THE shipping industry faces a generational challenge. It must transition away from fossil fuels as the dominant marine energy source within the lifespan of today’s newbuilt ships, but it must do so amid regulatory, financial and technical uncertainty.

And the industry is behind the curve. 

Today’s efficiency efforts are not emerging fast enough. The consequence of that is a pathway of CO2 emissions diametrically opposed to the now-radical reductions required across all sectors by 2030 to make up for the lack of progress made so far.

The sector is on a path that requires urgent correction from both a commercial and policy perspective in order to avoid significant risks to the sector and to global trade. 

To examine what that means for shipping businesses, Lloyd’s List interviewed dozens of the industry’s most influential business leaders from across the maritime value chain to discuss the changes that lie ahead and the obstacles yet to be overcome. 

Between them they set out the essential elements of the transition ahead: the political, technical, economic and commercial requirements, and the actions needed from the sector to deliver on them.

The industry debate to date has focused on fuel choice and then leapt straight to carbon pricing and policy. This oversimplifies the transition, which is likely to be disjointed and not led by a single policy solution in the near term.

The consensus that emerged among the experts interviewed for this report therefore prioritised industry leadership, collaboration and early-stage public and private investment over and above near-term regulatory clarity as the most important drivers of change today. Following that, first mover action with efforts to secure a global policy framework that will bridge the pricing gap to viable emerging zero-carbon fuels is a given, but the absence of an immediate regulatory framework is no longer seen as a prerequisite to progress.

Rather than focusing on the slow pace of regulatory consensus as the starting point for zero-carbon plans, the priority has now shifted to the quick wins and first-mover projects that can create demand signals and secure public sector and private investment quickly. 

Rather than focusing on a single ideal fuel option, multiple fuel pathways and multiple infrastructures are now being assumed.

Rather than investing in siloed projects, the race is now for collaborative solutions to be tested and evaluated, costs reduced, and opportunities and risks crystallised.

The five steps to zero-carbon shipping
Through our conversations with industry leaders we have identified five critical areas of change that will need to happen to get shipping on track to meet zero emissions targets.

1. Demand
First movers need to invest ahead of regulatory certainty

A regulatory framework with carbon pricing at its core will be an essential component of the pathway to zero carbon, but first movers need to invest ahead of immediate regulatory certainty. In the near term, clear demand signals from shipowners and cargo owners are required to catalyse collective investment, reduce costs, and scale pilot projects.

Partnerships between first movers to establish long-term offtake agreements for zero-emissions fuels ahead of the first vessel becoming operational are essential, but the industry still needs to rapidly scale projects, particularly in infrastructure where funding requirements are most significant.

Initiatives such as the US-supported First Movers Coalition, launched during the recent COP26 climate talks, aim to create the framework that will allow this early-stage investment to take place.

The creation of green corridors — specific trade routes between major port hubs where zero-emission solutions have been demonstrated and are supported — aims to create a framework to support growth and de-risk early-stage investment.

In the case of the First Movers Coalition, cargo owners commit to shipping 10% of their cargo using zero-emission fuels by 2030, while shipowners and charterers commit 5% of their fuel use to be zero-emission by the same deadline. This sends a strong demand signal for zero-emission shipping and fuels this decade — crucial for the early deployment of zero-emission vessels.

Without a near-term regulatory framework to bridge the cost differential between fossil and zero-carbon fuels, such efforts will struggle. However, those we interviewed for this report argue that industry leadership, collaboration, and early-stage investment from both the private and public sectors is critical to kick-start the transition and reduce costs and risks.

There was a consensus among the group that by reaching 5% scalable zero-emission fuels in shipping by 2030, there is now sufficient momentum behind first mover projects to create a tipping point that will allow for a rapid uptake across the industry in the following decades.

There was also widespread optimism that the roll-out of pilot projects will allow for early adaptation of technology and infrastructure, driving down costs.

2. Technology
The pace of R&D investment needs to accelerate and scale infrastructure

Zero-carbon vessel technology is still in early stages of development. However, a there is growing acceptance that multiple fuels and infrastructures will be required, not least because shipping will be competing globally for zero-carbon fuel supply. That will be a costly and complex transition in which energy efficiency and retrofitting will likely guide near-term strategies and flexible dual- or tri-fuel tonnage will dominate the mid-term transition.

There is now urgent need for accelerated R&D to develop zero-carbon vessels and electrolysis technology to bring down the costs of green hydrogen, the basic ingredient from which all future fuels will be made.

Under the accelerated timelines pledged by industry leaders interviewed for this report, large-scale system demonstrations are needed by 2025 to demonstrate viability and draw lessons learned. These will require collaboration between governments, industry, and financiers. It will also require a balance between the flexibility provided by multiple fuel and infrastructure scenarios and the increasing cost, complexity and availability to shipping competing with multiple sectors vying for zero-carbon fuels.

An industry guided by fragmented decarbonisation strategies may see not only increased costs, but also reduced attractiveness of vessels as an asset class for both institutional equity investors and debt providers. While seed funding for zero-carbon pilot projects is relatively abundant, significant financial backing to scale pilot projects remains scarce amid in the absence of a regulatory framework to support growth and de-risk investment. Investments required to ensure the fleet of ships can use scalable zero-emission fuels are significant and will not be limited to the financing of newbuildings, but also the huge cost of retrofitting the existing fleet.

However, the largest investments will be associated with land-side assets and the ultimate speed and scalability of land-side infrastructure for producing and supplying new fuels will be the key determining factor of shipping’s fuel transition, rather than the shipping industry’s choice of technology or ship design.

Much of the current strategic thinking from those leaders interviewed is based on the assumption that growing demand for hydrogen and hydrogen-derived fuels will help lower their costs, especially for green hydrogen-based fuels, by driving up the scale of production.

3. Finance
Transparency will change business models and filter investment

In the short term, the industry needs to bridge the gap between aspirational rhetoric and the minuscule quantities of cash currently scaling siloed pilot projects. Advances in the production and distribution of zero-carbon fuels are still required before a business case can be made, so the short-term challenge for shipowners to at least 2030 rests on energy efficiency, transitional dual-fuel flexibility and financing retrofits of the existing fleet.

Longer term, clarity is required on the pricing of sustainability risk and how big the carrots and sticks will need to be to make shipping’s accelerating zero-carbon transition a reality.

The largest finance requirements will be associated with land-side assets, but the investments required to ensure the fleet of ships are able to use scalable zero emission fuels are significant and these will not be limited to the financing of newbuildings, but also require significant expenditure on the existing fleet. That presents a challenge to the increasingly stringent requirements of ESG lenders.

The zero-carbon transition will challenge traditional ownership models ill-equipped to adapt, but decarbonisation alone is not a business strategy and the overall ability to yield a return on invested capital in shipping will not improve just because the fuel mix changes.

Most of the owners interviewed for this report anticipate more structural shifts as part of the energy transition longer term that will in part be driven by environmental, social and governance requirements; political, regulatory, and financial transparency requirements; cost of capital and shifting trade patterns. While that will not necessarily equate to a sea change for all sectors and individual companies, those factors will encourage trends towards companies with scale, likely integrated into cargo supply chains, where the predictable stability of long-term contracts and financial requirements end speculative building cycles.

It is more difficult to identify a scalable business case for tramp operators that do not operate on long-term cargo contracts for specific cargo owners. The natural conclusion of that will increasingly challenge mid-sized private entities that have dominated shipping’s fragmented business models for much of the last century.

Meanwhile, lending to shipping has already begun to hinge on shipowners’ ability to satisfy the banks’ environmental, social and governance criteria. While many of the remaining bank lenders to shipping and capital market providers have long held so-called ESG targets linked to projects, a combination of regulatory pressure from governments keen to accelerate climate change policy and ratings agencies factoring in sustainability risk on rated debt has intensified pressure on lenders to tighten standards on lending.

That process is expected to accelerate and while banks have no ambition to regulate by proxy, they also have no obligation to lend. Banks and financial institutions merely have to figure out which clients to select and that will increasingly be a case of capital only flowing in the direction of companies that are doing ‘the right things’.

4. Collaboration
A holistic supply chain approach is required to stretch beyond shipping’s siloed borders

The decarbonisation challenge is shared across industries and sectors, but maritime will not be able to make progress alone. Feasible fuel pathways exist. But accelerated action and cross-industry collaboration are needed to spur research and development and realise large-scale system demonstrations by 2025.

Specifically, collaboration between governments, industry and finance, with governments playing a larger role early on to catalyse first mover activity, is now needed. But it also requires individual companies to collaborate on innovation and create new business models and new ways of sharing costs in the search for a more efficient supply chain.

Industry leaders interviewed acknowledged that the maritime sector’s traditionally insular and siloed approach had slowed progress, but the emergence of cross-sector platforms pulling in expertise from across the maritime value chain has catalysed collaboration.

5. Policy
A carbon pricing framework is required to bridge the gap between fossil and zero-carbon fuels

A political and commercial consensus is growing around a push to accelerate shipping’s decarbonisation targets to net-zero emissions by 2050, effectively doubling the ambition of the current internationally agreed targets.

But the process of agreeing that lift promises to be a divisive battle inside the International Maritime Organization between developed and developing states still wrangling over the basics of climate finance contributions, not to mention the mechanics of market-based mechanisms and which institutions control climate cash. No proposal that fails to explain and address the cost burden to developing countries will pass at IMO – or anywhere else. This problem helped doom COP26 and future talks over carbon pricing cannot ignore it.

But the IMO’s push for a global regulatory consensus is by no means the only regulatory game in town.

The European Union has committed to an economy-wide greenhouse gas emissions reduction target under the Paris Agreement, which has been translated into European Climate Law. This makes the EU climate objectives — of at least 55% net GHG emission reductions by 2030 below 1990 levels and climate neutrality by 2050 — legally binding for EU member states, and shipping is firmly in the mix.

The regulatory piece of the industry’s decarbonisation jigsaw puzzle is yet to fully take shape and, until it does, uncertainty will continue to create risk for businesses.

While industry leaders agree that early-stage progress is not entirely dependent upon a global regulatory framework. But without new policies, the price gap between green and dirty fuels will persist for decades, hindering the decarbonisation of shipping and that of the global economy dependent on shipping.

Regional and bilateral policies will help early mover short- to mid-term decarbonisation efforts, but ultimately a global regulatory system will be required. Pricing carbon and reducing the costs of zero-emission alternatives through subsidies, using a basket of market-based measures, will help those alternatives compete. How fast the IMO can agree this is not clear, but it has barely scratched the surface and a long war looms. Few countries have managed carbon prices; agreeing a global measure is incomparably harder.

Back in 2013, when market-based measures were last on the table, the IMO debate spectacularly imploded, as climate economics created a schism between developed and developing nations. Not enough has changed in the intervening years to instil any confidence that history won’t be repeated.

So, while technology, demand signals and collaboration have an important part to play, this is ultimately a climate finance battle, not an engineering problem.

For the IMO, there is also the added question of who controls those funds once they are agreed. The IMO itself is not an agency capable of administering billions of dollars of climate funds. The World Bank is already eyeing the opportunity, and if it can ensure that the money is ring-fenced to shipping, would seem to have the more apt skill set.

It will also be essential to adopt a tough mid-term measure, from around 2023, to close the price gap between fossil and green fuels by 2030.

An enforceable global IMO-led market-based mechanism therefore remains the key to unlocking the shipping industry’s ultimate decarbonisation.

Creating clarity from complexity

The shipping industry’s action plan to accelerate decarbonisation is not reliant on any single factor. Rather, it requires levers to be pulled across all five identified areas of action simultaneously

Regulation is needed to help bridge the initial zero-emission fuel cost premium and kick-start the transition, but initial investment must come first.

Freight purchasers need to commit to using decarbonised maritime freight to create a strong demand signal for zero-emission shipping and fuels this decade — crucial for the early deployment of zero-emission vessels.

Investment structures with longer maturity periods, a shift towards longer-term charters and stronger adoption of more stringent environmental, social and governance standards are required to support scaled zero-carbon investment.

Ultimately, market-based measures will be required to close the competitiveness gap between fossil fuels and zero-emission fuels by increasing the costs of using fossil fuels through setting a price on carbon. However, the immediate absence of a global agreement does not preclude progress at a regional level. Embracing actions at all regulatory levels is also more likely to accelerate adoption of global IMO solutions.

It seems clear that the industry’s decarbonisation efforts will fundamentally alter the competitive landscape and ultimately require different business models. Companies must be ready to consolidate, integrate, and collaborate across the value chain, using the full breadth of the capital markets to become more competitive, if they are to survive.