As it’s often the cheapest form of transportation, more than 90% of all world goods, from raw materials to finished products, are carried by sea. Spurred by worldwide population growth and increasing globalisation, global trade has grown by 85% in the last 18 years. The shipping industry merchant fleet has grown to c.100,000 vessels producing an estimated 3% of global greenhouse gas emissions annually. According to the International Maritime Organisation (IMO), the UN agency responsible for the safety and security of the shipping industry, emissions will increase between 50 and 250% by 2050 under a business-as-usual scenario, if no drastic measures are taken.
Emissions from shipping are particularly harmful because of the calorific ‘High Sulphur Fuel Oil’ used. Seldom used onshore because of its toxic nature, these fuels release large quantities of pollutants into the air in the form of sulphur dioxide and nitrogen oxides (Sox and Nox) linked to asthma, lung cancer and heart disease. This is quickly becoming a major issue for populations living near the coastlines of global shipping routes.
Until now maritime trade was exempt from control and global governance thanks to its transnational position. In the Paris Climate Agreement the section that included air and maritime transport reduction of greenhouse gases was removed. Thus, the shipping industry was the only economic sector without an emission reduction target after the civil aviation sector acquiesced in 2016. The first of its type for the shipping industry, new regulation will come into force on January 1st 2020 to reduce the ceiling on sulphur content of maritime fuel from 3.5% to 0.5%, reducing the Sox and Nox. Already this is creating disruption and is likely to affect the economics of the industry.
Shipping operators have several different options for compliance with the new limits. One would be to switch to a lower-sulphur fuel compliant with the new IMO rules but the cost, the availability and its utilization is still uncertain. According to the forward pricing of HSFO and the new low-sulphur fuel, there will be a wide spread between prices from the start of 2020. Ship owners could also opt for liquefied natural gas (LNG), although so far few have taken this step.
Another choice is to install scrubbers – this is an after-treatment method which reduces the Sox of ship emissions by washing is out of the exhaust gas. This is a cheaper option for the heavier tankers but at about $2.5m each, it’s still a considerable cost. Multiple companies are investing and fitting their ships with this technology – an estimated 1,900 in 2019 and another 1,500 in 2020 which amounts to c10% of the global fleet. The process of installing the scrubbers requires the ship to be in port for multiple weeks, causing short-term disruption to supply.
From an environmental perspective, this is only the start. Scrubbers systems may wash out sulphur and particles from the exhaust but usually they discharge straight into the ocean which has led some ports like Singapore to have already banned this variety of cleaning system. Furthermore, this regulation doesn’t address the significant carbon emissions of the industry; in 2018 the IMO reached an agreement of an ‘initial strategy’ to cut CO2 emissions in the industry by 50% by 2050 and to pursue efforts to phase out carbon emissions entirely.
Some companies have started to invest in alternative fuels like wind and power, on the realisation that this will likely lead to tighter regulation. However, the technology is far from ready – container vessels can carry 150 times as many boxes over distances 400 times as long at speeds three to four times as fast as the most pioneering electric ship. These solutions are likely to be implemented for small craft undertaking short voyages as is already the case in Scandinavian countries, or with ferry operators that run battery-diesel hybrids.
Environmental regulation is expected to be a costly headache for the shipping industry which already faces difficult market conditions and slowing world trade. According to a report published by the Energy Information Administration, « the change in sulphur limits will have a major impact on the world refining industries as well as on oil supply, demand, trade flows and prices », and this will likely create new winners and losers. Goldman Sachs evaluates the cost effect on commodities could be c5-7% inflation and the total impact to consumer wallets in 2020 will be around $240bn, while S&P Global Platts estimates that this regulation could cost the global economy $1tn over five years.
The information contained herein is provided for discussion purposes only, is not complete and is not, and may not be relied on in any manner as, legal, tax or investment advice or as an offer to sell or a solicitation of an offer to purchase an interest in securities. QUAERO CAPITAL believes the information contained herein to be reliable and has been obtained from sources believed to be reliable, but no representation or warranty is made, expressed or implied, with respect to the fairness, correctness, accuracy, reasonableness or completeness of the information and opinions.
The estimates, investment strategies, and views expressed herein are based upon current market conditions and/or data and information provided by third parties and are subject to change without notice. There is no obligation to update, modify or amend these materials or to otherwise notify a reader in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.
These materials include certain opinions, statements and projections provided by Quaero capital with respect to the anticipated future performance of certain asset classes. Such opinions, statements and projections reflect significant assumptions and subjective judgments by QUAERO CAPITAL’s management concerning anticipated future events. these forward-looking statements are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond QUAERO CAPITAL’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The data as presented has not been reviewed or approved by any party other than QUAERO CAPITAL.
Nothing contained herein shall constitute any representation or warranty as to future performance of any financial instrument, currency rate or other market or economic measure. Opinions expressed herein may not be shared by all employees of QUAERO CAPITAL and are subject to change without notice.