Shipping's decarbonisation journey is under way

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There has been a gradual transition in the way the shipping sector perceives decarbonisation. In the recent past, it was more of an aspirational ideal to which only lip service was paid. This was due to there being no commercial incentive to act, coupled with a lack of recognition of the significant carbon footprint of the shipping sector on the environment, climate and society.

However, the sector is now committed to a decarbonisation trajectory. Policy intervention and consumer and commercial pressures have helped push decarbonisation to the top of client agendas, accentuating both its challenges and opportunities. Still, making decarbonisation a realistic target requires an understanding of both the scope and scale of the change required, and an acceptance that (at least part of) the cost of the transition is likely to be passed down the physical transport chain to the end consumer.

Appropriate market-based financial incentives and investment in new technology, infrastructure, low-carbon and sustainable maritime fuels (SMFs) and access to sustainable finance will be required to make decarbonisation pathways commercially viable. However, an ongoing barrier to progress has been the cost, scalability and availability of low-carbon infrastructure, technology and SMFs. Consequently, first movers require appropriate market-based financial incentives to stimulate the significant investment required in these areas to, ultimately, promote growth in the sector.

Policy intervention and regulation also have an important role to play here, not only imposing robust rules with appropriate enforcement and sanctions for non-compliance (aimed at all the main stakeholders) to move the sector away from fossil fuel dependency, but also encouraging the uptake of low-carbon fuels and SMFs through innovative regulation which rewards first movers and monetises the energy transition at scale.

Inevitably this will place a significant cost burden on shipowners as they seek to invest in newbuilds or technology (for example, retrofits). However, there must be a realistic acceptance that the cost of compliance or investment in more sustainable practices will, ultimately, be passed down the physical transport and supply chain to the end consumer.

Legislative policies such as the EU’s ‘Fit for 55’ legislative package (a suite of proposals aimed at the EU cutting its GHG emissions by at least 55% by 2030), which enshrines the “polluter pays” principle – whereby the fuel purchaser or commercial operator is assigned the financial burden of compliance – is a clear indicator of the direction of travel. And the shipping sector’s inclusion in the EU Emission Trading System (EU ETS) and the introduction of FuelEU Maritime (FuelEU) are good examples of regulations promoting this cost allocation in practice.

What are the opportunities presented by decarbonisation?

Whilst the decarbonisation landscape is still taking shape, there are commercial opportunities for those stakeholders who offer low-carbon or net-zero emission transport solutions. First movers may be able to take advantage of sustainable financing or state grants to help fund investment in sustainable newbuilds and retrofits. In turn, this may open up new (and potentially lucrative) business opportunities for commercial clients willing to pay to reduce their own Scope 3 emissions carbon footprint. For instance, the recent ZEMBA (Zero Emission Maritime Buyers Alliance) tender won by Hapag-Lloyd, for a waste-based biomethane shipping service achieving significant reductions in GHG emissions, is an example of winning new business which promotes sustainable practices.

First movers can also be specifically rewarded by operation of regulatory intervention. For example, FuelEU incentivises investment in SMFs by imposing limits on fuel GHG intensity (on a well-to-wake basis) and provides systematic rewards for use of lower carbon or renewable fuel sources. For shipowners taking advantage of compliance benefits for ‘renewable fuels of non-biological origin’ or technologies such as wind propulsion to reduce their overall GHG intensity limit under FuelEU, the benefits are reaped in parallel with other legislation, such as the EU ETS, whereby fewer total regulated GHG emissions also minimises cost liability for compliance.

Furthermore, those vessels which operate on SMFs and over-comply under FuelEU may be able to manage their compliance liability cost-effectively, or even generate revenue through an innovative pooling mechanism. Vessels can share the benefit or burden of compliance on an intra-group basis or with third parties, and at its highest level offer their over-compliance to under-compliant vessels to generate funds.

Financial incentives or policy interventions and new regulations?

Both market-based incentives and policy intervention have a role to play in shaping the shipping sector’s decarbonisation pathways. Whilst regional policies such as Fit for 55 are clearly taking the lead on legislative decarbonisation efforts and, arguably, have extra-territorial application (by virtue of the scope of voyages regulated under the EU ETS and FuelEU), they seek to regionalise an otherwise global issue. Indeed, global regulatory intervention is the missing piece of the regulatory jigsaw puzzle.

MARPOL’s existing regulatory tools (the Energy Efficiency Existing Ship Index and Carbon Intensity Indicator) promote operational energy efficiency, but much more is required to transition a sector heavily dependent on fossil fuels to SMFs. The good news is the IMO is currently debating the nature, scope and form of a global carbon levy on vessel’s emissions, although it remains to be seen precisely when this will formally materialise into legislation.

This is why market-based incentives, standards and collaborative voluntary efforts have their own part to play in promoting decarbonisation. The Poseidon Principles for Financial Institutions and Poseidon Principles for Marine Insurance establish a framework for assessing and disclosing the climate alignment of ship finance portfolios and marine insurance, respectively, and these are gradually encouraging more sustainable and responsible practices from the main stakeholders in the shipping sector. Initiatives like green shipping corridors – while still in their infancy – also provide a clear signal that stakeholders who are committed to decarbonisation across the value chain can provide favourable conditions for decarbonisation in the future, provided this is backed by targeted policy and regulations.

There is no doubt which way the wind is blowing for the shipping industry. That shouldn’t disguise the fact that there is still significant work to do for stakeholders across the industry, if progress on decarbonisation is to be maintained. The positive news, however, is that thanks to commercial incentives, legislative and regulatory interventions, the expectations of clients and consumers – not to mention the ongoing efforts of the shipping industry – the pace of decarbonisation is picking up.

This is a guest post by Alessio Sbraga, partner, and Violet O’Gorman, trainee solicitor, at HFW