Investment to increase in green hydrogen-based fuels as regulations tighten.
Around 90% of the world’s goods are seaborne at some point in their lifecycle – from our Christmas presents up to crucial supplies of food and fuel.
“It’s an industry you can’t put on the internet; we will need shipping in the years to come, which means we have to ensure it is sustainable in the long term,” says Stephen Fewster, Global Head of Shipping Finance at Amsterdam-headquartered ING Bank.
Shipping is currently very carbon intensive, accounting for around 3% of global emissions, according to the Organisation for Economic Co-operation and Development (OECD), with maritime trade volumes set to triple by 2050, propelled by demand for global freight.
“Shipping decarbonisation is driven by four factors: the pace at which technology and alternative fuel costs come down, the demand and willingness from customers to pay for ‘green’ shipping services, changes in the regulatory landscape, and the availability of financing for green versus brown assets,” Matt Stone, Partner at consultancy firm McKinsey, tells ESG Investor.
“All four are moving quickly, but the big unlocks will come from accelerating technology and fuel cost-downs and major global-level changes in the regulatory environment.”
Decarbonising the shipping industry is expected to cost around US$1 trillion by 2050, according to a report published by maritime consultancy firm UMAS and the UN Climate Change High-Level Champions.
New regulations are emerging across regions like Europe, governments are making plans for green shipping corridors, and the UN-convened shipping regulator is introducing new decarbonisation rules from next year. The pressure is on for shipping companies to move more quickly in the climate transition.
As regulatory expectations force shipping companies to chart greener paths across the ocean, there are emerging opportunities for investors to invest in the upscaling of climate-positive solutions.
Buoyed by solutions
With the shipping industry using more than 300 million tonnes of fossil fuels a year (around 5% of global oil production), upscaling green hydrogen is seen as crucial.
Green hydrogen is produced by splitting water through electrolysis powered by renewably-generated electricity. It can then be utilised to power ships, while the oxygen can be vented back into the atmosphere with no negative impact.
In October, Hydrotug 1, arrived at a port in Belgium, where it will be fitted with a dual fuel system that can run on both 415kg of compressed hydrogen and traditional fuel. It’s expected to be fully operational by Q1 2023 and will eliminate the equivalent CO2 emissions of 350 cars.
However, pure green hydrogen isn’t necessarily the right solution for all shipping, according to Chiara Mingozzi, Junior Shipping Policy Analyst at Transport and Environment, a European clean transport campaign group.
“Hydrogen has very low density, making it difficult to store on large ships. The biggest ships will therefore have to use other, denser fuels made from hydrogen,” she says.
Green hydrogen-based fuels, like ammonia and methanol, are therefore becoming increasingly popular.
Ammonia is produced by combining hydrogen with nitrogen and is more ‘energy-dense’ by volume at around 3.5 kWH per litre, 30% higher than liquid hydrogen. It has already been used as fuel and fertiliser globally, but to fully convert deep sea shipping to ammonia will require huge investment in production capacity. Some estimates suggest it would need to quadruple by 2050 (a market size of US$5 trillion).
There are also concerns about its adverse side effects, such as toxicity and potential to “substantially alter” the global nitrogen cycle.
Some shipping companies and investors are expressing a preference for methanol, which is produced by combining hydrogen with captured CO2. Its volumetric energy density is even higher (4.33 kWh/l) and it’s also liquid at room temperature, which makes it much easier to handle than both liquid green hydrogen and ammonia – which need to be stored at around -253°C and -33°C respectively.
There are a variety of types of methanol fuel production to invest in. Blue methanol is produced using natural gas with carbon capture and storage (CCS). The most sustainable, known as e-methanol, is produced by pairing green hydrogen with CO2 from either bioenergy with carbon capture and storage (BECCS) or direct air capture (DAC).
However, the “feasibility” of these alternative fuels still needs to be demonstrated at scale, Rocio Nunez, Analyst at Moody’s Investors Service, tells ESG Investor. “Beyond production and development, testing will require significant investments,” she adds.
The best way to ensure these sustainable green hydrogen-based fuels are tested is to back well-known shipping companies who have “the biggest muscles to innovate and contribute to decarbonisation”, says Hans Thrane Nielson, Senior Portfolio Manager at Storebrand Asset Management.
Danish international container shipping company Maersk is seen as a leader in the development of green fuels.
With 19 vessels capable of running on green methanol expected to be in operation by 2023-25, Maersk has said it will require 750,000 tonnes of green methanol to run this fleet alone, prompting the company to announce seven strategic partnerships earlier this year.
In early November, Maersk also signed a General Protocol for Collaboration with the Spanish government, pledging to explore opportunities for large-scale green fuels production in Spain, a commitment which could potentially deliver up to two million tonnes of green fuels a year.
At COP27, a number of other shipping companies signed a joint statement committing to the “rapid and ambitious” production and use of low-carbon fuels based on green hydrogen, including representatives of the Aspen Shipping Decarbonization Initiative.
Shipping companies will face increasing pressure over the next few years to reduce their emissions, thanks to an upsurge in new initiatives and regulations targeting the decarbonisation of shipping.
“Regulations that have the highest potential to drive the uptake of e-fuels in shipping are the EU’s Renewable Energy Directive (RED III) and FuelEU Maritime, which target fuel suppliers and fuel demand respectively,” says Transport Environment’s Mingozzi. Both directives were introduced as part of the Fit for 55 raft of measures.
In September, the European Parliament voted through RED III, which includes a commitment that 5.7% of all transport fuels must be renewable fuels of non-biological origin (RFNBO), including green hydrogen and green ammonia. In addition, 1.2% of all transport fuels should be supplied to the maritime sector in the form of RFNBOs.
However, Parliament decided against a delegated act that would have required all renewable energy hydrogen producers to only source electricity from green-energy projects. Grid-sourced electricity would have been allowed in instances where it could be offset by renewable energy within an hour.
“RED III is the holy grail for the shipping sector; it’s a very strong directive that will accelerate the adoption of green fuels,” says Thomas Engelmann, Head of Energy Transition at German asset manager KGAL.
The following month, the European Parliament voted to adopt the FuelEU Maritime law. Ships travelling within the EU will be required to reduce the GHG intensity of their shipping fuels by 2% by 2025 (compared to 2020 levels), 20% by 2035 and 80% by 2050. However, only half of the energy used by vessels coming from or travelling to regions outside of the EU will be covered by the law.
At the end of November, the inclusion of maritime transport within the EU Emissions Trading System (ETS) was finally agreed, with further negotiations on raising the existing ETS’ ambition and finalising EU ETS 2 continuing this week.
ETS 2 captures “a significant portion of ocean-going vessels,” says Declan O’Brien, Head of Research and Strategy for Infrastructure at UBS Asset Management.
The existing ETS currently covers industrial and energy industry production processes, setting a cap on the amount of CO2 emissions that can be released by EU-listed companies in these sectors through a limited number of ‘free allowance’ credits. Over time, this will be replaced by the Carbon Border Adjustment Mechanism (CBAM), for which the European Council and Parliament announced their provisional agreement on Tuesday.
ETS 2 will cover other industries, including maritime transport. The current draft notes that EU-listed shipping companies will have 40% of their emissions covered by ETS 2 by 2025, increasing to 70% in 2026 and 100% by 2027. Initially focused only on CO2 emissions, nitrogen oxide, soot and methane will also be included from 2026.
“However, at current ETS price levels and considering the estimated carbon abatement costs, we do not think it will move the needle by much,” O’Brien notes.
Notwithstanding the extraterritorial nature of CBAM, carbon pricing for the shipping industry “needs to be global and enforced through the International Maritime Organization (IMO)”, says ING Bank’s Fewster, noting that “shipping is a global industry and should therefore fall under global regulations”.
The IMO is a specialised agency of the United Nations responsible for regulating shipping, so has the capability of enacting widespread, sustainable changes.
“Regulating emissions from international shipping has been slow progress as any IMO rules need to be agreed upon by its 175 member states, and sector participants have conflicting motives to invest in clean technologies,” notes Louis Bromfield, Lead Sustainability Associate at UK-based Foresight Capital Management.
IMO currently has ambitions to at least halve the sector’s annual CO2 emissions from 2008 levels by 2050 – a target Bromfield labels as “modest” – through the Carbon Intensity Indicator (CII) and Energy Efficiency Ship Index (EEXI), which both come into effect on 1 January 2023.
The EEXI will require ships with a 400 gross tonnage (gt) capacity and above to determine their energy efficiency compared to a baseline (which varies depending on the size of the ship). The IMO has said a ship’s EEXI must be lower than the required EEXI for its size to ensure the ship meets the minimum energy efficiency standard.
The CII determines the annual decarbonisation rate needed to ensure “continuous improvement” in a ship’s operational carbon intensity, in line with IMO’s commitment to reduce the carbon intensity of international shipping by 40% by 2030.
We are also seeing more cooperation on green shipping between governments.
Following the Clydebank Declaration announcing the establishment of green shipping corridors at COP26, COP27 saw the introduction of the Green Shipping Challenge.
Norwegian Prime Minister Jonas Gahr Støre and US Special Presidential Envoy for Climate John Kerry chaired the launch of the challenge during COP27’s World Leaders Summit, with partners pledging to carry out actions to help develop, design and build zero-emission ships. Over 40 major shipping-related announcements were made by countries, ports and companies that aim to further the transition to green ships and low- or zero-emission fuels.
These include Australia and Singapore’s collaboration on green shipping corridors and Germany pledging €30 million a year to the development of climate neutral ships.
With the regulatory landscape shifting to accommodate sustainability, it’s now up to the companies to transition. Increasing regulatory certainty also paves the way for investors to inject capital into the climate-positive solutions needed to ensure that the shipping industry can fulfil net zero commitments.
“The shipping industry has made substantial progress over the past three to four years in deepening its understanding of what it will take to decarbonise,” says McKinsey’s Stone.
“We now see companies really leading the charge, and there are very few boardrooms where the topic of decarbonisation isn’t a top three topic of discussion today.”