that those ships either possess at build or gain over time through retrofits. Indeed, cost advantages, measured in the study as cost per thousand tonne kilometres, typically translate to better IRRs and offer a buffer to future shocks or improved competition.
The next step
Given the number of different environmental regulations that are already impacting shipowners and financiers, the need to apply additional technology or introduce changes to operations is not new. Therefore there should already be a baseline understanding of climate change mitigation policy risks.
As James Mitchell, CWR’s senior associate for shipping, says: “Risk is nothing new to the shipping industry or to the major financial institutions that bankroll it, but climate transition risk is. If a newbuild financing decision is made today, that vessel will probably have to compete under new IMO or EU policy actions before its first drydock.
“We recognise the challenges faced today: markets are weak, capital requirements are increasing and compliance with upcoming regulations will require significant capital investment. However, actions taken now by financiers, owners, and shareholders will position both individual assets and the industry as a whole for greater long-term profitability, and will ensure that the first step of decarbonisation is a success.”
One straightforward action, he suggests, is to keep abreast of the evolving public and private sector discussions on greenhouse gas emissions, and look out for signals that could cause changes in demand for your sector of the shipping market or affect the technology requirements and operation of your ships.
UMAS’ Dr Tristan Smith adds that future regulation on shipping GHG is now certain – “it’s just the velocity and stringency that remain unknown, and we can handle this by thinking in terms of scenarios,” he says.
He explains that the collaboration between CWR and UMAS has given both companies the opportunity to further think about how techno-economic modelling can help to identify risks and opportunities to different scenarios and has given them many ideas for their ongoing work.
“The key takeaway from the report,” he says, “is for financiers and shipowners to be prepared and thus it is crucial to future-proof assets now and plan for flexibility from the onset through, for example, designing for future retrofits and using innovative financing mechanisms to deal with a variety of future scenarios.
“Scenario analysis that combines an integrated techno-economic assessment with a number of foreseeable policy scenarios can help navigate future uncertainties, and help financiers and shipowners make more informed decisions about their assets.”
However, as demonstrated in the report, tools to investigate competitiveness, risks, and resilience of different ship designs and specifications are increasingly available and are increasing in their rigour, it says. Such assessments are not currently standard practice, something that the report’s authors question. In lieu of that, it suggests that shipowners and brokers should have the answers to the following questions:
- What would be the most profitable way to modify your ship in the future to lower operational carbon emissions (e.g. as a response to carbon pricing) per t.nm by 20, 40, 60 or even 80%?
- What could you do to your ship now to enable it to accept these future modifications at minimal additional cost?
- Is there a way to justify any of these modifications now, perhaps through innovative solutions such as the use of options or by securing charterer investment through retrofit shared-savings clause?
- How would any future retrofitting be financed?
“Planning for these retrofits in advance may make identifying and justifying funding easier, as well as potentially reducing overall implementation costs,” concludes the report. “Furthermore, having an eye out for innovative financing and identifying a method of financing future retrofits, could help ensure that if and when the time comes, finance can be raised and the retrofits can be deployed – something that has become non-trivial in today’s depressed market.”
The full report is available to download at http://shippingefficiency.org/resources.