If the shipping industry were a country on its own, it would be the sixth largest greenhouse gas emitter worldwide. Economic and regulatory pressures, including the much-discussed IMO 2020, have been building up and there is no question that it is time for all maritime stakeholders to start preparing for new decarbonisation challenges. In this blog we explore an internal pricing mechanism and an external collaboration, which each provide new opportunities for financiers to aid and profit from decarbornisation initiatives.
The main obstacle to industry-wide decarbonisation lies with the industry’s composition; it is largely privately owned, and both shipowners and charterers are driven by short-term cyclical patterns. So far, public environmental concerns have not effectively been translated into any tangible pressure.
Incentivising shipowners is further complicated by the fact that they are responsible for investing in fuel-efficient technologies whereas it is the charterers who, in most cases, pay for fuel. As a result, only a small part of the fuel savings are passed back to the shipowners.
Nevertheless, financiers have an important role to play in helping the industry move towards effective decarbonisation. There has been an increasing desire to hold greener portfolios, which stems from a practical need to mitigate against the risk of future (and more stringent) environmental regulations that could directly impact the value and liquidity of vessels, as well as the profitability of potential loans. The two strategies we explore below, could be the first steps towards financiers incentivising shipowners to invest in cleaner technologies.
Internal carbon pricing
Leading economists and industry experts have shown that carbon pricing can play an important role in steering the maritime sector towards decarbonisation. An internal carbon price works as a shadow (or hypothetical) carbon price selected by the financier and it is used to evaluate the sensitivity of prospective financing to future regulatory scenarios. The financier can use this information to identify and manage risks associated with the implementation of carbon policies. It will also provide the financier with a benchmark of where the vessel sits among peers and can give the bank an idea of the vessel’s ability to remain competitive in carbon-constrained markets.
Using internal carbon pricing will allow financiers to carry out quantitatively informed due diligence on new investments and to apply internal carbon pricing to any lending decisions they make. In practice, this will help financiers make smarter investments based on a more accurate picture of a loan’s or portfolio’s value in an economic landscape affected by new environmental policies.
Earlier this summer 11 leading banks with a collective portfolio of more than U.S.$100 billion (around 20 per cent of the global ship finance portfolio) came together to sign up to the Poseidon Principles – the world’s first sector-specific, self-governing climate alignment agreement between financial institutions. They established a global framework for assessing and disclosing the climate alignment of their ship finance portfolios and ensuring they are consistent with the policies and ambitions of the IMO.
It is expected that the Poseidon Principles will provide a new financial incentive towards the IMO’s ambitious goal of reducing shipping’s total annual greenhouse gas emissions by at least 50 per cent by 2050. Like the internal carbon pricing incentive, the Poseidon Principles should change the conversations between shipowners and financiers, especially in relation to the types of vessels and projects the financiers might or might not choose to finance.
The banks have agreed to use a uniform methodology to measure the carbon intensity of their shipping portfolios, as well as to assess how their portfolios compare with established decarbonisation trajectories. The banks will then contractually enforce the principles with their clients and also publish the scores for their portfolios’ climate alignment annually. The scoring will not only help financiers make informed decisions when they choose (or choose not) to finance a vessel, but also help inform potential buyers of loan portfolios of their current value and future profitability.
These two methods are preliminary steps in what we expect to be a long and challenging journey towards decarbornisation of the industry. For there to be a substantial effect on decarbonisation, it is likely that these initiatives must continue into the next decade and beyond.