To make a meaningful reduction in carbon emissions the tanker industry must prepare for a radical transition
A new report by Maritime strategies International (MSI) on behalf of the European Climate Foundation considers the consequences for tanker shipping of a major shift in energy consumption away from hydrocarbons and towards renewables and biofuels. The report highlights that future projects will require two frameworks – ‘Reduction’ and ‘Reference’ – designed to provide a broad narrative and a structure to long-term global energy demand.
The decarbonisation of global energy supplies to address climate change will have radical implications for the global shipping industry. If the Paris Agreement goals are met, the fossil fuel cargo base that shipping serves will undergo an aggressive and prolonged transformation.
The MSI report does not provide commentary or assessment on the likelihood of the projected scenarios occurring, rather the scenarios are intended as frameworks to explore the implications for the shipping industry and associated capital markets of a major shift in energy demand.
The two scenarios are informed by projections made or commissioned by the Intergovernmental Panel on Climate Change (IPCC) and the timeframe of the report is out to 2050, though the temperature targets associated with the IPCC scenarios have timeframe objectives that extend beyond this period.
The Reference scenario is designed to provide a comparator to Reduction and describes a much more limited change in the global energy consumption profile. Under this scenario, global energy demand continues to grow robustly through the 2020s before stabilising in the 2030s.
The report uses MSI’s shipping market modelling systems to analyse how global fossil fuel demand reductions could alter inter-regional commodity trade flows and the associated shift in required shipping capacity, industry earnings and asset prices, across all segments of the shipping industry.
“While some sectors of the shipping industry, such as container ships, would be virtually unscathed, those for which hydrocarbons comprise a significant proportion or all of the cargo mix would undergo decades of falling demand,” says MSI director Stuart Nicoll.
“The results would be multi-decade declines in fleet capacity, earnings and asset prices across the affected sectors. Shipowners would be forced to slash new ordering and scrap uneconomic vessels.”
Under the Reduction scenario, global energy consumption is not projected to see significant growth out to 2050, but rather, fluctuate close to recent levels, with significant a reduction during the 2020s.
However, hydrocarbon use sees massive reductions. The most dramatic case is coal, which transitions from meeting about one quarter of global energy requirements to less than 5% by 2050. Over the same period the share of ‘Oil and Liquids’ halves from about one-third to less than 20%. Of the major hydrocarbon energy sources, natural gas sees the least relative reduction, but nonetheless drops from about a quarter of global energy to close to 15%.
The Reduction scenario also assumes an explosion in the use of both biomass/biofuels and renewables. Whilst the former presents its own environmental challenges, it also potentially offers alternative employment for ships. In the case of renewables, this replacement of shipping demand is difficult to envisage.
Mass renewable energy and vehicle electrification may require significant shipping of infrastructure materials and metals for batteries, etc, but this would be a one-off event in the energy chain, as these are components not feedstocks.
The majority of commodity shipping is associated with moving primary feedstocks. Further, renewable energy in the form of wind, solar etc cannot be shipped, only transferred electrically via fixed grid or battery once harnessed, so would not generate any trade in secondary processed commodities, such as seen now in the form of, for example, oil products and steel. In essence, this is one of the key benefits of renewables – they do not require a constant feed of extracted/polluting natural resources.
MSI concludes that by 2050 world consumption of oil would halve, coal consumption would fall by 80% and natural gas demand would peak in the near term before declining. The oil tanker market is most exposed to the low carbon transition, as its entire cargo base is made up of fossil fuels. Overall, MSI’s models suggest that under the Reduction scenario, tanker demand would fall by slightly more than a third. Setting aside the possibility of short-term factors driving spikes in demand, the MSI models suggest that tanker demand would fall year-on-year every year from 2025 onwards, under the Reduction scenario. Earnings in the 2030s for VLCCs would underperform their long-term median by around a third.
Of course, such dire markets would provoke a significant supply side reaction, with owners probably slashing new ordering and scrapping uneconomic vessels.
The tanker fleet would fall by around a third over the two decades after 2030. According to MSI, asset prices would be hammered, with a benchmark value of a five-year old VLCC under the Reduction scenario sliding by 29% over the same period.
MSI opines there may be mitigating factors. Renewable or non-carbon fuels may emerge, as could synthetic fuels (such as from carbon capture), and all would provide alternative sources of demand that are ideally suited to conventional bulk or gas shipping. But all of these potential sources of demand are in their infancy and represent a distant respite from the bleak picture painted above
In aggregate under the Reduction scenario, by 2030 the valuation of the tanker industry would be without respite, with the industry shedding 28% of its 2018 value by 2045.
The destruction of demand has significant ramifications for owners and financiers of vessels. It would hurt fleet utilisation, and the earning power of tankers and bulkers would collapse in the Reduction scenario.
The report suggests that restraining fleet supply would be key. Tanker shipping has been guilty of speculative ordering, warranted against historically low shipyard newbuilding prices without taking into account demand or long-term employment. In the past, a new ship would be first choice in the spot market due to lower fuel consumption; under the Reduction scenario, there may not be the depth of employment possibilities.
Ship financiers would also find themselves caught in a vice, with earnings unable to cover debt repayments and falling life expectancy reducing the runway to recover a loan before the vessel is scrapped. More efficient vessels may be somewhat better placed, as greater efficiency should lead to longer life expectancy. However, the prospects for successfully recouping a loan, never mind an equity investment, in a vessel heavily exposed to fossil fuel cargoes seem challenging under a Reduction scenario.
The report does not focus on the type of tankers required in the future, but notes that efficiency would be a key feature. This could lead to a shortening of lifecycles and the risk of tankers becoming stranded assets – unable to trade due to their relative inefficiencies. This would have a knock-on effect on revenue.