Shipping Alternative Fuels
The Good, the Bad, and the Unknown
Approximately 80% of traded goods are transported by sea internationally. With the shipping industry producing close to 3% of the total greenhouse emissions, and in the hopes of achieving net zero emissions in the shipping industry by 2050, the International Maritime Organization (IMO) has introduced a new strategy, especially after the IEA recognized that the industry is running behind.
Green Fuels and EU ETS Allowances
The new strategy starts off by reducing greenhouse emissions by no less than 20% in 2030 compared to 2008, and by at least 70% by 2040, and to increase the use of zero or near-zero greenhouse emissions technologies to form no less than 5% of energy sources used in the industry by 2030. The collaboration of all parties involved will be required in order to successfully overcome the challenges of decarbonizing container shipping and to achieve the IMO goals, which most companies have encouraged. Unfortunately, it is currently significantly more financially demanding to accommodate to the suggested alternative fuels than to pay for carbon emissions, with the cost mainly being due to:
- The implementation of new technology through retrofitting or installing new vessels.
- The difference in operational costs.
Substantial investments in green fuels are crucial in the long run to prevent the transfer of emissions from ships to land. With methanol being the current top alternative fuel replacing LNG, switching to it has significant financial ramifications, possibly leading to a drastic increase in fuel cost by an average of 144%. To balance this out, the rate of the containers will also drastically increase by 20-40%. The authors believe that approximately $400 billion in capital might be needed for fleet renewal.
In addition, to facilitate the decarbonization of the shipping industry, an investment of over $1.4 to $1.8 trillion in developing green alternative fuel production capacity is also required, making the purchase of EU ETS allowances a more affordable option, even in the long term. The authors predict that it would be more cost-effective for container shipping companies to utilize bunker fuel and pay for carbon emissions at the current EU ETS rate, even when considering long-term rates (€160 per ton of EU Allowance). A 11-30% rise in spot freight rates on the three major East-West routes will be required in order to balance out the costs of carbon at our given long-term carbon price, if it were to be imposed internationally.
Paying a Premium
Although the freight rate amounts for only a fraction of the cost of goods for consumers, a survey conducted in 2022 by the BCG demonstrated that consumers showed little to no willingness to pay more than 10% above the current asking price for goods. On the other hand, 40% of participants agreed to paying an additional 2% for shipping, bringing the total percentage of customers willing to pay a premium fee up to 82%. Only 18% did not show willingness to accept any additional costs, which is an improvement in comparison to the results of last year, as the percentage of the latter group was 29%. With many consumers opting for the more affordable option of purchasing carbon credits, this does not push them in the right direction of having net zero emissions.
The data shows that the shift to ships with low-emission rates has already begun and newer ships are now entering the market. One of the main entities profiting from this switch are chemical producers, as green methanol production is expected to be ten times higher in 2027 compared to 2023.
According to the estimates of the IEA, alternative energy sources ought to account for 15% of sources of energy available in the market by 2030 in order to achieve a net zero emission, which will be challenging considering that it currently forms only 0.5% of the market. Hence the urgent need of major technological enhancements.
Methanol, ammonia, hydrogen, natural gas, and biofuels are some of the most dominant alternative fuels in the market, with the expectation that the latter will be the most used form of alternative fuels in 2030, according to IEA predictions, while current records show a high interest in methanol. The limitations to methanol are the current insufficient supply and its high costs. LNG and methanol ready ships cost 19% and 58% more per Twenty-Foot Equivalent Unit (TEU) on average.
LNG is a favorable “transition” alternative, as not only does it produce less CO2 than mainstream systems by 15-30%, but it is also easily replaceable in case more affordable alternative fuels become available in the market in the future. The disadvantage of LNG is that it poses environmental risks, including the risk of a methane leakage.
Additional primary concerns associated with alternative fuels pertain to their availability, lack of required technology for sufficient production, insufficient fuel infrastructure, and safety considerations. Moreover, not only do vessels need to be retrofitted or constructed to accommodate these alternative fuels, but ports must also undergo modifications to facilitate refueling services.
Further Areas of Interest
Although the implementation of alternative fuels is the most effective way to reduce emissions, decarbonization is to be achieved not only through utilizing alternative fuels, but rather ought to be supplemented by other methods, such as creating more efficient routes and retrofitting energy saving technologies.
Only a small percentage of fleet currently runs on alternative fuel. And considering that the “lifespan” of a ship typically ranges from 20-30 years, if no policies and penalties were implemented, we can only expect the transition of the fleet to alternative fuels to require a long period of time. Retrofitting can serve to achieve a faster fleet renewal.
Nevertheless, it is worth mentioning that there is a notable increase in the percentage of the order book, which currently stands at 66% in 2023 compared to 33% in 2022, albeit majorly consisting of LNG (39%).
Retrofitting and its Challenges
It is planned for the first methanol engine retrofit to be introduced in the middle of 2024, which can initiate a 95% decrease in CO2 emissions and does not pose as many risks as the LNG. The cost remains unknown.
Retrofitting poses some challenges, the biggest being financial, as each can cost anywhere between $5-24 million, with not enough evidence of returns that justify this investment. Furthermore, there is an inadequate number of qualified shipyards to accommodate the volume of vessels requiring services. Scrapping capacity is a crucial element to consider, as according to Lloyd’s List, scrapping 2% of global fleet will fill 70% of shipyards capacity. Additionally, if not conducted proficiently, this process may lead to having a large number of vessels out of service, resulting in a shortage in the industry. Moreover, there is the risk of insufficient alternative fuels for the huge volume of vessels and the underdeveloped infrastructure. Lastly, according to the DNV, the amount of existing fleet that qualifies for a retrofit does not exceed 10%.
Wartsila and Alfa Laval are the two institutions that will majorly gain from the retrofitting of fleet and the decarbonisation in the shipping industry.
There remain ongoing discussions regarding the timeline of the new strategy. With this being an uncharted territory, the are no clear rules and regulations, there is a lack of readiness in the infrastructure, and large investments are required.
According to the authors, the European Commission and the IMO are the main regulatory institutions, and their regulations have the most significant impact on the shipping industry.
EU ETS Regulations
In 2025, container shippers are to pay 40% of reported emissions from the previous year. In 2026, they are to pay 70% of reported emissions from 2025, and starting 2027 they are to pay for 100% of their reported emissions.
We calculated the carbon cost associated with transporting a TEU on designated routes. This estimation is based on the distance the TEU would cover, which, in turn, allowed us to estimate the carbon emissions. We applied carbon pricing to determine the associated cost. By expressing this cost as a percentage of both the spot and 5-year average on these routes, we can gauge the extent to which the freight rates on these routes would need to increase in order to balance out the carbon cost.
Why would customers agree to the extra charges that comes with green shipping? According to a survey conducted in a BCG Shipping Decarbonisation study, approximately 50% of customers indicated that “Regulation” is their reasoning. Another motivator is “Customer Demand”, as consumers hold corporations accountable for their emissions. Additional factors are “Financial Market Pressure” and “Charge Higher Prices”.
The Science Based Targets initiative (SBTi)
Science-based targets clarifies the way for corporations to minimize their greenhouse gas emissions. These targets are deemed “science-based” when they align with the objectives of the Paris Agreement, which aims to restrict the temperature rise to 1.5°C above pre-industrial levels.
As of September 2023, COSCO, NYK, and K-Line had their net-zero goals verified. Meanwhile, Evergreen and Maersk have pledged to modify and/or hand in their targets for validation within 24 months. The commitment status of CMA-CGM is no longer valid.
Considering that the shipping industry is responsible for nearly 3% of greenhouse emissions, it is crucial to introduce the industry to green fuels and to mandate guiding regulations. At its current early stages, green fuels cost significantly more than EU ETS rates, making the challenging task of switching to green fuels even more difficult. A survey was conducted by the BCG in 2022, revealing that most people agree to paying a minor shipping premium.
Hydrogen, methanol, natural gas, ammonia, and biofuels are only some examples of available alternative fuels in the market, with LNG being a popular transitional fuel. Each alternative fuel poses its own risks and challenges, but the benefits essentially outweigh the risks. In addition to alternative fuels, more needs to be done to minimize emissions, such as optimizing shipping routes. People expressed different reasons for pursuing green fuels despite the challenges, ranging from following regulations to fulfilling customers’ demand. To guide the way towards achieving decarbonization, the SBTi was introduced and is being followed by major corporations.