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Full steam ahead: As IMO 2020 approaches, how is the shipping industry preparing?

Full steam ahead: As IMO 2020 approaches, how is the shipping industry preparing?

Following the recent Marine Money Ship Finance Forums in both London and Hamburg, Ocorian Executive Director, Gary Bowman, who heads up the Ocorian Maritime team, analyses how commercial ship owners are facing the dilemma of deciding how to address international regulations minimising commercial shipping fuel sulphur content.

A common theme took centre stage across the Marine Money forums, with shipping companies, managers and brokers sharing concerns over the impending introduction of the International Maritime Organisation's (IMO) fuel sulphur regulations.

What is required?

To put the concerns into perspective, from 1 January 2020, the limit for sulphur content in fuel oil used by commercial ships operating outside designated emission control areas will be reduced from 3.5% m/m to 0.5% m/m.

Why the introduction?         

Put simply, standard bunker fuel is a major pollutant. The existing High Sulphur Fuel Oil (HSFO) used by the majority of commercial ships, contains 3,500 times more sulphur than standard specification diesel used in most everyday road vehicles in Europe. Following its combustion in the ship's engine, sulphur oxides are released into the surrounding environment as part of the ship's emissions.

If we put shipping's impact into context; in the port city of Hong Kong, shipping represented 54 percent of the city's total sulphur oxide emissions in 2008. HSFO of this nature is banned from every other industry and although it accounts for just two percent of global carbon emissions, it produces 13 percent of the world's sulphur emissions and 15 percent of the world's nitrous oxides. Both sulphur oxides and nitrous oxides are significant pollutants, but it is sulphur oxides in particular, that are a danger to human health.

In fact, a 2016 study on the impacts of ship sulphur oxide emissions on human health if fuel sulphur levels were not reduced, estimated that air pollution from ships would contribute to more than 570,000 additional premature deaths between 2020-2025.

Although shipping may be the most efficient option available to the trade and transport industry - carrying over 80 percent of all goods - the worrying health statistics feed into a larger narrative. Growing concerns over climate change and a rising consumer population demanding more in terms of trade, have forced the hand of the IMO; who have slowly cut sulphur content levels in bunker fuels since 2005's MARPOL Convention.

How is the industry reacting?

As evident across both forums, the industry is still searching for the best way forward. With differing views on the feasible alternative to HSFOs, ship owners are facing major investment decisions. The commonly held view is that there are four main options:

  • Switching to using Low Sulphur Fuel Oil (LSFO) of  0.5% m/m or Ultra Low Sulphur Fuel Oil (ULSFO) containing a maximum of 0.1% m/m. Initial concerns over potential undersupply of LSFO seem to have dissipated somewhat. Producers such as Sinopec and Abu Dhabi National Oil Company are increasing their production of 0.5% m/m bunker fuel in accordance with IMO's 2020 regulation. Regardless, LSFO costs significantly more than HSFO and with major players such as ExxonMobil having already patented their LSFO products, the lack of competition in pricing, excessive demand and fear of patent infringements will likely send LSFO prices skyward, driving many out of the market.

    It would make sense to switch to ULSFO, which is currently a requirement in designated Emission Control Areas (ECA) like the coastal waters in North America. Yet supply and price cloud decision making. Pricing is particularly accentuated by the challenge vessels face in cleaning their engine systems as they transition towards the new compliant fuel. This is also a costly and time-consuming process.
  • Ships can fit 'scrubbers' that clean the emissions resulting from HSFO combustion. Although the most convenient option for the majority - allowing vessels to continue using HSFO - fitting emission abatement technology such as scrubbers is costly (prices range from £800,000 to around £5 million per ship) and involves the vessel going off hire while the equipment is fitted. The industry also has a limited capacity to retroactively fit the vast number of ships requiring scrubbers by 2020.

    It was initially thought that HSFO would be sold at a discount of $250-$300 per tonne to  compliant vessels; an expectation that caused a good number of ship owners to install    scrubbers last year. However, recent
    fuel derivatives data reveals that the discount was only around $175 per tonne for 2020 calendar contracts. This will result in disappointing returns for ship owners.
  • Scrapping vessels. Although the more radical route, scrapping the vessels could prove to be more commercially efficient once the age and condition of the vessel is assessed.
  • Going green with liquefied natural gas (LNG). Many owners who are looking to order new vessels are considering LNG fuelled vessels. Opting for this route will avoid IMO 2020 issues completely and remove them from any future sulphur-related regulations. Although still a fossil fuel, LNG emits 10 to 20 percent less CO2 than even low-sulphur fuel oil. This option certainly holds potential, with analysts at Swiss bank UBS estimating the green shipping market could be worth at least $250 billion over the next five years. However, commercial ship owners need to consider that vessels powered by LNG cost around $5 million more annually than regular vessels.

A captain with little authority

In short, enforcing the new regulation will be a challenge. The IMO itself has no authority to enforce the 2020 rule and responsibility will lie with Flag and Port States who have ratified MARPOL Annex VI, giving them an obligation to enforce IMO 2020. However, the IMO has not established a set fine or sanction, so it remains to be seen how Flag and Port States will adjudicate the enforcement over such great expanses of ocean. Some may opt for criminal charges whereas others may be substantially more lenient.

For the greater good?

Responsible for 10 percent of all oil used in global transportation, the shipping industry and each associated sector have felt sizable tremors as a direct result of the IMO regulation. Estimates suggest that for the liner industry, the cost of compliance with the IMO's sulphur cap could be as much as $15bn annually, with a typical round trip from Asia to Northern Europe costing carriers an extra $1m.

From oil refineries through to ship builders, ship owners' race to comply in time with the introduction of the regulations is straining all involved. Yet the positive impact of the regulation must be remembered; whilst it is shaking up the refinery and shipping industries, compliance will contribute to a greener industry and catalyse the transition to higher-spec, energy efficient models.

Ocorian provides corporate administration for many vessel owning structures in the maritime industry, and we will be monitoring developments with interest as 2020 fast approaches.

Given the varying costs involved in complying with these new regulations, depending on which option is chosen, situations could very well arise where the refinancing of vessels is required to cover the costs of compliance and in such situations, especially where syndicated loans are favoured, Ocorian can provide a tax neutral offshore platform to facilitate this. To discuss this further, get in touch with Gary below or to find out more about our maritime offering, click here.

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