Shipping requires high operating leverage, relying on borrowing to ride out trading patterns, cost price fluctuations, and changing economic conditions. Now, the supply of money is pivoting towards incentivising greener shipping as poor environmental outcomes are equated with credit risk and evolving regulations give financiers pause for thought about asset stranding.
Global professional services giant PWC believes that there is a strengthening bond between better ESG performance and shipping finance. In 2020, their Head of ESG and Maritime Sustainability, Dimitris Sakapis, said, “Investors are now considering that ESG performance is highly correlated to creditor risk and they look to integrate ESG related risk factors into their investment processes.”
By interpreting ESG performance as a measure of creditor risk, financial institutions are favouring operators who are making positive progress towards decarbonisation. The Poseidon Principles are a clear example of pressure being exerted from the finance sector that is likely to have an impact on the competitive landscape in shipping.
Poseidon Principles
The Poseidon Principles is a voluntary ship finance charter which discloses the ‘climate alignment’ of the shipping portfolios of signatory financial institutions. The principles are:
- An assessment of climate alignment. This requires carbon intensity to be measured and assessed to ensure individual portfolios are on the correct trajectory in line with decarbonisation targets.
- Accountability. The information used will be issued by classification societies or other IMO-recognised bodies to eliminate bias in the reporting.
- Enforcement. Covenant clauses are included in new business contracts that are designed to ensure the quality of the reporting information.
- Transparency. Climate alignment scores for all signatories are shared publicly on an annual basis.
They are intended to encourage increased investment in greener ships by setting a baseline that aligns with the UN Paris Agreement to limit global warming to below 2 degrees celsius over pre-industrial levels .
Fleets that are financed by Poseidon lenders are required to report carbon intensity data to help the lender ascertain whether their portfolios fall in line with climate goals – i.e. reducing total annual emissions from shipping by at least 50% by 2050. The measurement used is called the Annual Efficiency Ratio (AER) which is reported in grams of CO2 per deadweight ton-nautical mile (gCO2/dwt-nm).
The principles are aimed primarily at financiers, lenders, and export credit agencies, with 29 major financial institutions currently signed up. They were extended in December 2021 to include the marine insurance industry and this creates a double-pronged approach because ships cannot sail uninsured and finance cannot be secured on uninsured ships.
In a 2021 open letter to the U.S. Securities and Exchange Commission (SEC), sustainability NGO Ceres noted how Poseidon supports the idea that, “Today’s investors and lenders seek to track absolute GHG emissions to measure and hold companies accountable for promised reductions, in order to arrest both specific and systemic collapses in asset values and businesses.” The letter continues to describe how investors “…want honesty about how net zero commitments are being met” and Ceres believes financial institutions and the banking sector “seek this information both to protect the capital they have invested in individual companies as well as to protect their portfolios overall from the systemic risks of climate change.”
As a founding signatory to Poseidon, ABN-AMRO believe that transparency and reporting on sustainability is the first step towards sustainable shipping. They go further, stating that their role is now “to decline funding for projects which fail to contribute to the greening of the shipping sector.”
ABN believes that achieving sustainability in shipping requires greater cooperation between cargo owners and ship operators, and supporting “…innovations, technical adjustments, and operational improvements – all with an eye to their financial feasibility.”
Commenting on the process, ABN’s Global Head of Transport and Logistics Clients, Joep Gorgels, said, “Just getting rid of all the non-efficient vessels in one fell swoop would not only be a destruction of capital, but it would also be impossible from a practical perspective. The shift will take decades.”
The growing reality is an industry where carbon levies are common, financial backing options are limited and climate-aligned, and more stringent enforcement of efficiency measures consolidate meaningful change in order to meet industry wide regulatory requirements.
The world’s largest shipping financier BNP Paribas also aims to “align our ship finance portfolio to be environmentally responsible and to lead by example in the reduction of GHG emissions”. The highly influential French banking group has a shipping portfolio in excess of US $17bn and reporting on its climate alignment annually will apply sustained pressure to work with their clients to make improvements.
Sea Cargo Charter
In many ways, the Sea Cargo Charter, or SCC, is a carbon copy of the Poseidon Principles. However, there are some key differences. Firstly, this initiative is aimed at cargo owners and charterers rather than financial institutions and currently it is only open to bulk cargo.
The SCC attempts to promote decarbonisation by setting an environmental benchmark for charterers and improving transparency on emissions reporting in the sector.
The principles match those in Poseidon – assessment, accountability, enforcement, and transparency, and similar to Poseidon, the SCC also has 29 signatories to date, including Chevron, Maersk Tankers, and Shell.
Another important distinction between the two frameworks is that they focus on subtly different measurements. Where Poseidon uses a carbon intensity metric called AER, which measures the grams of CO2 emitted per vessel deadweight ton over one nautical mile, the Sea Cargo Charter uses the IMO’s Energy Efficiency Operational Indicator (EEOI), which measures the grams of CO2 emitted per ton of cargo carried per nautical mile. What this means in principle is that, reported annually, Poseidon incentivises absolute improvements to ship efficiency, whereas the Sea Cargo Charter is measured on a voyage specific basis – discharge to discharge – encouraging charterers to maximise slot, pit, or tank utilisation and discouraging voyage legs in ballast conditions (i.e. with no payload onboard).
Sea freight data and insight provider Siglar recently described the SCC as “a major catalyst in the green transition of the shipping industry due to the potential opportunities it can bring in emissions reductions”’ It is possible that over time, the SCC will grow in scope and scale, or be replicated across other ship sectors. Many stakeholders agree that these initiatives have the potential to encourage companies to take responsibility and take leading roles in self-regulation.
Bulk shipping has been largely immune from corporate social responsibility in the past. But as previously discussed, the reality is that having a transparent approach to the environmental, social, and governance aspects of business management (ESG), is becoming increasingly important to cargo owners, charterers, and financiers. Taking proactive approaches like joining the SCC sends a clear message that shipping has become more self aware and is willing to become more transparent.
The growing reality is an industry where carbon levies are common, financial backing options are limited and climate-aligned, and more stringent enforcement of efficiency measures consolidate meaningful change in order to meet industry wide regulatory requirements. What better way to manage change than to show regulators that an industry is capable of mature self-governance?
The SCC has been welcomed more cautiously by some industry bodies. BIMCO and the International Chamber of Shipping (ICS) have both publicly expressed reservations around the measurement formula chosen. However, more ambitious targets are expected to be announced in the first half of 2022 and for now at least, it looks like the utilisation-based metric is here to stay.
Global maritime carbon levies
In September 2021, the ICSpresented the UN New York City Climate Week with an in-depth proposal for what would become the shipping industry’s first global carbon levy. This submission called for an internationally accepted market-based measure (MBM) to accelerate the uptake and deployment of zero carbon fuels. Targeted at globally trading vessels exceeding 5,000 gross tons, ship owners would be required to contribute towards an IMO climate fund for each ton of CO2 emitted by their vessels. This climate fund is intended to be used for further development of alternative fuel technologies and bunkering infrastructure.
This mandatory global MBM is not the only proposal to have been presented as a call to action within the industry in this way. Operators such as Maersk Tankers have themselves been calling for a levy of $150 per ton of CO2 emitted in the form of a carbon tax. Others, including Trafigura, one of the largest ship charterers, have proposed levies of $250-$300 per ton of emitted CO2 to be enforced. While these companies will have one eye towards maximising green market differentiators and further marginalising more polluting carriers, it is clear that these types of levy have the potential to spread the cost of funding the research and development required for shipping to make a mass-market move towards clean energy. According to a 2022 report by UMAS on behalf of the Getting to Zero Coalition, a carbon price of US $173/ton CO2 would fund a 50% reduction in CO2 by 2050, but interesting a 10% price rise to US $191/ton would be sufficient to fund a full 100% decarbonisation effort.
The European Union (EU) is also encouraging a proportional shared responsibility for creating market conditions that are favourable to decarbonisation with their ‘Fit for 55’ package, which has included maritime emissions in the bloc’s emissions trading scheme (ETS). The scheme, when enforced, will see ship owners regardless of the flag they fly, buy carbon allowances to cover all emissions during voyages in the EU.
Sustainable Shipping Initiative (SSI)
According to the organisers, the SSI is a ‘beyond compliance’ scheme that is working to ‘drive change through cross sectoral collaboration and a holistic approach to addressing the sustainability challenges faced by the shipping industry’.
In essence, members of the SSI set standards for themselves, with the overriding goal of representing industry thought leadership and proposing standards across their wider peer group. Among the 15 current members are Lloyds Register, Swire Shipping, and Wilhelmsen Ship Management to date.
To achieve their aims, the SSI has six vision areas; oceans, communities, people, transparency, finance, and energy. Each of these areas has defined objectives related to the UN Sustainable Development Goals (SDGs), and includes desired outcomes and milestones to measure progress with ambitions to reach beyond shipping across the entire supply chain.
Since its inception in 2010, the SSI has announced a range of outcomes, including the creation of the ship recycling transparency initiative which aims to encourage self regulation that improves ship recycling processes. Clean technology has been another working area for the SSI with work being completed that enables the widespread uptake of technologies. Interesting work is also ongoing within sustainable biofuels. The SSI are actively contributing to focus on facilitating an assurance process and common reference point for the industry around sustainability criteria for zero and low carbon fuels.
The call to shipping is loud and clear: Fleets must digitally decarbonise and improve their compliance now with the shifting needs of their customers and the finance sector, or risk losing too much ground to competitors to even consider a ‘future fuels’ based decarbonisation program.
Ignorance to ESG policies no longer satisfies global demand – cargo owners now need more help to reduce their scope 3 emissions and global regulators and the finance sector are aligned on providing measures to ensure they get it.
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