IMO ponders new GHG policies, while shipping sector awaits low-carbon economic incentive

Global shipping regulators will soon have to decide whether and how to penalise the use of fossil fuel and whether and how to incentivise the use of greener fuel. Drewry provides a short analysis and comparison of policy discussions, including their possible shortfalls.

In July 2023, the International Maritime Organisation (IMO) set new decarbonisation targets and announced an aspiration that 5 to 10% of marine fuel would be low- or zero-greenhouse gas (GHG) by 2030.

At that time, Drewry and other industry stakeholders noted that the huge question of how to bridge the cost gap and level the playing field between conventional fossil fuel and new, more expensive greener fuel, has not yet been addressed by the IMO.

Green marine fuel currently costs 3 to 4 times conventional marine fossil fuel like Very Low Sulphur Fuel Oil, for the same energy. It is hard to ignore this huge economic disincentive.

The IMO is now expected to discuss in MEPC  81 in March “mid-term measure(s) including an economic element, namely a maritime GHG emissions pricing mechanism, for adoption by 2025 and entry into force by 2027.”

Technical and economic regulations ahead

All the proposals to be considered at MEPC 81 stress that they are guided by the 2023 IMO Strategy on reduction of GHG emissions from ships, and the trajectory to zero emissions set out in that Strategy.

The strategy and overall policy direction can be summarised as follows:

• The IMO’s Mid Term Strategy envisages a combination of “technical” and “economic” measures to achieve those goals.
• The “technical” GHG Fuel Standard measure, a marine fuel standard limiting marine fuel’s GHG emissions, to be ratcheted up over time, appears to have wide support at the IMO.
• “Economic” measures – penalties for using fossil fuel and rewards when avoiding emissions, are more controversial.
• It is worth noting that in concept the proposed basket of technical and economic regulations is no different from the EU’s combination of the Emission Trading System (ETS) mechanism (economic) and ‘FuelEU Maritime’ (technical).
• It is also accepted that economic measures are needed in addition to the GHG Fuel Standard to accelerate the reduction in GHG emission fuels, and to ensure a ‘critical mass’ is achieved in the production and use of low emission fuels.

Policy proposals

A number of papers for consideration at MEPC 81, from both governments and Non-Government Organisations, put forward a variety of economic measures, intended to apply in parallel with a Fuel Standard technical measure.

Drewry notes that:

• All proposals have as their objective providing a financial incentive for shipping lines to use low GHG fuels by balancing the cost of these fuels vs high GHG emission fuels.
• Several propose a ‘feebate’ system where there is a levy on the emission of GHG emission fuels, with funds being allocated to reward those using eligible low/zero GHG fuels, as well as providing funds to support projects designed to assist in the GHG reduction in the maritime sector.
• At least one proposal proposes a levy, without a counterbalancing reward.
• Some proposals are based on the principle of equalising costs between GHG/non-GHG fuels (see comparison table below), with a mechanism to determining the actual fee/reward later; others propose that cash values should be established for (say) a five year period, to give certainty to those investing in new fuels, with the ability to increase the cash fees/rewards later as needed.

With a variety of approaches proposed, it is hard to evaluate which would be the most successful at incentivising increasing uptake of low/zero carbon fuels, and no doubt this will be one of the main debates at MEPC 81.

• At one end of the scale, the World Shipping Council (WSC)’s ‘Green Balance Mechanism’ is one of the most rigorous proposals, as the feebate levels will be whatever is needed to equalise fuel costs.
• The other industry proposal from the International Chamber of Shipping (ICS) and others focuses more on setting an administratively straightforward feebate mechanism, which gives a degree of certainty to the shipping lines, but leaves governments at IMO to set the levels of fees/rebates.
• In contrast, a proposal from several island nations (including Marshall Islands, Solomon Islands) proposes a fixed fee of $150/t CO2-eq, with facility to review/increase the level. It is not specific as to how the money collected would be disbursed.
• A different proposal from a number of governments who have been opposed to a levy (Argentina et al) have nevertheless put forward an economic measure to supplement the fuel standard, based on a required carbon intensity per vessel, with penalties for those who do not achieve the required value, and ‘surplus units’ generated by those which over-comply. A different way of achieving the same goal?

Concerns about new regulations and impact assessment

One of the concerns expressed by some governments in previous debates has been the potential impact on trade of increasing the cost of shipping through fuel levies/taxes. IMO will be required to conduct an Economic Impact Assessment (EIA) on whatever measures it intends to take forward; an interim report on the potential impact of the cost of these measures will be discussed at MEPC 81.

Another concern is that the new regulations would have to address the cost gap between green fuel and fossil fuel to result in a rapid take-up of low/zero GHG fuel, a sufficient transition and sufficient investments. The timetable for transition is tight.

Governments are split between those who would have a high economic penalty to properly incentivise conversion, vs those who are more concerned about constraints on economic growth, and would only support a low penalty.

As a contribution to the inter-government discussions at the IMO, both the ICS and the WSC – representing the shipping sectors – have proposed pricing schemes that they believe would accelerate the decarbonisation of shipping and remove the cost penalty of greener shipping.

With the above variables, it is hard to predict whether IMO will succeed in adopting an economic measure which will be sufficient to drive the required levels of shift in fuel being consumed, but Drewry provides below a comparison.

Comparison of economic measures under consideration

The key comparators between the economic measures proposed are:

1. Who gets the money? Are the measures ‘sticks and carrots’ (WSC and ICS) or just ‘sticks’ (states’ proposals where the money goes to governments or good causes, but not direct to the shipping companies)
2. Is the quantum sufficient to be a proper incentive?

Under the ICS’s proposed scheme of a “Zero Emission Shipping Fund” mechanism, “contributions from ships per tonne of CO2e emitted will be used to reduce the significant cost gap between zero GHG fuels and conventional fuel oil, providing financial rewards (“feebates”) to ships for the GHG emissions prevented by use of these new marine fuels.”  Click here for further information

Under the WCS’s proposed “Green Balance Mechanism” scheme, “fees are taken from fossil fuels and allocated to green fuels used, so that the average cost of fuel is equal.” Click here for further information

The ICS said that the proposed scheme would be managed by the IMO using its existing fuel oil data collection system.

The WSC proposal appears to require a central fund to manage the penalties and the rewards.

Would these economic schemes act as a proper incentive? How much will it cost?

The WSC proposal would, since they state as a principle that it should be full reimbursement of the cost differential of green fuel (though the devil will be in the detail).

The ICS proposal needs more careful consideration. While in principle they want the ‘good’ shipping lines to be paid, they leave the quantum to governments at IMO. The warning signal appears to be that the economic assessment has an upper carbon price of $100 a tonne. If that is a signal to governments, it is not ambitious.

Japan’s feebate pricing scheme also envisages a low penalty/contribution per tonne of CO2e – only about $20 per tonne.

Clearly, the shipping industry is looking after its own interest – asking that new fees or taxes are reinvested in the industry to promote decarbonisation.

But the ICS and WSC proposals also have the merit of ‘doubling up’ the economic incentives to use low or zero-GHG fuel, as they both penalise use of high GHG fuel as well as rewarding low GHG fuel.

Decarbonisation will be costly for shipowners and for the end-customers, charterers/shippers.

The ICS calculated that to reach the IMO target for just 5-10% of the energy used by shipping to come from zero/near-zero GHG sources by 2030, the cost of reducing the cost gap with conventional fuel oil and rewarding the accelerated uptake of alternative fuels would be between US$5 to U$10 billion per year.

Nobody knows to what extent technical progress and scale economies will reduce the future cost of green fuel, or what the most effective future green fuel will be, but shipowners are unlikely to be willing to sail “green” voluntarily (except for low-scale experiments) if a cost premium of 200% or 300% kills their profit margins.

Drewry’s ESG team will quantify the impact of future regulations on GHG prices in due course.

Our View

The IMO is likely to adopt a mix of measures, including a technical measure (limited GHG contents in marine fuel) and a pricing measure (with penalties and with or without incentives).

Spreading the extra cost of decarbonisation across the industry – particularly in the early years – through a combination of incentives and penalties should be considered by regulators.
Source: Drewry