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A game changer forshipping industry
An analysis of the futureregulations on environment
www.pwc.com
An analysis prepared forthe ongoing discussionsin IMO and otherin IMO and otherinternational foraregarding future globalregulations of carbonemissions
June 2011
A game changer for theindustry?
future impact of carbonenvironment and industry
This material was prepared by PricewaterhouseCoopers AS (PwC) for the specific use of the NorwegianShipowners Association and is not to be used, distributed or relied upon by any third party without PwC’sprior written consent.
This publication has been prepared for general guidance on matters of interest only, and does not constituteprofessional advice. You should not act upon the information contained in this publication without obtainingspecific professional advice. No representation or warranty (express or implied) is given as to the accuracy orcompleteness of the information contained in this publication, and, to the extent permitted by law, PwC, itspartners, employees and agents do not accept or assume any liability, responsibility or duty of care for anyconsequences of you or anyone else acting, or refraining to act, in reliance on the information contained inthis publication or for any decision based on it.
© 2011 PricewaterhouseCoopers AS (N0rway)network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate andindependent legal entity.
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Contact: Team lead Ivar Strand: [email protected]
This material was prepared by PricewaterhouseCoopers AS (PwC) for the specific use of the Norwegianand is not to be used, distributed or relied upon by any third party without PwC’s
This publication has been prepared for general guidance on matters of interest only, and does not constituteprofessional advice. You should not act upon the information contained in this publication without obtainingspecific professional advice. No representation or warranty (express or implied) is given as to the accuracy orcompleteness of the information contained in this publication, and, to the extent permitted by law, PwC, itspartners, employees and agents do not accept or assume any liability, responsibility or duty of care for anyconsequences of you or anyone else acting, or refraining to act, in reliance on the information contained inthis publication or for any decision based on it.
PricewaterhouseCoopers AS (N0rway). All rights reserved. “PricewaterhouseCoopers” refers to thenetwork of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and
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Strand: [email protected]
Scope andobjective
Emerging policies are targeting CO2 emissions from shipping.Organization (IMO) have produced policy proposals, backed by research, on an international regulatoryregime to manage CO2 emissions from shipping.other international fora. The EU has also announced that it is examining the shipping industry’s role inmitigating climate change, potential through inclusion in the existing EU Emissions Trading Scheme(ETS).
In total, ten proposals have been submitted to the IMO for consideration as possiblemarket-based measures.– a levy and an emissions trading scheme. The proposals differ in detail and in principle.
The objective of this study is to clarify the policy options and their impacts onenvironment and industry.comparison and could be masking the underlying objectives of the schemes. The ongoing dialoguebetween policymakers and industry actors could benefit from a consolidation of facts and analysis as thebasis for deciding upon further action.
The policy process has producedunder the auspices of the International Maritime Organization (IMO), the European Union (EU) andothers. One area which has also not examined in detail is the impact on the shipping industry.
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others. One area which has also not examined in detail is the impact on the shipping industry.
The study aims to inform the ongoing process with analysis based on the core principles of the marketbased mechanisms. This includes crystallizing the impacts of key policy options and highlighting thetrade-offs between policies.
The scope of this study is to analyze the environmental and economic impact of marketbased instruments aimed at reducingis on the impact on GHG mitigation and the costs to the industry. This independent analysis hasleveraged and built upon previous research. Other issues, for example administrative arrangements, arebeyond scope of this study, but may also have significant implications on the policy decisions.
The work has been conducted during the spring of 2011 by an international PwC team. The workcommissioned by the Norwegianand the analysis is the responsibility of the team
3
Emerging policies are targeting CO2 emissions from shipping. The International MaritimeOrganization (IMO) have produced policy proposals, backed by research, on an international regulatoryregime to manage CO2 emissions from shipping. Deliberations of the options are ongoing in IMO and in
. The EU has also announced that it is examining the shipping industry’s role inmitigating climate change, potential through inclusion in the existing EU Emissions Trading Scheme
In total, ten proposals have been submitted to the IMO for consideration as possiblebased measures. Six of these proposal can be generalized to two basic market-based schemes
a levy and an emissions trading scheme. The proposals differ in detail and in principle.
The objective of this study is to clarify the policy options and their impacts onenvironment and industry. The details and variations in the existing proposals complicatescomparison and could be masking the underlying objectives of the schemes. The ongoing dialoguebetween policymakers and industry actors could benefit from a consolidation of facts and analysis as thebasis for deciding upon further action.
The policy process has produced an impressive body of robust scientific and economic work undertakenunder the auspices of the International Maritime Organization (IMO), the European Union (EU) andothers. One area which has also not examined in detail is the impact on the shipping industry.others. One area which has also not examined in detail is the impact on the shipping industry.
The study aims to inform the ongoing process with analysis based on the core principles of the market-based mechanisms. This includes crystallizing the impacts of key policy options and highlighting the
offs between policies.
The scope of this study is to analyze the environmental and economic impact of market-aimed at reducing global GHG emissions from international shipping. The focus
is on the impact on GHG mitigation and the costs to the industry. This independent analysis hasleveraged and built upon previous research. Other issues, for example administrative arrangements, arebeyond scope of this study, but may also have significant implications on the policy decisions.
The work has been conducted during the spring of 2011 by an international PwC team. The work iscommissioned by the Norwegian Shipowners Association. We have been working fully independentlyand the analysis is the responsibility of the team
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Key findings4
Summary of
Key findings
USD per metric ton fuel ($2010)
1320
700
0
Distillate
Bunker
Context
Summary of key findings
Massive efficiency gainsrequired to reduce emissions totarget levels
Considerable fuel cost increaseas fleet shifts to low-sulfur fuels
0
500
1000
1500
2000
Metric tons CO2 (million)
Emissions
Target
57%
3,3%p.a
Target and growth of emissions Fuel price 1990-2030
80%
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1990 2010 2030
0
A proposed 10% reduction of emissionsbelow 2007 would require a reductionof 57 percent below business-as-usualby 2030.
Forthcoming low sulfur regulations areexpected to drive fuel costs aboveUS$1,300 per metric tonne by 2030from about US$600 today. Theincrease in fuel costs under the sulfurregulations is expected to raise fuelprice to the point where currentlyknown opportunities to improve fuelefficiency would have been exhausted.More measures may become availablein the future with technologicalimprovements – but significantuncertainties remain on this.
0
1990 2010 2030
5
Fuel cost increase would driveefficiency gains
Dramatic reduction of fuel useand emissions since 2008
gram fuel/ton mile
11
9
7
-1,25%p.a.
Fuel efficiency 1990-2030
0,6
0,7
0,8
0,9
1,0
IndexFuel consumption(International fleet)
-30-40%
Global fuel reduction 2008-2011
Speed reductions have reduced fuelconsumption (and emissions) by 30percent globally since 2008. However,any emission reductions from speedreduction observed over the last threeyears are unlikely to be sustainable. Asfreight rates rebound as a result of theeconomic recovery, it is likely thatspeed may increase again.
Fuel cost is estimated to drive 26percent efficiency gain, equivalent to1.25 percent improved efficiency eachyear and a break with historical trends.The IMO proposals on market basedmeasures are aimed at reducingemissions further to meet the target.
1990 2010 2030
0,6
2011201020092008
5
Options
Summary of key findings
Measures to put a price on carbon toincentivizefuel efficiency and reduction ofemissions
Emissions Trading Scheme (ETS) proposalsinvolve auction of certificates, submission atports, and trading in carbon markets
One tonne of fuel three tonnes of CO2*
Carbon emission from shipping fuel
Central authorityto allocate
certificates(freely orauction), and
collect from ships
Conceptual model for shipping ETS
A cost of carbon is expected to be added to the price offuel through a future market-based measure.Currently, for every tonne of fuel consumed,approximately three tonnes of CO2 are emitted.
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*Actual relationship is between 3.09-3.17 varying with fuelquality. We have assumed 3.13 throughout this study
Ships to acquireand submit
certificates at portbased upon
emissions fromeach voyage
The policy options and various design features for amarket-based measure for the shipping sector,including how it is linked to these existing carbonmarkets, will impact the price of carbon, the industryand the environment.
The two main market-based measures beingconsidered are a levy and an emissions trading scheme(ETS), based on the principle that the shippingindustry will respond to a price signal to encourageemission reductions.
In total, ten proposals have been submitted to theIMO for consideration as possible market-basedmeasures. Six of these proposal can be generalized totwo basic market-based schemes – a levy and anemissions trading scheme. The remaining proposalsaddress a rebate mechanism applicable to any MBMand technical measures such as efficiency index ordesign standards.
An Emissions Trading Scheme (ETS)setting a cap for the aggregate emissions allowed to beemitted in the system. Typically one unit of allowancepermit its holder to emit arequired to surrender an allowance unit for everytonne of CO2 emitted during the voyage. Allowancescan be issued for free, which can be based on pastemissions, and/or through auctioning. Shippingcompanies can then trade these allowances in thecarbon markets. If it is cheaper to reduce emissionsthan to buy an allowance, a company will do so andsell any excess allowances; conversely, if it is cheaperfor a company to buy allowances than to reduce itsemissions, then it will purchase an allowance forcompliance.
Emissions Trading Scheme (ETS) proposalsinvolve auction of certificates, submission atports, and trading in carbon markets
The Levy proposal is a centralized scheme,putting direct charges on fuel, and links tocarbon markets through a central entity
Certificateowners
(shipoperators/owners) can
trade certificatesin market
Conceptual model for shipping ETS
Centralauthority setsand collects
levy
Centralauthority
engages inmarket topurchase
offsets
Conceptual model for shipping Levy
6
A levy can be imposed on fuel during sales based onthe carbon content of fuel, or at a port based uponemissions of a completed voyage. The levy increasesthe cost to a ship voyage. If it is cheaper to reduceemissions than to pay the levy, the ship-owner orcharterer will prefer to do so. The proposalrecommends that the proceeds are collected by aninternational body and used to purchase carboncredits to achieve an emissions reductions target. Thelevy would need to be set at a level sufficient to fundthe purchase of sufficient carbon credits to meet thetarget (and to include other contributions or costs ofadministration). If the funds are mobilized for otherpurposes than to purchase carbon credits theenvironmental outcome cannot be determined withcertainty.
Ships to paylevy on fuel
An Emissions Trading Scheme (ETS) entailssetting a cap for the aggregate emissions allowed to beemitted in the system. Typically one unit of allowancepermit its holder to emit a tonne of CO2. Ships arerequired to surrender an allowance unit for every
of CO2 emitted during the voyage. Allowancescan be issued for free, which can be based on pastemissions, and/or through auctioning. Shippingcompanies can then trade these allowances in thecarbon markets. If it is cheaper to reduce emissionsthan to buy an allowance, a company will do so andsell any excess allowances; conversely, if it is cheaperfor a company to buy allowances than to reduce itsemissions, then it will purchase an allowance for
Impacts on the shipping industry
Summary of key findings
A levy and the ETS could achieve identicalenvironmental outcomes
A levy, or an ETS without any auction, wouldachieve the environmental outcome at thelowest cost to the industry
Carbon abatement options from Shipping Impacts of low-cost levy and ETS zero
800
1200
1600
2000
Metric tons C02 (million)
Abated throughmarket-based
measures
Abated throughefficiency gains
32%
26%ETS with 0%
auction =$66
per metric ton fuel
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0
400
800
2010 2020 2030
Remaining emissions43%
2,6 billion toglobal fund
With appropriate target setting and policy design, alevy and the ETS can achieve identical outcomes. Thisis achieved with the size of the levy set as a function ofa pre-determined abatement target on emissions andthe proceeds of the levy used to purchase the requirednumber of credits to meet the targets.
A levy based on the purchase of CDM carbon creditswould incur a cost of about $66 per metricfuel to the industry by 2030. An ETS proposal withfree allocation (i.e. 0% auction) would achieve thesame impact. The cost of purchasing carbon creditsthrough the proceeds of a levy scheme will be identicalto the total costs for firms to purchase allowances tocomply under an ETS.
Under the ETS, allowances can be allocated freely orthrough auction. With auctioning, the industry incursadditional cost as it has to purchase the allowancesbeing auctioned. The greater the proportion ofauctioning, the greater the cost to the industry.
A levy, or an ETS without any auction, wouldachieve the environmental outcome at thelowest cost to the industry
A higher levy, or auction under the ETS, wouldmobilize more funds for a global climate fund
cost levy and ETS zero-auction Impact of high-cost levy and ETS 100% auction
Levy minimumrequired to offsets
=$66
per metric ton fuel
Levy minimum +large global fundcontributions =
$152per metric ton fuel
ETS with 100%auction =
$152per metric ton fuel
41 billion toglobal fund
41 billion toglobal fund
7
2,6 billion toglobal fund
A levy based on the purchase of CDM carbon creditswould incur a cost of about $66 per metric tonne offuel to the industry by 2030. An ETS proposal withfree allocation (i.e. 0% auction) would achieve thesame impact. The cost of purchasing carbon creditsthrough the proceeds of a levy scheme will be identicalto the total costs for firms to purchase allowances to
Under the ETS, allowances can be allocated freely orthrough auction. With auctioning, the industry incursadditional cost as it has to purchase the allowancesbeing auctioned. The greater the proportion ofauctioning, the greater the cost to the industry.
A levy, or an ETS without auction wouldmobilizeUS$3 billion annually by 2030. However, if a primeobjective of a scheme is to raise revenues, the levy canbe increased beyond what is required to purchaseoffsets.
After accounting for the purchase of carbon credits,the auction proceeds and contribution to globalclimate fund are additional revenues raised.
The ETS with 100 percent auction of allowances wouldmobilize about US$41 billion annually by 2030.
Handysize Bulker
Handysize Product Tanker
VLCC
Capesize Bulker
ContainerMain Liner
699
618152
1469
17 %
16 %
18 %
15 %
8 %
20 %
19 %
12 %
12 %
5 %
57 %
58 %
63 %
65 %
78 %
Impacts on the shipping industry
Summary of key findings
The impact of carbon polices isdwarfed by trends in the fuel cost
Components of cost base per shiptype 2010-2030with ETS 100% auction (daily costs)
Capex FuelOpex
Impact on cost base varies muchbetween vessels and could reach 9percent for a 3500 TEU container
Impact on fuel cost 2030 ($2010)
Carbon
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Handysize Bulker 17 % 20 % 57 %
The amount of carbon emissions for aship is strongly linked to fuelconsumption, which as a proportion ofthe cost base, differs substantiallyacross the ship segments. A containermain liner has the largest share of fuelcost, and therefore by extension carboncosts. Smaller ships (handysize bulkersand tankers), with a proportionallylarger capex and opex cost base, findscarbon cost a smaller proportion oftheir cost base.
A levy would result in an increase in thetotal cost base between 3-4 percentacross common vessel segments. AnETS with auctioning would result in anincrease between 6-9 percent.
Compared to the forthcomingregulations which mandates lowersulfur content of fuel, carbon pricing isestimated to have a relatively smallimpact on the cost to the industry. 80percent of the expected increase invoyage costs for vessels will stem fromthe sulfur regulations.
A levy would result in an averageincrease of voyage costs of about 5percent. On the other extreme, an ETSwith full auctioning will result in an 11percent increase in voyage costs.
Bunkerbase
Sulfurregs
impact
Carbonhighcase
impact
Newfuelprice
71 %
47 %
45 %
38 %
-74 %6,6 %
6,7 %
7,3 %
7,5 %
9,0 %
Profit would be lost as a largeshare of the cost increase wouldbe absorbed by the industry
Seaborne trade volumes woulddecline
Absorption of cost increase at 25 percent initialmargin
Impact of high-cost levy and ETS 100% auction
Loss of volume:• Short-sea to road and
rail• Deep-sea to local
products which dontrequire ocean transport
Carbon
-74 %6,6 %
The increases in voyage costs resultingfrom carbon pricing will lead to higherrates. Freight rates and a ship’s profitmargin are determined by a multitudeof factors, including the competitiveconditions, operational andmanagement efficiency of the ship andmarket conditions. A levy would leadto an increase of freight rates ofbetween 1-5 percent across commonvessel types and goods. An ETS withfull auctioning would increase freightrates between 7-9 percent.
Profits of the industry would fall. Allship types will be able to pass-throughsome of their costs to their customers.The extent depends upon the goodsbeing transported and the capacity inthe market.
As freight rates increase, especially inthe short-term, the level of shippingactivities may fall. Modal shift is aparticularly relevant scenario for theshort-sea freight segment where roadtransport is an option, for example indensely populated regions such as Asia,Europe and North-America. Studiesfrom Europe indicate a severe impactwith fuel costs above $1000 per metrictonne.
As freight rates increase, locallyproduced goods would become morecompetitive. The demand forinternational transport would declineas a consequence. However, theseimpacts are likely to be a result of thelow-sulfur regulations rather thancarbon costs.
Bottom line
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Three key issues will be addressed
1 ContextWhat is the problem and why should it beaddressed? How does this fit in withwider developments in the industry?
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3 Impact
2 OptionsHow much will it cost? How will differentpolicy options impact costs? How willshipping profits be impacted? How willpatterns of global trade change?
What are the options? What models arebeing proposed? What are the keyparameters which policymakers need todecide?
What is the problem and why should it beaddressed? How does this fit in withwider developments in the industry?
How much will it cost? How will differentpolicy options impact costs? How willshipping profits be impacted? How willpatterns of global trade change?
What are the options? What models arebeing proposed? What are the keyparameters which policymakers need todecide?
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Context11
Section 1
Context
Emissions from 100,000 ships equivalent to three percent of global CO2 emissions
About 3,3 percent of the global CO2 emissions stem from the global shippingsector. This is a larger share than aviation and rail sectors, but much less thanemissions from the road transport sector which is more than 6 times higher.
About 1050 million tonnes of carbon are emitted from the global shipping fleetevery year. Most of this is international shipping, i.e. transport betweencountries and across oceans, which accounts for 870 million tonnes of carbonemissions.
Figure 1.1: Global emissions of CO2 by sector
Context
Emissions from global shipping less than road transportand more than aviation
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All other; 73 %
Roadtransport;
21 % Globalshipping;
3,3 %
Aviation;1,9 %
Rail; 0,5 %
Source: IMO 2009
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Emissions from 100,000 ships equivalent to three percent of global CO2 emissions
Figure 1.2: Emissions and vessels by major fleet segments (contribution to total)
There are about 100,000 ships weighing above 100 Gt, of which about half arecargo ships which constitutes the largest share of emissions. The containerfleet, which is the fastest moving and therefore more carbon-intensive segmentof the industry, releases as much carbon as the city of Tokyo in a year.
This study is focused on “international shipping” which is the scope of the IMOproposal.
Most emissions are from cargo transport
50% 80%
22 %17 %
10 %9 %
8 %
7 %5 %
5 %4 %
3 %2 %
2 %2 %
2 %2 %1 %0 %0 %
ContainerBulk
Crude oil tankerGeneral cargo
FerryMiscellaneous
ServiceChemical tankerProducts tanker
VehicleLNG tanker
Other dryOf fshore
CruiseRoro
LPG tankerYacht
Other tanker
Source: IMO 2009 Buhaug et al. ,Notes: Estimates are from 2007 and based upon detailedassessments of vessel types, fuel consumption and size conducted by IMO in 2009. There isstated a 20 percent margin of error in the estimates.
12
50% 80%
Shipping is the most carbon efficient mode of transport
Despite emissions levels, ships are overall the most carbon efficient mode oftransport.
This, however, varies by type of goods. Heavy bulk cargos such as iron ore, coaland crude are more efficiently transported on ships. Shipping of lighter goodsand cargos, on the other hand, competes with rail and road. Airfreight is alsoused for high value-to-weight goods, especially if they are perishable or of acritical nature.
Figure 1.3: Intermodal carbon efficiency compared
Context
Shipping is the most carbon efficient mode of transport
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Source: IMO 2009: * 747-F
Grams C02/tonkm
13
0 100 200 300 400 500
Shipping
Rail
Road
Air*
Average
Range
Large
Vessel types also affect fuel efficiency. Smaller ships, which are often used incoastal short-sea freight routes, are more carbon intensive than larger vessels.
However, compared to their direct competition of road and rail, they stillcompare favorably on carbon emissions per tonne km travelled.
Shipping is the most carbon efficient mode of transport
Figure 1.4: Carbon efficiency of different vessels (examples)
Larger vessels are more carbon efficient
Average loadLarge
Very large Ore
VLCC
Suezmax Tanker
Container 8000 TEU+
Medium
Bulk Handymax
Panamax tanker
Handymax product
Container 5000-7999 TEU
Smaller
Bulk Handy
Coastal product
Container 1000-1999 TEU
Vehicle carrier 0-3999ceu
-30 -15 0 15 30 45 60
Grams C02/tonkm
13
Average load
Max load
As the demand for maritime transport services derives from global economicgrowth and the need to carry international trade, trends in the shippingsector are closely interlinked with the movement of trade.
Economic growth and globalization will continue to drive the levels ofseaborne trade, however future scenarios by the IMO suggest that some trademight shift away from sea to land – for example onto the Trans-Siberianrailway.
As such, we expect a growth of seaborne trade of about 3,3 percentconsistent with the IMO 2009 scenario. Fuel consumption, and therebyemissions, will also follow this growth scenario if nothing else changes. Thisalso constitutes the reference case for our further calculations.
Massive efficiency gains required to reduce emissions
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also constitutes the reference case for our further calculations.
The carbon intensity of the industry, however, may improve over timethrough efficiency improvements in the sector. The degree of efficiencyimprovements will depend on a variety of factors, which include ongoingtechnological improvements, reacting to the cost of fuel, and potentiallyfuture regulations in the shipping industry.
We will discuss these impacts in the following sections.
Sources: PwC GHG Shipping model. IMF, UNCTAD, IMO 2009 (Buhaug), Future growth rates are derived from: GDP: The Intergovernmental Panel on Climate Change high growth scenario (A1B), anda scenario analysis by IMO in 2009. (Buhaug et.al). Our growth rates are in this study aligned with those scenarios developed in the IMO study.
14
1500
2000
Metric tons CO2 (million)
Figure 1.5: Target and growth of emissions
1053mt
3,3%
Massive efficiency gains required to reduce emissions
100% moreemissions if
unconstrained growthalongside growth in
seaborne trade
0
500
1000
1990 2000 2010 2020 2030
Emissions growth
Target reduction
), Future growth rates are derived from: GDP: The Intergovernmental Panel on Climate Change high growth scenario (A1B), andet.al). Our growth rates are in this study aligned with those scenarios developed in the IMO study.
mt
57%
Target for reductions at783 million tonnes
14
Potential to reduce emissions is substantial through existing proposals
The IMO has identified three wedges to reduce emissions.
Volatility and increases in fuel costs (particularly from EU regulations on low-sulfurfuels)are a strong driver for the shipping industry to improve its fuel efficiency.Thus even in the absence of any intervention or regulation, the industry expects animprovement in the carbon intensity of the sector as a result of business-as-usual efficiency gains. An extensive scenario exercise by IMO in 2009 identifiedthese to be amount to a 14% reduction by 2030, which is higher than the fuel-efficiency gains for the global fleet over the last decades. The IMO emissionsscenario for 2030 of about 1550 million tonnes of carbon takes account of theseimprovements.
A current proposal within the IMO to introduce the energy efficiency designindex (EEDI) to encourage design improvements for new ships is also expected toresult in carbon efficiency improvements for the sector beyond the business-as-usual efficiency improvements.
1
2
Context
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usual efficiency improvements.
The use of market-based measures is a further set of proposals within the IMOcommunity to reduce the contribution of the shipping sector to carbon emissionsand is the focus of this study. The current proposals can potentially reduceemissions through two routes: a) by reducing emissions within the sector throughresponding to a price signal; and/or b) by making shipping companies pay foremissions reduction in another sector.
The scope for emissions reduction of market-based measures depends on the targetset. Analyses conducted for the IMO suggests that the range of targets beingconsidered of up to 20% below 2007 emission levels.
Political economy influences heavily on the actual level of target to be agreed. Forthe purpose of our analysis we assume the target set by IMO expert group review ofproposals of 10% below 2007 levels. For international shipping this translates into783 million tonnes. We also assume that the process will only be implementedfrom 2015.
The remaining emissions will depend on the compounded impact of theemissions reduction measures above.
3
4
15
1200
1600
2000
Metric tons C02 (million)
Potential to reduce emissions is substantial through existing proposals
The impactin 2030
248
213
14%
12%
sulfurfuels)are a strong driver for the shipping industry to improve its fuel efficiency.Thus even in the absence of any intervention or regulation, the industry expects an
. An extensive scenario exercise by IMO in 2009 identified
of carbon takes account of these
energy efficiency designto encourage design improvements for new ships is also expected to
-
Abated through businessas usual efficiency
improvements
Abated through mandatedenergy efficiency design
index (EEDI)
Abatement measures
Figure 1.6: Abatement potential
0
400
800
1200
2010 2015 2020 2025 2030
592
783
32%
43%
is a further set of proposals within the IMOcommunity to reduce the contribution of the shipping sector to carbon emissions
emissions through two routes: a) by reducing emissions within the sector through
based measures depends on the target
Political economy influences heavily on the actual level of target to be agreed. Forthe purpose of our analysis we assume the target set by IMO expert group review ofproposals of 10% below 2007 levels. For international shipping this translates into
. We also assume that the process will only be implemented
Abated through market-based measures
Remaining emissions
Sources: IMO 2009, 2010; PwC GHG Shipping model
15
Speed reductions have reduced fuel consumption by 30 percent globally since 2008
Speed reduction is an important fuel efficiency measure, highly influencedby a number of market factors. Ship operators respond to low rates,overcapacity and higher fuel costs by reducing speeds.
A measurable decrease in total fuel consumption has been observed since2008, reflecting changes in operational patterns as a result of the increase infuel costs in recent years.
The speed reductions are in the range of 14-16 percent over the three yearsacross tankers, bulkers and containers; with the exception of iron orebulkers which are less sensitive to fuel cost increases; and with theexception of ferries which operate scheduled services often subject to licenserequirements.
Context
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Figure 1.7 Global fuel reduction estimate 2008-2011
Sources: PwC Shipping fuel model. Baseline fuel data from IMO 2009 (Buhaug); AISlive satelite datastreamsconsumption. Segmented by 24 vessel categories. The relationship between fuel consumption and speed has been assumed as a thirelationship and is shown as upper line. Not accounted for fuel consumption at anchor or in ports. The figures incorporates tdate. Weekly data.
More vessels in the market,but fewer are actually atsea
Speed reductions across thefleet 2008-2011
Fuel consumption reducedby 30-40 percent
0,8
0,9
1,0
1,1
2011201020092008
IndexVessels at sea
-6%
0,8
0,9
1,0
2011201020092008
IndexSpeed International fleet
-15%
20092008
Fuel consumption(Global fleet)
Speed reductions have reduced fuel consumption by 30 percent globally since 2008
Despite the significant speed reduction observed, due to data unavailability itis difficult to conclude the impact on emissions since 2007, when the IMOestimated emissions to be 870 million tonnes.
Moreover, any emission reductions from speed reduction observed over thelast three years are unlikely to be sustainable. The economic and trade boomleading up to 2008 followed by the deepest recession in decades is likely toimpact the industry far greater than a ‘typical’ economic cycle. As freight ratesrebound as a result of the economic recovery, it is likely that speed mayincrease again.
16
datastreams. Bloomberg. Coverage of about 25.000 vessels constituting about 65 percent of global fuelconsumption. Segmented by 24 vessel categories. The relationship between fuel consumption and speed has been assumed as a third power relationship. Total for all vessels tonne kilometers expressed as squarerelationship and is shown as upper line. Not accounted for fuel consumption at anchor or in ports. The figures incorporates the number of vessels on the market and those that are actually moving at sea at a given
30-40 percentreduction in
carbon emissionssince early 2008
Not sustainableWill increase again
if demand fortransport increases
Fuel consumption reduced40 percent
0,6
0,7
0,8
0,9
1,0
201120102009
IndexFuel consumption
-30-40%
But speed reductions are very market sensitive and cannot be counted as reliableabatement measures
Figure 1.8: Containership speed response to rate collapse, overcapacity, and higher costs 2008There has been much volatility over the last few years inmany of the factors that would induce response in speed.
• The market for seaborne transport collapsed at the end of2008 upon reaching historical heights. Demand has sincecome back and increased since 2009.
• Many more ships were ordered at the end of the high cycleand these have been entering the market since. There wasoversupply and rates dropped across most segments.
• Fewer of the ships are utilized, meaning that they are atanchor and not at sea at a given day.
• Fuel costs have increased and are expected to increasefurther in the future due to both the: (i) market
Demand for transportcollapsed
20092008
Singapore throughput(Containers TEU)
-25%
Context
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20092008
Utilization fleet(Container)
-9%
17
Sources: Singapore Port Authority, Lloyds,
further in the future due to both the: (i) marketexpectations; and (ii) The shift in fuel mix towards low-sulfur fuels.
Speed reduction will be most cost effective if there isovercapacity in the market (as for the last three years). If not,there will capital investments required to build new vesselsto compensate for the drop in transport capacity. Thedynamics are very volatile and hard to forecast.
Examples from the container fleet are shown on the right.The container fleet has reduced speed by about 14 percentsince early 2008. This is consistent across most other typesof vessels and the typical range of speed reductions over thethree years is about 14-16 percent.
Fewer ships are utilized
But speed reductions are very market sensitive and cannot be counted as reliable
Figure 1.8: Containership speed response to rate collapse, overcapacity, and higher costs 2008-2011
Demand for transportcollapsed
More ships entered themarket
1,8
2,4
3
201120102009
MillionSingapore throughput(Containers TEU)
25%
3800
4200
4600
5000
2011201020092008
VesselsContainerfleet
+12%
024681012
2011201020092008
IndexContainer freight rates(index)
-75%
Rates dropped
70 %
80 %
90 %
100 %
20112010
PercentUtilization fleet
9%
17
Sources: Singapore Port Authority, Lloyds, Hamburg Shipbrokers Association , Bloomberg AISlive datastreams
Fuel cost are higher Speed is lowerFewer ships are utilized
0
200
400
600
800
2011201020092008
USD/TonBunker fuel(Rotterdam)
+200%
10
11
12
13
14
2011201020092008
KnotsContainerspeed(Average)
-14%
Low-sulfur fuel regulations will be a game changer
This report is focused on carbon regulations, but other internationalenvironmental legislation are also likely to drive changes in the industry. Inparticular the IMO’s amendments to Annex VI of the MARPOL Conventionin relation to SOx (sulfur oxides) reductions are expected to drive asignificant rise in average fuel costs over the coming years. These include:
• The global limit for sulfur content in fuel will be reduced from 4.5% to3.5% effective from 1 January 2012; then gradually to 0.5% by 2020(subject to a feasibility review).
• The limits applicable in Sulfur Emission Control Areas (SECAs) will bereduced from 1.5% to 1%, beginning on 1 July 2010; then further to 0.1 %,effective from 1 January 2015.
Context
Fuel costs may remain highIncreased use of lowexpensive fuel
PwC
0
300
600
900
1200
1990 2000 2010 2020 2030
Distillate
Bunker fuel
USD per metric ton fuel($2010)
18
Figure 1.9: Fuel prices 1990-2030 Figure 1.10: Change in fuel mix
Sources: IMO 2010, Bloomberg, Bunker fuel projections from Annual Energy Outlook 2011 (Departmentincrease top-off at 20% from 2020. Similar to IMO 2010 expert group assumptions. Bunker costs historical shown at Singapore rateenergy. About 350 kg of carbon may be released per tonne of fuel in the production process, which compares to about 10 percent of the carbon emitted during combustion at the ships. Tmore efficiently at the ships, but not enough to offset the energy required in the refining process.
80%
Fuel costs may remain highexpensive fuel
80 %
20 %
20 %
80 %
2010
Share of fuel type used
sulfur fuel regulations will be a game changer
Complying with these fuel sulfur reduction requirements will require change,through the use of distillate or alternative fuel oils, LNG or gas-cleaningtechnologies (scrubbers). LNG can only be used for newly built ships. This willhave a strong upward pressure on fuel prices as distillates are historically 80-90%more expensive than traditional bunker fuel. There is also limited capacity at therefineries to produce distillate fuel and this is expected to create further pricepressure on the fuel.
The price increase from the shift of fuel mix will create incentives for considerablefuel efficiency in the fleet. This will result in a much more significant impact to theindustry than the current proposals on carbon regulation.
The price levels corresponds to an underlying cost of crude oil of about US$115per barrel ($2010).
Increased use of low-sulfur, moreMuch higher average fuel cost
0
300
600
900
1200
2010 2020 2030
USD per metric ton fuel(2010$)
18
Figure 1.10: Change in fuel mix of fleet Figure 1.11: Average fuel unit cost for fleet whenusing bunker and distillate
150%
Annual Energy Outlook 2011 (Department of Energy US), Purvin Getz 2009. EMTS 2010. Assumes distillate at 60% higher than bunker+demandoff at 20% from 2020. Similar to IMO 2010 expert group assumptions. Bunker costs historical shown at Singapore rates. The production process from residual to distillate fuels also requires
of fuel in the production process, which compares to about 10 percent of the carbon emitted during combustion at the ships. The distillate fuel burns
Much higher average fuel cost
20 %4 %
80 %96 %
2020 2030
Share of fuel type used
Higher fuel costs unlikely to result in sufficient efficiency improvements
Context
The extent to which fuel saving technologies are economically viable depends onthe capital and recurrent costs of implementation and the fuel savings potentialfor each measure.
The figures below shows examples of two vessels where the efficiency optionsare exhausted below $900 per tonne a fuel. The vertical axis shows the costbelow which the investment will be profitable. The horizontal axis shows theimpact on the annual fuel consumption of the ship.
Marginal efficiency cost$/tonne fuel
Savings as share of annual fuelconsumption for ship
There are many ways to reduce fuel consumption of a typicalSuezmax tanker and increase profits
Figure 1.12 Marginal cost of efficiency improvements at $900 fuel price in2030. Midrange estimates. W.o speed reduction. Suezmax tanker
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-100
-80
-60
-40
-20
0
20
40
60
10% 20% 30% 40% 50%
400
Weath
err
outing
Pro
pelle
rbushin
gre
q
Hullb
ushin
g
Coating
Bosscapfin
Pro
pelle
rbushin
gre
g
Air
lubri
cation
Win
dE
ngin
e
Lig
hting
Common Rail
Pro
pelle
rupgra
de
Tow
ingki
te
WH
R Pro
pelle
rrudderu
pgra
de
Sola
r
Auto
pilo
t
METuning
Sources: Project cost and abatement potential data in examples from IMO 2010 INF 61:18 ; Imarest (2010). Wehave converted this to fuel equivalents.
$/tonne fuel consumption for ship
Speedcontrolpumps
19
10% 20% 30% 40% 50%
Higher fuel costs unlikely to result in sufficient efficiency improvements
Marginal efficiency cost$/tonne fuel
Savings as share of annual fuelconsumption
Similar savings can be made by a Panamax bulker; and all theseoptions are profitable with $900 per tonne fuel
Figure 1.13 Marginal cost of efficiency improvements at $900 fuel price in2030. Midrange estimates. W.o speed reduction. Panamax bulker
All of these technologies (except solar on the Suezmax) are found to be profitableat fuel prices of $900 a tonne. If all these measures can be implemented at thesame vessel – the resulting emissions reductions are estimated to exceed 50percent.
In practice, there are many uncertainties and implementation constraints whichare not included in these estimates. Other measures, or stronger price incentivesmay help to overcome these barriers, which is beyond the scope of this study.
-100
-80
-60
-40
-20
010% 20% 30% 40% 50%
Weath
err
outing
Pro
pelle
rbushin
gre
g
Auto
pilo
t
Hullb
ushin
g
Bosscapfin
Coating
Air
lubri
cation
Win
dE
ngin
e
Common RailMETuning
Speedcontrolpumps
Pro
pelle
rrudderu
pgra
de
Tow
ingki
te
(2010). We
$/tonne fuel consumption
19
The fuel economy is an increasingly important component of the competitivedynamics in the of future shipping. We may see strategic shifts in the industry.Impacts may differ across main segments:
Short-sea shipping in densely populated regions face the most immediate threatof modal shifts towards land-based transport. Studies indicate that a thresholdlevel at about $1000 dollars/ton fuel will lead to significant modal shift and marketvolumes will be lost to land. The risk for environmental regulators is that this maylead to higher total emissions as road and rail transport is less carbon efficient.
Deep-sea shipping will face different dynamics, in particular the threat ofincreased competition from each other as fuel efficiency becomes a competitivelever. Locally produced goods will also become more competitive as the freightcosts of the distantly produced goods increases, leading to falls in seaborne tradevolumes.
Success in the future fuel economy will require innovation and strategic shifts
Context
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1990 2010 2030
gram fuel/ton mile
11
9
7
Sources: IMO 2009, 2010; AEO 2010, Fernley, UNCTAD 1990-2010 reports, EMTS 2010. Consistent with the BAU+EEDI scenarios presentePwC GHG Shipping models.
20
-1,25%
Fuel efficiency forecast improve by 1,25% annually
Figure 1.14: Fuel efficiency improvement 1990-2030
Efficiency gainsrepresents a break with
recent history
The industry will respond strategically.
Larger vessel types might be deployed, such as ultra large container vesselswhich have greater fuel efficiency per tonne mile than the smaller vessels.More attention will be paid to address port infrastructure, which currentlyhas limitations on vessel sizes.
Downward management of other cost components and further integrationof supply chains will rise in focus.
Consolidation in the sector may also follow to exploit greater economies ofscale.
Success in the future fuel economy will require innovation and strategic shifts
0
0,25
0,5
0,75
1
1990 2000 2010 2020 2030
$ cents/ton mile
2010 reports, EMTS 2010. Consistent with the BAU+EEDI scenarios presented on page 15
20
+95%
3,4%
Efficiency gains will be outrun by increased fuel cost
Figure 1.15: Fuel costs per tonne mile of transport 1990-2030
Fuel costs will increasefaster and outrun the
gains in efficiency
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Options21
Section 2
Options
Two main groups of market-based measures are being considered by the IMO
The two main market-based measures being considered are a levy and an emissions trading scheme (ETS), based on the principle tharespond to a price signal to encourage emission reductions. In total, ten proposals have been submitted to the IMO for consimeasures. Six of these proposal can be generalized to two basic market-based schemesrebate mechanism applicable to any MBM and technical measures such as efficiency index or design standards.
The table below outlines the key features of each proposal. We will review the key features and policy options on the next pa
Proposal Scope and responsibility Expected source ofemissions reductions
(Levy) GHGFund: MEPC60/4/8Denmark etal.
• All party ships engaged in internationaltrade and emissions from all marine fuels.
• GHG contributions due when takingbunkers are made to the Fund by bunkerfuel suppliers or shipowners.
• Out-of-sector
(Levy) LIS:MEPC
• Direct payment to International GHGFund through electronic accounts for
• In-sector
• Out-of-sector (from
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MEPC60/4/37Japan
Fund through electronic accounts forindividual ships.
• Small ships may be excluded.
• Out-of-sector (fromremaining proceeds)
(Levy) PSL:MEPC60/4/40Jamaica
• Uniform emissions charge on all vesselscalling at all ports.
• Process enforced by Port Stateauthorities.
• In-sector
• Out-of-sector (fromremaining proceeds)
Global ETS :MEPC60/4/22Norway
• Applies to all CO2 emissions from the useof fossil fuels by ships engaged ininternational shipping above a certainsize threshold.
• Primarily out-of-sect0r
Global ETS:MEPC60/4/26 UK
• Ship operators would be responsible forcomplying with the system. Individualships would be the point of obligation.
• Primarily out-of-sector
Global ETS :MEPC60/4/41France
• Applies to all ships above a threshold,regardless of their flags.
• Primarily out-of-sector
based measures are being considered by the IMO
based measures being considered are a levy and an emissions trading scheme (ETS), based on the principle that the shipping industry willrespond to a price signal to encourage emission reductions. In total, ten proposals have been submitted to the IMO for consideration as possible market-based
based schemes – a levy and an emissions trading scheme. The remaining proposals address arebate mechanism applicable to any MBM and technical measures such as efficiency index or design standards.
The table below outlines the key features of each proposal. We will review the key features and policy options on the next pages.
Mechanismdesign features
Revenue generation and allocation
• Purchasing ofproject basedcredits (CERs)
• Fund used to offset GHG emissions from internationalshipping which exceed global reduction targets. Could alsobe used to finance adaptation in developing countries, R&D,technical cooperation & administrative expenses of GHGFund.
• Revenue generated available for mitigation and adaptionactivities.
22
activities.
• Part refund to industry.
• No discussion regarding the use of funds generated.
• Partial or fullauctioning
• Links to otherETS schemes
• A Fund would be established by the auctioning of allowancesto be used for climate change mitigation and adaptation andR&D for shipping.
• Partial or fullauctioning
• Links to otherETS schemes
• Allowances could be allocated to national governments forauctioning and therefore revenue generated would remainwith the governments to be used for a variety of(unspecified) purposes.
• Partial or fullauctioning
• Links to otherETS schemes
• The revenues could follow the principles laid out in theDanish proposal, with the final allocation of the revenues tobe decided by the Parties taking into account the principle ofcommon but differentiated responsibilities and respectivecapabilities.
Both ETS and Levy models involve carbon markets and trading
ETS proposals resemble existing emissions trading schemes
Central authorityto allocate
allowances (freelyor auction), and
collect from ships
Figure 2.1 Conceptual models for shipping carbon market engagement
PwC 23
Certificateowners
(shipoperators/owners) can
trade allowancesin market
Ships to acquireand submitemissions
certificates basedupon each
voyage
Both ETS and Levy models involve carbon markets and trading
The levy proposal is a more centralized scheme which alsolinks to existing carbon market
Central authoritysets and collects
levy
Conceptual
23
Ships to pay levyon fuel
Centralauthorityengages inmarket to
purchase offsets
ETS involves known implementation mechanisms but at a larger scale
Figure 2.2 Key issues for implementation of shipping ETS
Mechanism
Central authority to allocate allowances(freely or auction) to shipowners/operators.Large number of owners, but less than numberof ships. About 100.000 ships may be coveredcompared to about 12.000 sites under EU ETS.
Portside collection of emissions certificatesfor voyage. Each ship to submit certificates.Certificates may be ultimately owned by
PwC 24
Certificates may be ultimately owned byshipowner, operators or charterers.
Monitoring and verification checks. Technologyor paper based. May require verificationpersonnel.
Owners of certificates can trade certificates incarbon markets to optimize the economics ofships or fleet.
Certificates can also be acquired in themarketplace if additional certificates are needed.
Various trading strategies possible within designconstraints of the ETS mechanisms.
Source: MEPC 60 various proposals.
ETS involves known implementation mechanisms but at a larger scale
Simplified
Key risks and mitigation
Risk of misallocation of free allowances due to:(i) Much volatility in emissions due to speed and market fluctuations; and(ii) Lack of standardized information required to benchmark performance.
Large number of different vessel and engine configurations.The use of auction can mitigate misallocation. Better testing, pilotingand/or technology to assess actual emissions can also improve informationbase.
Risk of:(i) Excessive costs for monitoring, reporting, verification. This can be
24
(i) Excessive costs for monitoring, reporting, verification. This can bemitigated by intelligent administrative systems or technology; and
(ii) Fraud and corruption risks, e.g. bunker notes can be falsified,(iii) Avoidance of scheme through e.g. sea-to-sea transfers.
These can be mitigated by appropriate controls and/or technology.
Risk of:(i) Excessive price volatility. This can be mitigated by allowing for banking
and borrowing of certificates across phases;(ii) Risks of supply constraints of CDM credits. This can be mitigated by
also allowing linkages to other markets; and(iii) Transaction and trading costs. This can be mitigated by developing
efficient technology based marketplaces.
Levy involves simpler mechanisms but also has risks
Figure 2.3 Key issues for implementation of shipping Levy
Mechanism
Central authority to set levy for 1+ years aheadbased upon estimates of emissions and carbonprice in the future.
Collection at point of fuel sales. Levy to bepaid alongside fuelcharge.
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About 400 bunkersales points. About 20% oftotal sales at three ports: Singapore, Rotterdamand Fujairah.
Monitoring and verification checks could berequired.
Central authority will engage in carbonmarkets to acquire CDM or similar credits toensure offsets of emissions.
May engage in market from time-to-time toadjust portfolio or employ hedging strategies.
Source: MEPC 60 various proposals; EPA 2008.
**Levy based upon emissions would require much the same monitoring and verification requirements as an ETS. Such a design wou
Levy involves simpler mechanisms but also has risks
Simplified
Key risks and mitigation
Risk of setting wrong levels: setting a levy that is too low will lead toinsufficient funds to acquire required offsets; while setting a levy that is toohigh will tax the industry unduly.This can be mitigated by having shorter levy phase (e.g. where the levy isupdated every 1-2 years) coupled with an adjustment mechanism to reflectactual carbon prices. This needs to be balanced against the desire to providelonger term price stability.
Risk of:(i) Fraud and corruption risks. This can be mitigated by appropriate
controls and/or technology; and
25
controls and/or technology; and(ii) Risk of leakage to fuel outside of scheme boundaries. This can be
mitigated by ensuring compliance at major centers, setting entryrequirements to major ports, or impose charge based upon emissionsduring voyage to be paid at port rather than fuel sales.**
Risk of:(i) The central authority, as a very large actor in the CDM market, may
substantially affect prices in the CDM market or cause undue volatility.This can be mitigated by spreading purchases over time and usingintermediaries;
(ii) Risks of supply constraints of CDM credits (similar to ETS).
**Levy based upon emissions would require much the same monitoring and verification requirements as an ETS. Such a design would also resemble the Norwegian NOx fund currently in operation.
Policy decisions and options on mechanism design affect the environmental andindustry outcomes
The policy decisions that underlie a market based measure and the mechanism designs heavily influences the outcomes of the scthese decisions affect the outcomes; for the industry and the environmental. Our analysis will look at three options in detaallocation method and banking and borrowing.
Figure 2.4 Policy decisions and options on market based design
Size of emissionstarget or cap
ETS or levy
Linkage to anothercarbon market
Levy
Core policydecisions
PwC
ETS
Cost to industry
Profit impact onindustry
Industry freightrates
Cost of carbon
Mechanismdesignpolicy
options
Outcomes
26
Policy decisions and options on mechanism design affect the environmental and
The policy decisions that underlie a market based measure and the mechanism designs heavily influences the outcomes of the scheme. Below is an illustration of howthese decisions affect the outcomes; for the industry and the environmental. Our analysis will look at three options in detail – linkage to another carbon market,
Geographicalcoverage of scheme
ETS or levy
Banking and
Phasing over timeLevy
Use of proceeds
Allocation method(auctioning)
Banking andborrowing allowances
Cash flowEnvironmental
outcomeTrade
Use of proceeds
26
Levy: Core principles and options
Coreprinciplesof the levy
(MEPC 60/4/8*)
To be imposed globally on fuel during sales based on the carbon content of fuel.
Proceeds are collected by an international body and used to purchase carbon credits to achieve an emissionsreductions target.
The levy increases the cost to a ship voyage. If it is cheaper to reduce emissions than to pay the levy, the shipowner or charterer will prefer to do so.
The target for emission reductions would need to be determined. The central entity would purchase offsetsrequired to meet this target.
The size of the levy can be set to meet this abatement target and as such, the size of the levy is a function of a predetermined abatement target on emissions. The levy would need to be set at a level sufficient to fund the purchaseof sufficient carbon credits to meet the target (and to include other contributions or costs of administration). The
PwC 27
Policy options
of sufficient carbon credits to meet the target (and to include other contributions or costs of administration). Thesize of the levy is also a political decision and can be set smaller or higher than the amount required to ensure thatemissions are offset. For example, the levy can also be set to mobilize funds for a global climate fund or otherpurposes in addition to the amount required for offsets. Variations would impact cost and environmentaleffectiveness. We analyze this in section 3.
Linking to other carbon markets would be an issue. The central entity would need markets to purchase carbonoffsets in some markets and issues of linking would arise. The mechanism for linking would impact
Phasing of the levy would need to ensure that the levy overall track the price trends of a major carbon market towhich there is a linkage. It is a design decision how often the levy is adjustedbetween creating certainty in the price signal, and the risk of charging to much or to little.
There are also various options for use of proceedsoffsets). This includes possibilities of recycling revenues back to the industry through mechanisms which wouldtarget efficient ships (i.e Japanese proposal).
There are a number of implementationemissions of a completed voyage instead of fuels sales. The environmental and compliance cost impacts wouldhowever be similar as for a fuel sales based levy. Difference would be in efficiency of implementationarrangements and costs of those.
* MEPC 60/4/8 refers to a proposal submitted by Cyprus, Denmark, Marhsall Islands, Nigeria and IPTA. There are two additional proposals which are based upon similar principles: MEPC 60/4/37Japan; and MEPC 60/4/40 Jamaica.
To be imposed globally on fuel during sales based on the carbon content of fuel.
Proceeds are collected by an international body and used to purchase carbon credits to achieve an emissions
The levy increases the cost to a ship voyage. If it is cheaper to reduce emissions than to pay the levy, the ship-owner or charterer will prefer to do so.
for emission reductions would need to be determined. The central entity would purchase offsets
of the levy can be set to meet this abatement target and as such, the size of the levy is a function of a pre-determined abatement target on emissions. The levy would need to be set at a level sufficient to fund the purchaseof sufficient carbon credits to meet the target (and to include other contributions or costs of administration). The
27
of sufficient carbon credits to meet the target (and to include other contributions or costs of administration). Thesize of the levy is also a political decision and can be set smaller or higher than the amount required to ensure thatemissions are offset. For example, the levy can also be set to mobilize funds for a global climate fund or otherpurposes in addition to the amount required for offsets. Variations would impact cost and environmentaleffectiveness. We analyze this in section 3.
to other carbon markets would be an issue. The central entity would need markets to purchase carbonoffsets in some markets and issues of linking would arise. The mechanism for linking would impact a.o costs.
of the levy would need to ensure that the levy overall track the price trends of a major carbon market towhich there is a linkage. It is a design decision how often the levy is adjusted i.e 2-4 years. This is a trade-offbetween creating certainty in the price signal, and the risk of charging to much or to little.
use of proceeds (if funds are collected beyond the amount required foroffsets). This includes possibilities of recycling revenues back to the industry through mechanisms which would
Japanese proposal).
implementation issues. For example, a levy can also be collected at port based uponemissions of a completed voyage instead of fuels sales. The environmental and compliance cost impacts wouldhowever be similar as for a fuel sales based levy. Difference would be in efficiency of implementation
Islands, Nigeria and IPTA. There are two additional proposals which are based upon similar principles: MEPC 60/4/37
ETS: Core principles and options
Coreprinciplesof the ETS
(MEPC 60/4/22*)
Typically one unit of allowance permit its holder to emit a tonne of CO2.allowance unit for every tonne of CO2 emitted.
All allowances allocated through auctioning (100%).
Assumes linking to CDM market.
Shipping companies can then trade these allowances in the carbon markets. The market price is determined bythe demand and supply of the allowances. If it is cheaper to reduce emissions than to buy an allowance, acompany will do so and sell any excess allowances; conversely, if it is cheaper for a company to buy allowancesthan to reduce its emissions, then it will purchase an allowance for compliance.
A cap will need to be determined for the aggregate emissions allowed to be emitted in the system.
Allowances can be issued for free (free allocation) and/or through auctioning. Thepolicy choice. The auction share has cost implications which are reviewed in section 3.
If a share of allowances are allocated freely, there will need to becan be based upon be based on past emissions benchmarks (from ships) (known as ‘grandfathering’). The
PwC 28
Policy options
can be based upon be based on past emissions benchmarks (from ships) (known as ‘grandfathering’). Theprinciples for this will need to be determined.
A decision on linking to other carbon marketsmarket. Other options are possible and have different economic impacts.
Banking and borrowing have been raised but not discussed in detail in the proposals to the IMO. Thesefeatures help to stabilise the price of an allowance, particularly across different phases of an ETS . Decisions onthe mechanisms are required and have economic impacts.
There are also a number of implementationneed to be established to ensure that ships submits certificates equivalent to the emissions during the voyage.
* MEPC 60/4/22 refers to a proposal submitted by Norway. There are two additional proposals based upon similar principles: M
Typically one unit of allowance permit its holder to emit a tonne of CO2. Ships are required to surrender anof CO2 emitted.
All allowances allocated through auctioning (100%).
Shipping companies can then trade these allowances in the carbon markets. The market price is determined bythe demand and supply of the allowances. If it is cheaper to reduce emissions than to buy an allowance, acompany will do so and sell any excess allowances; conversely, if it is cheaper for a company to buy allowancesthan to reduce its emissions, then it will purchase an allowance for compliance.
will need to be determined for the aggregate emissions allowed to be emitted in the system.
Allowances can be issued for free (free allocation) and/or through auctioning. The share of auctioning is apolicy choice. The auction share has cost implications which are reviewed in section 3.
If a share of allowances are allocated freely, there will need to be allocation of free allowances. This allocationcan be based upon be based on past emissions benchmarks (from ships) (known as ‘grandfathering’). The
28
can be based upon be based on past emissions benchmarks (from ships) (known as ‘grandfathering’). Theprinciples for this will need to be determined.
linking to other carbon markets is required. The base case assumes linking to the CDMmarket. Other options are possible and have different economic impacts.
have been raised but not discussed in detail in the proposals to the IMO. Thesefeatures help to stabilise the price of an allowance, particularly across different phases of an ETS . Decisions onthe mechanisms are required and have economic impacts.
implementation issues. For example, monitoring and verification arrangements willneed to be established to ensure that ships submits certificates equivalent to the emissions during the voyage.
* MEPC 60/4/22 refers to a proposal submitted by Norway. There are two additional proposals based upon similar principles: MEPC 60/4/26 United Kingdom; and MEPC 60/4/41 France.
Both carbon levy and ETS have their advantages and limitations
Levy
Effectivenessat reducingemissions
Imperfect information means that the levy may not be set accurately togenerate the desired environmental outcome, creating environmentaluncertainty. However, it provides a clear price signal which willencourage long-term investment in fuel efficient vessels andequipment, as well as more efficient operational practices.
The IMO GHG Fund proposal sets the levy to meet a specifiedenvironmental target which provides greater environmental certainty.
Price signalconsistency
A clear fixed price signal is created which adds certainty to investmentdecisions.
Levy rates are subject to changes over time, but volatility would beconstrained by the state within a set period.
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Revenuegeneration
A carbon levy provides revenue generation. The revenues would bemore stable and controlled centrally, rather than by the market.
Simplicity
The implementation of a carbon levy scheme is relatively simplecompared to an ETS. Complexity depends on which entity the levy isimposed and the number of participants involved.
Politicalsentimentandacceptability
Varies by region. For example, within the EU, new taxes needunanimity, whereas decisions on the ETS only need a (qualified)majority vote.
Any form of carbon pricing may also face resistance from developingcountries regarding the sharing of responsibilities in the mitigation ofclimate change.
Current IMOProposals
GHG Fund - Denmark et al. : Purchases out-of-sector project creditswith levy funds to meet an emission reduction target.
LIS – Japan : Aimed at improving energy efficiency of ships withpotential refunds for ‘good performance ships’.
Port State Levy – Jamaica : Globally uniform emissions chargeadministered through Port State arrangements.
29
Both carbon levy and ETS have their advantages and limitations
ETS
Imperfect information means that the levy may not be set accurately togenerate the desired environmental outcome, creating environmental
environmental target which provides greater environmental certainty.
An emissions trading scheme imposes an absolute quantity cap whichcan be managed in line with environmental requirements.
In practice, the mechanism design of the scheme can affect itseffectiveness. For example, the level of auctioning vs. free allocation, theduration of the commitment period and the ability to bank and borrowallowances can all affect the strategic response of participants.
A clear fixed price signal is created which adds certainty to investment
but volatility would be
Price volatility, as seen in the EU ETS until 2009, provides a fragile basisfor investors looking to incorporate a long-term price for carbon intotheir decision making. This is a particular issue for investment decisionsin relation to long life assets such as vessels.
The revenues would be Auctioning of permits provides revenue generation. However, revenuesmay be unstable as they are dependent on the price of the allowances.
Complexity depends on which entity the levy isAn ETS requires an administrative system to be put in place to manageand monitor compliance, particularly if auctioning is involved. Marketparticipants may require training or a phasing-in period to familiarisewith the scheme.
of carbon pricing may also face resistance from developingcountries regarding the sharing of responsibilities in the mitigation of
Varies by region. An ETS is likely to gain acceptance politically in Europebut there is currently little appetite for similar schemes in some otherregions.
Any form of carbon pricing may also face resistance from developingcountries regarding the sharing of responsibilities in the mitigation ofclimate change.
sector project credits
at improving energy efficiency of ships with
Global ETS - Norway
Global ETS - UK
Global ETS - France
29
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Impacts30
Section 3
Impacts
This study considers the impacts of a levy and an emissions trading scheme on three key areas. A fourth areathe current analysis but is an important consideration on the choice and design of the scheme.
The choice of the shipping community on the market-based mechanism or any other policy instrument, as well as the design of thereflect the balance of outcomes across these four areas. This section considers each in turn.
The focus of our analysis is on the impact on the environment,shipping industry and trade
Impact on the environmentImpact on the shipping
industry
This first section considers how theenvironmental outcome (assumed
This section will review the impact onthe shipping industry, focusing on the
Impacts
PwC
environmental outcome (assumedhere mainly to be the amount ofcarbon emissions abated) is affectedby the choice of policy instrument.
the shipping industry, focusing on theimpacts on:
1) Cost base; and
2) The implications on profits.
This will be considered primarily at anindustry level.
We will also consider the impactsacross different shipping segments, asthere can be substantial variationswithin the industry.
31
This study considers the impacts of a levy and an emissions trading scheme on three key areas. A fourth area – the administrative impact – is beyond scope ofthe current analysis but is an important consideration on the choice and design of the scheme.
based mechanism or any other policy instrument, as well as the design of the mechanism, will need toreflect the balance of outcomes across these four areas. This section considers each in turn.
The focus of our analysis is on the impact on the environment,
Impact on seaborne tradevolumes
Administrative burdens
The shipping industry is afundamental part of global and
The practicalities of implementationand the required administrativefundamental part of global and
regional trade. Drawing on resultsfrom the preceding section, as well asoverall trends in trade, we willconsider in this section theimplications on:
1) Overall trade levels; and
2) Potential impacts on traderoutes or distribution of trade.
and the required administrativeburden is considerable for bothauthorities and the industry. Keyconsiderations include:
1) Governance of mechanism –parties required;
2) Administrative burden; and
3) Monitoring, reporting andverification requirements.
31
Cost impacts will impact profits, transfer through freight rates and also impacttrade volume
Impacts
The main impact of carbon pricing on the shipping industry is on cost andprofitability.
A change in cost base as a result of increased cost of carbon will affect industryprofitability, but the extent of this depends on demand and supply factorswithin the sector and relative to other transport modes, as well as levels andpatterns of global trade.
A key determinant is whether the ship is able to pass on the costs to itscustomers in increased freight rates, therefore retaining the profits earned.
Our analysis first considers a top-down analysis for the industry, by consideringthe impact of the cost of carbon on the industry’s cost base. This includeslooking at the impacts of changing policy options on the mechanism designunder a levy and an emissions trading scheme.
PwC 32
Cost to industry Industry freight rates
Cost of carbon
Cost of carbon will increase freight rates to a varying extent across the industry; profitability will be impacted
Figure 3.1: Conceptual model for impacts
Administrativeburdens*
*Costs of administrative burdens are not analyzed
Cost impacts will impact profits, transfer through freight rates and also impact
An industry level analysis can mask the true impact on a shipping company.There are two key sources of variation:
a) The amount of carbon emissions for a ship is strongly linked to fuelconsumption, which differs substantially across the ship segments. Thecost of carbon will therefore also vary for different ship types.
b) The nature of the products being transported by different ship types mayaffect the freight rates, and the extent to which the cost of carbon can bepassed on as increased freight rates.
Our analysis therefore also considers a bottom-up analysis by ship type.This looks at the impact of carbon cost on the cost base, the extent to which thiscan be passed onto the ship’s customers, and the associated implications forprofitability.
32
Profit of shippingindustry
Industry freight rates
Cost of carbon will increase freight rates to a varying extent across the industry; profitability will be impacted
Seaborne tradevolumes
Local goods morecompetitive
Road and rail morecompetitive
Carbon cost components of the ETS and levy differ
Impacts
The cost impact of the ETS and the levy differ principally with regards to how the remaining emissions below the target line
• Under the ETS, industry will need to purchase allowances for emissions above the target line. There is a policy option to allthrough auction. Auctioning will lead to additional costs for the industry.
• Under the levy, the costs are driven by emissions above the target line. The levy will need to be sized so that a central ecarbon markets to ensure abatement. The cost of purchasing these offsets in the market will be identical to the total costsabove target line emissions under an ETS.
Cost impacts driven by target, offset share, auction percentage, carbon price and global fund contribution
Figure 3.2: Conceptual illustration of carbon cost components
2000
Tons C02 (million) ETS
PwC 33
0
400
800
1200
1600
2010 2015 2020 2025 2030
Remainingemissions
Target
Emissions to beoffset
Firms to purchase allowances for tonneCO2 emitted above target line
Allocated allowances to firms to emittonnes of CO2 for emissions under target
line:(i) freely, or;
(ii) through auction up to 100%
Tonnes Co2 reduced at no cost
Carbon cost components of the ETS and levy differ
The cost impact of the ETS and the levy differ principally with regards to how the remaining emissions below the target line are charged.
Under the ETS, industry will need to purchase allowances for emissions above the target line. There is a policy option to allocate below-the-line allowances freely or
Under the levy, the costs are driven by emissions above the target line. The levy will need to be sized so that a central entity can purchase sufficient offsets in thecarbon markets to ensure abatement. The cost of purchasing these offsets in the market will be identical to the total costs for firms to purchase allowances for the
Cost impacts driven by target, offset share, auction percentage, carbon price and global fund contribution
Levy
33
tonne
Allocated allowances to firms to emitof CO2 for emissions under target
+10% forglobal
climate fund
CO2price
Tonnes Co2 reduced at no cost
Central entity to purchase offset creditsequivalent to emissions above target line
Potential fuel efficiency gains may not all be realized in practice
Low sulfur regulations are expected to drive fuel costs above US$1,000 permetric tonne, but current analysis on the technological potential for efficiencygains suggest that all efficiency measures will have been exhausted at that pricelevel. With technological improvements on newer or currently undevelopedtechnologies, e.g. solar, more measures may become available in the future.
Several studies have calculated these by estimating the marginal cost andpotential for carbon reductions. They find most measures are economicallyviable with fuel cost of $1000 per metric tonne of fuel. Beyond that level, thereis little technological potential (known of today) that can be exploited. There arefew studies which explicitly considers abatement potential at higher price levels.The most optimistic estimates show a carbon savings potential of 56 percentby 2030. This is equivalent to about 900 million tonnes of carbon annually inreduced emissions.
The shipping engineering community has expressed skepticisms about thepracticalities of implementing these measures. Some technologies have beenavailable for decades without being adopted, suggesting practical barriers exist.
Impacts
PwC
available for decades without being adopted, suggesting practical barriers exist.Others are not possible to combine on the same vessel, and there are questionson the assumptions used in the calculations particularly on financing.
There are two main implications of this:
1. There are insufficient information to estimate the impact ofincremental carbon price on carbon abatement when fuel costexceeds about $1000 per metric tonne.
In theory, an incremental carbon pricing in the sector is expected to lead tofurther emissions reduction. However, based upon knowledge of currenttechnologies, all abatement measures are expected to have been exhausted whenfuel cost exceeds $1000 per metric tonne. Our results therefore assume that theshipping industry would have to buy carbon credits to meet their regulatoryobligations rather than invest in carbon reduction, i.e. there are no in-sectoremissions reduction resulting from incremental carbon pricing. In the future itis likely that new technologies will emerge, especially if the cost of carbonprovides incentives for further R&D.
34
2000
Metric tons C02 (million)
Potential fuel efficiency gains may not all be realized in practice
2. For the purposes of this study we apply a conservative assumption aboutfuel efficiency savings of 26 percent by 2030. This is also consistent with theIMO business as usual scenario (which assumes implementation of many of thesemeasures) and the effects of implementing a mandatory EEDI.
The figure below indicates the expected efficiency potential with respect to totalemissions and the wedges for emission reductions discussed on page 15.
The maximum efficiency potential is not enough to reachemissions target
Figure 3.3 Impact of fuel efficiency on total emissions 2030
Total emissions inreference case
0
400
800
1200
1600
2010 2015 2020 2025 2030
Sources: Pwc GHG Shipping model. Various Marginal Abatement Cost (MAC) studies: IMO2009; 2010 INF 61:18 ; SNAME (2010); CE DELFT 2009; DNV 2009.
34
26%
56%
Target (57%)
reference case
Maximum theoreticalefficiency potential
Assumed efficiencygains (basecase)
Key assumptions in our cost impact analysis
Our analysis considers the impact of carbon cost under the different policy options and implementation choices on the operatiunderpinned by the following assumptions. See the supplementary annex for further details.
Impacts
We assume that the bunker fuel cost reachestonne on average for the fleet in 2030. Forecast fromDOE/AEO 2010 used as the basis for bunker fuel. Weassume an increasing share of (more expensive) distillate inthe fuel mix.
We assume there are improvements in fuel efficiency, drivenby technology, fuel cost and EEDI regulations. This leads toa 26 percent reduction in fuel consumption below businessas-usual by 2030, against a growth in seaborne trade of 3,3
Fuel
Efficiency &
PwC 35
as-usual by 2030, against a growth in seaborne trade of 3,3percent annually. Starting point is 870 mt CO2 emissions in2007.
We have based our forecast on the CER price (carbon creditsfor the CDM market). The estimate is based on the currentCER-EUA spread and the May 2011 Point Carbon forecastfor EUAs, and will be around US$31 by 2020 and US$44by 2030.
growth
Carbon
Policyscenarios
We have considered four key scenarios :
1: Levy, where funds are used to buy offsetsto reach target abatement2. ETS without auction of allowances3. ETS with 15% auction (as with the EUaviation regulations)4. ETS with 100% auction of allowances
We assume that thepercent below 2007 levels (783 milliontonnes
We have also included a 10% additionalcontributions to aas proposed by the key IMO proposals.
Forecast $ per ton fuel (2010$)
assumptions in our cost impact analysis
Our analysis considers the impact of carbon cost under the different policy options and implementation choices on the operating cost and profits of a ship. This isSee the supplementary annex for further details.
We assume that the bunker fuel cost reaches $1320 afor the fleet in 2030. Forecast from
DOE/AEO 2010 used as the basis for bunker fuel. Weassume an increasing share of (more expensive) distillate in
We assume there are improvements in fuel efficiency, drivenby technology, fuel cost and EEDI regulations. This leads toa 26 percent reduction in fuel consumption below business-
usual by 2030, against a growth in seaborne trade of 3,3 1,25%
1320
600
02010 2020 2030
Forecast $ per CER (2010$)
35
usual by 2030, against a growth in seaborne trade of 3,3CO2 emissions in
We have based our forecast on the CER price (carbon creditsfor the CDM market). The estimate is based on the current
EUA spread and the May 2011 Point Carbon forecastUS$31 by 2020 and US$44
1,25%annual efficiency gains
10% of 2007level emissions target
2010 2020 2030
44
20
0
10%contributions to global climate fund
We assume that the target will be set at 10percent below 2007 levels (783 milliontonnes).
We have also included a 10% additionalcontributions to a global climate fundas proposed by the key IMO proposals.
Bottom line is that levy and ETS can be designed to have identical impacts
Proposals at face-value givesunbalanced impacts
Low-impact variations gives balancedresult
Impacts: Overview
Levy minimumrequired tooffsets =
$66per metric ton
fuelETS with 100%
auction =
$152 2,6 billion toglobal fund
ETS with 0%auction =
Figure 3.4: Summary of impacts by main options by 2030 ($2010)
PwC 36
Source: PwC GHG Shipping model
$152per metric ton
fuel
41 billion toglobal fund
global fundauction =
$66per metric ton
fuel
2,6 billion toglobal fund
Bottom line is that levy and ETS can be designed to have identical impacts
impact variations gives balanced High-impact variations can also givebalanced result
Levy minimumrequired tooffsets =
Levy minimum +large global fundcontributions =
$152per metric ton
fuel
ETS with 100%auction =
$152per metric ton
fuel
36
offsets =
$66per metric ton
fuel
2,6 billion toglobal fund
fuel
41 billion toglobal fund
41 billion toglobal fund
All models would give the same environmentalimpact=
592 millions tonnesCO2 abated
Environmental effectiveness is fundamentally determined by the emissions target
Impacts: Environmental effectiveness
There are three determinants of environmental outcome (i.e. the amount ofcarbon emissions abated through the scheme).
1. Emissions cap or target
The emissions cap or target, regardless of whether a levy or ETS isoperating, creates market scarcity of the amount of GHG emissions thatships can emit. Typically the target is set lower than the level needed forbusiness-as-usual emissions. This is the core determinant of theenvironmental outcome.
A stringent cap or target will create greater scarcity and result in higherprices or levies. Conversely, a weak cap will result in lower prices ascompanies have a reduced incentive to improve efficiency.
2. The size of a levy
Under a levy scheme, there are potentially further implications for the
PwC 37
Under a levy scheme, there are potentially further implications for theenvironmental outcome. The current levy proposal sets the size of the levyas a function of a pre-determined abatement target on emissions. This is thebase case assumed for our analysis – we estimated that the cost of carbonper tonne of fuel is US$66 by 2030 to meet the abatement target of 10%reduction below 2007 levels (assuming CDM carbon credits used forcompliance).
However, the size of the levy could be politically influenced, and theamount of carbon credits purchased (i.e. the environmental outcome) willvary by the size of the levy. An extreme case would be if the funds aremobilized for other purposes than to purchase carbon credits – resulting infurther unpredictability of the environmental outcome.
Environmental effectiveness is fundamentally determined by the emissions target
3. Geographical coverage and the risk of carbon leakage
Current IMO proposals are intended to cover the entire shipping sector. Inabilityto strike a deal, however, may lead to unilateral moves by key shipping regions toimpose regional schemes, particularly in the EU. This has been observed in theaviation industry where the sector joins the EU-ETS in 2012.
If a regional scheme is implemented, this can result in some degree of ‘carbonleakage’, where more carbon is emitted outside the scheme as participants attemptto re-direct activities to other jurisdictions.
In the context of shipping, this may be a danger for mechanisms that apply acarbon levy on fuel or require ETS compliance of ships docking within the EU. Theapplicability of this depends on the degree of substitutability of activities and howthe scheme is implemented. For example, if a levy is applicable at the point of fuelpurchase, it is relatively easy for ships to refuel outside of the EU to avoid a carbonpremium (currently ships are already taking advantage of the relative fuel costsacross different geographies).
37
across different geographies).
$66
$70
-10 %
-15 %
More ambitious abatement targets results in more expensive LevyETS (100% auction)
Cost impact per tonne fuel fuel
Figure 3.5: Impact on cost and environment of varying abatement target (2030) ($2010)
Levy
Impacts: Environmental effectiveness
PwC
$75
$80
$85
-20 %
-25 %
-30 %
Source: PwC GHG Shipping model.
38
Abatement target below2007 levels
Cost of ETS with 100% auctiondoes not vary by target level as
purchase the same number of
At 100% reduction target, thelevy will = ETS with 100%
auction
$152
$152
592
635
More ambitious abatement targets results in more expensive Levy - but no impact for
fuel CO2 abated (million tonnes)
Figure 3.5: Impact on cost and environment of varying abatement target (2030) ($2010)
ETS 100% auction
CO2 abated is a function oftarget level.
Carbon abated is not affectedby choice of Levy or ETS.
$152
$152
$152
679
722
766
38
by choice of Levy or ETS.
Cost of ETS with 100% auctiondoes not vary by target level as
companies still need topurchase the same number ofcarbon credits to meet their
obligations.
110 %
133 %
232 %
$87
$152
A levy will need to be at least $66 per tonne fuel in 2030 to meet emissions target,higher levy will mobilize more global climate funds
Cost impact per tonne fuelDeviation from abatementtarget (100% = Target of 10%reduction below 2007 levels)
Figure 3.6: Impact on cost and environment of varying size of levy (2030) ($2010)
Impacts: Environmental effectiveness
(Similar to ETS100% auction)
(Similar to ETS15% auction)*
PwC
50 %
60 %
70 %
80 %
90 %
100 %
$33
$39
$46
$52
$59
$66
Source: PwC GHG Shipping model.
* 15 percent auction is a proxy for an auction percentage similar to international aviation under EU ETS
39
651
592
592
12
41
fuel in 2030 to meet emissions target,higher levy will mobilize more global climate funds
Carbon abated(milliontonnes)
Global fundcontribution
(US$ bn)
Contributions to aglobal fund increases
much and can besimilar to auction
proceeds under ETS.
A higher level ofcontribution to the
global climate fundswould increase thecontribution of the
shipping industry toclimate change
Carbon abated doesnot increase with a
higher levy.
296
355
414
474
533
592
1,3
1,6
1,8
2,1
2,4
2,6
39
climate changemitigation. The funds
could be used for R&Dor climate change
adaptation.
Contributions to aglobal fund falls with
lower levy.
Carbon abateddecreases withinsufficient levy.
A levy proposal based on the purchase of CDM carbon credits would incur a cost of about $66 perallocation (i.e. 0% auction) would achieve the same impact. With auctioning, there is an additional cost to the industry as iauctioned. The greater the proportion of auctioning, the greater the cost to the industry. If the shipping industry follows tauction 15% of allowances – this would cost the industry US$38b by 2030. Full auction will cost $152 per metric ton fuel. A levy
Over time, all costs will increase to offset the growing emissions from the sector. Not all measures will increase at the samETS with free allowances follows the same pattern. The cost of an ETS with full auction will increase relatively less, but is
Levy and ETS zero-auction imposes least cost on the industry
Impact ranges from $66 to $152 per tonne fuel in 2030 depending upon policy options
Figure 3.7: Costs by policy model option 2030. ($2010)
Impacts: Costs
Cost impact per tonne fuel 20302015
PwC
Source: PwC GHG Shipping model.
*15 % auction is a proxy scenario for the aviation sector auction percentage in the EU scheme. This may considered a realisti2025; and 25% until 2030. All cost include 10% contribution to global climate fund. We do not make assumptions about furtheabatement potential at these levels of fuel cost.
40
$66
$87
$152
Levy/ETS (0% auction)
ETS (15% auction)
ETS (100% auction)
$88
$28
$20
A levy proposal based on the purchase of CDM carbon credits would incur a cost of about $66 per tonne of fuel cost to the industry by 2030. An ETS proposal with freeallocation (i.e. 0% auction) would achieve the same impact. With auctioning, there is an additional cost to the industry as it has to purchase the allowances beingauctioned. The greater the proportion of auctioning, the greater the cost to the industry. If the shipping industry follows the practice in the EU ETS plans on aviation to
this would cost the industry US$38b by 2030. Full auction will cost $152 per metric ton fuel. A levy can be set to the same level if desired.
Over time, all costs will increase to offset the growing emissions from the sector. Not all measures will increase at the same rate. Levy costs will increase the fastest. AnETS with free allowances follows the same pattern. The cost of an ETS with full auction will increase relatively less, but is higher throughout.
auction imposes least cost on the industry
fuel in 2030 depending upon policy options
2015 2030Over time
ETS with full auction starts
*15 % auction is a proxy scenario for the aviation sector auction percentage in the EU scheme. This may considered a realistic benchmark. Aviation auction percentage assumed to be at 15% until 2020, 20%-2025; and 25% until 2030. All cost include 10% contribution to global climate fund. We do not make assumptions about further in-sector contributions due to lack of documented incremental in-sector
40
$88
$152
74%
$28
$87
207%
222%
$20
$66Levy increases very fast inthe beginning and growth
rates will come closer to theETS in the long run
ETS with full auction startswith a high auction cost
component and increaseswith the rate of emissionsand carbon price growth.
$618$66
$86
Compared to the sulfur regulations, carbon pricing has a relatively small impact on the cost to the industry. The increase inexpected to raise fuel price to the point where currently known emission reduction opportunities would have been exhausted.
The incremental carbon price is therefore unlikely to drive additional in-sector emissions reduction. Our results therefore assuto buy credits rather than invest in fuel efficiency. In other words, in-sector emissions reduction resulting from incremental
Figure 3.8: Drivers of impact on fuel cost 2030 ($2010)
Contribution toincrease 80% 9% 11%
Impact is dwarfed by trends in the fuel cost
80 percent of increase in fuel cost is due to sulfur effect
Impacts: Costs
PwC
$699
Bunker baseSulfur regulation
impactLevy/ETS 0% auction
offsetsETS 100% auction
Source: PwC GHG Shipping model.
41
$1469$86
Compared to the sulfur regulations, carbon pricing has a relatively small impact on the cost to the industry. The increase in fuel costs under the sulfur regulations isexpected to raise fuel price to the point where currently known emission reduction opportunities would have been exhausted.
sector emissions reduction. Our results therefore assume that the shipping industry would havesector emissions reduction resulting from incremental carbon pricing is unlikely.
11%
ETS auction: 6 %Levy: 5 %
5-11%
Share of total voyage cost 2030
ETS 100% auctionMax total
cost per metric tonnefuel
41
Levy: 5 %
Fuel 89-95%
+110%
Within an ETS, a core design feature is determining how the carbon allowancesare allocated to the industry. Allowances can be allocated free to the participantsor auctioned.
The benefits of auctioning include:
• Generation of revenue which can be used, for example, to fund mitigationand adaptation in developing countries and/or R&D into green technology; and
• Reduction of initial distortions within an ETS as it allows participants topurchase their required number of allowances.
In practice, however, ‘grandfathering’ (allocation of allowances for free based onhistorical emissions data) has often been the allocation method of choice,particularly when schemes are initially set up to reduce the upfront cost to the
Auctioning allowances in the ETS increases revenue to the implementing authorities
Impacts: Costs
PwC
particularly when schemes are initially set up to reduce the upfront cost to theindustry.
42
The EU ETS is gradually moving away from the free allocation of allowances thattook place in Phases I and II towards greater share of allowances beingauctioned. At least 50% of allowances will be auctioned from Phase III in 2013,compared to around 3% in Phase II.
The aviation sector which will be included in the EU ETS from 2012 hasrelatively generous emissions caps (2012 emissions capped at 97% of average2004-06 emissions, falling to 95% in 2013) and has 15% auctioning in 2012(2013 onwards: to be negotiated).
Impact on sector:
Under 100% free ‘grandfathering’ allocation, each participant is allocatedallowances based on historical emissions, rather than the reduction potential orcost. A small number of participants may benefit if they are ‘over-allocated’allowances especially if the cap is not strict enough, and can sell emissionallowances to make a profit. The problem is less likely under a strict cap.
Participants under a full auctioning scheme will purchase their allowances at theauction based on their willingness to pay and quantity required.
Most importantly the method of allocation affects the amount of revenue paid bythe industry as a whole. Under free allocation, allowances are traded within theindustry (subject to assumptions about linking to external carbon markets) and
Auctioning allowances in the ETS increases revenue to the implementing authorities
industry (subject to assumptions about linking to external carbon markets) andparticipants which are efficient in reducing emissions can profit from the scheme.Under full or partial auctioning, the revenue is collected by a central entity, whichmay or may not recycle the revenue back into the industry. Efficient participantsstill have to pay under (full) auctioning when the revenue is not recycled back intothe industry.
At an individual business level, there will also be a cashflow impact of auctioning.Timing and volumes of purchases of allowances will need to be factored into cashmanagement.
42
ETS costs increases with auction percentage
Depending upon the auction percentage share, the cost varies by more than 100 percent. Increasing the share of auction, and tfuel efficiency incentives. This impact is not quantified and as such the environmental effectiveness of 0 percent versus 100
Proceeds from the auction can be used by a global climate fund or by other authorities. Proceeds may be channeled back into tactivities. The fund may also be used for other purposes.
Figure 3.11: ETS and size of auctions by 2030 ($2010)
Range from $66 to $152 per tonne fuel in 2030 depending upon auction percentage
Impacts: Costs
PwC
29 bn 33 bn 36 bn 40 bn 44 bn 48 bn
0% 50 %
$66 $74 $83 $92 $100 $109
Figure 3.11: ETS and size of auctions by 2030 ($2010)
Source: PwC GHG Shipping model.
43
Auction percentage
Cost impact per tonne fuel
Total industry cost
Depending upon the auction percentage share, the cost varies by more than 100 percent. Increasing the share of auction, and this the cost, will in principle add to thefuel efficiency incentives. This impact is not quantified and as such the environmental effectiveness of 0 percent versus 100 percent are identical.
Proceeds from the auction can be used by a global climate fund or by other authorities. Proceeds may be channeled back into the sector to support R&D or related
fuel in 2030 depending upon auction percentage
52 bn 56 bn 59 bn 63 bn 67 bn
100 %
$118 $126 $135 $144 $152
43
+132%
Cost impact onindustry is highlydependent upon
auction percentage
Total outflows from industry may reach $67 billion by 2030, with contributions to aglobal climate fund reaching $41 billion
Financial outflows from the sector are comprised of three cost components:
- The amount required for carbon offsets
- Auction proceeds to authorities
- Additional contribution to global climate fund (10%)
These would increase over time driven by the increase in carbon price andabatement requirements over time.
Impacts: Costs
PwC
$7bn
$9bn
$29bn
$12bn
$17bn
$38bn
$19bn
$27bn
$51bn
$29bn
$38bn
$67bn
Levy/ETS (0% auction)
ETS (15% auction)
ETS (100% auction)
Figure 3.9: Outflows from sector ($2010)
*Includes both offsets, auction contribution and 10 percent contribution to global climate fund,CDM carbon price only.
44
Total outflows from sector range from $29 billion to $67billion by 2030*
Outflows from shipping sector
2015 20252020 2030
Increase2015-2030
+134%
+314%
+334%
Total outflows from industry may reach $67 billion by 2030, with contributions to a
After accounting for the purchase of carbon credits, the auction proceeds andcontribution to global climate fund are additional revenues raised. These canbe used in a number of ways:
• Recycled back into the sector through investments in R&D and technologydevelopment funds;
• Additional financing to climate change mitigation or adaptation;
• Compensation to particular countries (e.g. least developed countries) forpotential impact on the sector; and/or
• Shared by national governments as additional proceeds to the states.
$0,6bn
$3bn
$23bn
$1,1bn
$6bn
$27bn
$1,7bn
$10bn
$34bn
$2,6bn
$12bn
$41bn
44
Contributions from shipping**
Figure 3.10: Additional revenues raised from scheme ($2010)
Proceeds from the scheme can raise additional revenues forvarious uses
Increase2015-2030
+81%
+276%
+334%
**Includes auction contribution and 10 percent contribution to global climate fund, CDM carbonprice only
Source: PwC GHG Shipping model
2015 20252020 2030
Containers will see the highest impact
These impacts may vary within the industry by vessel types. The maindifferent types of ship in the world merchant fleet include:
a) Container Ships, which carry most of the world's manufactured goodsand products, usually through scheduled liner services;
b) Bulk carriers, which transport raw materials such as iron ore and coaland vary from handysize (small) to capesize (large) bulkers;
c) Tankers, which are similar to bulk carriers but transport crude oil,chemicals and petroleum products; and
d) Passenger ships, which includes ferries and cruise. This is excludedfrom our analysis.
Fuel most important component of cost base in2010
Impacts: Costs
Carbon cost a smaller share of cost base in 2030
PwC
26 %
25 %
29 %
25 %
15 %
30 %
30 %
19 %
20 %
10 %
44 %
45 %
52 %
55 %
75 %
Handysize Bulker
Handysize ProductTanker
VLCC
Capesize Bulker
Container Main Liner
18 %
17 %
19 %
16 %
8 %
21 %
20 %
12 %
13 %
6 %
45
Source: PwC GHG Shipping models. Opcost from Moore and Stephens LLP survey 2010. Capex fromCE DELFT 2010. Our analysis includes estimated average annual fuel efficiency gains for vessels.
Figure 3.12: Components of cost base per shiptype 2010-2030 with Levy and ETS 100% auction (daily costs)
Capex FuelOpex
2010
The amount of carbon emissions for a ship is strongly linked to fuelconsumption, which as a proportion of the cost base, differs substantiallyacross the ship segments.
A container main liner has the largest share of fuel cost, and therefore byextension carbon costs. Smaller ships (handysize bulkers and tankers), with aproportionally larger capex and opex cost base, finds carbon cost a smallerproportion of their cost base.
Figure 3.12 demonstrates the impact of a carbon levy and ETS on the costbase across different ship types (based on US$66($152 per tonne of fuel aspresented in the industry results).
Carbon cost a smaller share of cost base in 2030
21 %
20 %
12 %
13 %
6 %
59 %
60 %
66 %
68 %
82 %
2,9 %
3,0 %
3,3 %
3,4 %
4,1 %
45
DELFT 2010. Our analysis includes estimated average annual fuel efficiency gains for vessels.
2030 with Levy and ETS 100% auction (daily costs)
Carbon
2030
17 %
16 %
18 %
15 %
8 %
20 %
19 %
12 %
12 %
5 %
57 %
58 %
63 %
65 %
78 %
6,6 %
6,7 %
7,3 %
7,5 %
9,0 %
Levy ETS 100% auction
Carbon
Carbon levy represents a small share of the increase in voyage costs
Figure 3.13 presents contribution of the levy to a container’s cost base until 2030. Carbon costs are expected to be around Ucompared to fuel costs of around US$87,000 per day. Voyage costs, consisting of both fuel and carbon costs, will make up an ifrom nearly 75% of total costs today to around 86% in 2030.
Figure 3.13: Increase in the daily voyage cost for a container main liner under a levy ($2010) (3500 TEU)
Voyage costs will reach 86 percent of total for a container liner with levy
Voyage cost increase
+49%
+15%
Impacts: Costs
Levy/ETS0% auction
PwC
2010 2015 2020 2025
46
Source: PwC GHG Shipping models
$ 91,000
+30%
+49%
Carbon levy represents a small share of the increase in voyage costs
Figure 3.13 presents contribution of the levy to a container’s cost base until 2030. Carbon costs are expected to be around US$2,500 per day in 2015; relatively smallcompared to fuel costs of around US$87,000 per day. Voyage costs, consisting of both fuel and carbon costs, will make up an increasing share of the overall cost base,
under a levy ($2010) (3500 TEU)
Voyage costs will reach 86 percent of total for a container liner with levy
$ 162,000+15%
+6%4% Carbon
2025 2030
46
82% Fuel
6% Opex
8% Capex
Carbon cost is more significant under the ETS with full auction
Figure 3.14: Increase in the daily voyage cost for a container main liner under a ETS 100% auction($2010/3500 TEU)
Voyage costs will reach 87 percent of total for a container liner with ETS 100% auction
Voyage cost increase
+44%
+14%
Impacts: Costs
Levy$152/ ETS100% auction
Figure 3.14 presents the contribution of an ETS to a container’s cost base until 2030, assuming that 100% of carbon allowance
Carbon costs are expected to be around US$10,700 per day in 2015; not insignificant compared to fuel costs of around US$87,00both fuel and carbon costs, will make up an increasing share of the overall cost base, from nearly 75% of total costs today t
PwC
2010 2015 2020 2025
47
Source: PwC GHG Shipping models
$ 91,000
+37%
Carbon cost is more significant under the ETS with full auction
under a ETS 100% auction($2010/3500 TEU)
Voyage costs will reach 87 percent of total for a container liner with ETS 100% auction
$ 171,000+14%+5%
9% Carbon
Figure 3.14 presents the contribution of an ETS to a container’s cost base until 2030, assuming that 100% of carbon allowances are auctioned.
Carbon costs are expected to be around US$10,700 per day in 2015; not insignificant compared to fuel costs of around US$87,000 per day. Voyage costs, consisting ofboth fuel and carbon costs, will make up an increasing share of the overall cost base, from nearly 75% of total costs today to around 87% in 2030.
2025 2030
47
78% Fuel
5% Opex
8% Capex
Mid-range alternative with aviation style auction
Figure 3.15 presents the contribution of an ETS to a container’s cost base until 2030, assuming that 15% of carbon allowancesand 25% thereafter.
Carbon costs are expected to be around US$3,500 per day in 2015; still relatively small compared to fuel costs of around US$8of both fuel and carbon costs, will make up an increasing share of the overall cost base, from nearly 75% of total costs toda
Impacts
Figure 3.15: Increase in the daily voyage cost for a container main liner under an ETS with 15% auctioning ($2010)
Voyage costs could reach 86 percent of total costs for a container main liner
Voyage cost increase
+40%
+9%160
180Levy$87/ ETS15% auction
PwC 48
Source: PwC GHG Shipping models
$ 91,000
+33%
0
20
40
60
80
100
120
140
2010 2015 2020 2025
auction
Figure 3.15 presents the contribution of an ETS to a container’s cost base until 2030, assuming that 15% of carbon allowances are auctioned until 2020, 20% until 2025
Carbon costs are expected to be around US$3,500 per day in 2015; still relatively small compared to fuel costs of around US$87,000 per day. Voyage costs, consistingof both fuel and carbon costs, will make up an increasing share of the overall cost base, from nearly 75% of total costs today to around 86% in 2030.
under an ETS with 15% auctioning ($2010)
Voyage costs could reach 86 percent of total costs for a container main liner
$ 165,000+9%
+3%
5% Carbon
48
81% Fuel
6% Opex
8% Capex
2025 2030
A change in cost base as a result of increased cost of carbon will normally affect the profits for the industry. The extentability of shipowners to pass-through costs to the end customer, rather than allowing the increase in costs to reduce their own profits. The elasticiwith respect to fuel prices provides a measure of the percentage change in freight rates as a result of a 1% change in the fThese are historical estimates based upon decades of data. It is uncertain whether the analysis holds in a future of much higon real data as the higher fuel cost has only been a reality for the last few years. An average of key studies over recentproduct types. Elasticity is a statistical concept and the actual impact on profitability is dependent upon other factors whimpact on rates is shown below.
In the long-run the degree of substitutability between different forms of transport will be relevant. Importers have different mspecifically air and land transport. There are however likely to be overriding factors: goods which have a low valuewhereas land transport are not applicable for longer distance movements of goods. Specifically, the aviation industry is alsoswitch between air and sea freight as a result of carbon costs unlikely.
Profitability impact determined by demand for goods transported andcapacity in industry
Impacts: Profits
Figure 3.16: Impact on profits under varying market conditions
High demand and low capacity results in low profit impact
PwC 49
Source: PwC analysis. Data for elasticities from OECD 2008, 2009; Vivid Economics 2010. Long run elasticities determined th
Figure 3.16: Impact on profits under varying market conditions
0,96
0,30
0,27
0,20
Demand for commodity
Impact onprofit Elastic Inelastic
Surplusshippingcapacity
High Low Medium
Low Medium High
A change in cost base as a result of increased cost of carbon will normally affect the profits for the industry. The extent of the final change in profits depends on thethrough costs to the end customer, rather than allowing the increase in costs to reduce their own profits. The elasticity of freight rates
with respect to fuel prices provides a measure of the percentage change in freight rates as a result of a 1% change in the fuel price (for example due to a carbon levy).These are historical estimates based upon decades of data. It is uncertain whether the analysis holds in a future of much higher fuel cost and that cannot be tested yeton real data as the higher fuel cost has only been a reality for the last few years. An average of key studies over recent years estimates the elasticities across differentproduct types. Elasticity is a statistical concept and the actual impact on profitability is dependent upon other factors which we will review on the following pages. The
run the degree of substitutability between different forms of transport will be relevant. Importers have different modes of transport to move their goods,specifically air and land transport. There are however likely to be overriding factors: goods which have a low value-to-weight ratio are unlikely to be profitable by air,whereas land transport are not applicable for longer distance movements of goods. Specifically, the aviation industry is also subject to emissions regulation, making a
Profitability impact determined by demand for goods transported and
Predicted rate impact depends upon impact of carbon priceon fuel cost
Figure 3.17: Impact on rates
49
Source: PwC analysis. Data for elasticities from OECD 2008, 2009; Vivid Economics 2010. Long run elasticities determined through econometric methods in these studies. Rate impacts calculated by team.
Levy ETS 100% auction
1 %
1,3 %
1,5 %
5 %
2,3 %
3,1 %
3,5 %
11,1 %
Container
Clean bulk
Tanker
Dirty bulk (iron ore)
Rate impact
Figure 3.17: Impact on rates
Most shipping companies would absorb some of the cost increase
The ability to pass on costs is impacted by both the type of transport, and by the existing profit margin. The ETS with fullfuel) would result in more profit loss.
Figure 3.18: Absorption of cost increase at 25percent initial margin
Containers will absorb most of the costincreases
Impacts: Profits
71 %Container -4 695
And will see the hardest impact on thebottom line
Levy/ETS 0%
Figure 3.19: Daily loss of profit in 2030 with Levywith 25 percent initial margin on cost base($2010)
Both levy and ETS
PwC 50
Source: PwC GHG Shipping models.
2010
71 %
47 %
45 %
38 %
-74 %
Container
Handysize bulker(clean)
VLCC
Handysize producttanker
Capesize bulker (dirty)
-4 695
-512
-1 976
-601
Most shipping companies would absorb some of the cost increase
The ability to pass on costs is impacted by both the type of transport, and by the existing profit margin. The ETS with full auction (or a levy at $152 per metric ton
-10 879
And will see the hardest impact on the ETS with auction will increase theimpacts
Levy/ETS 0%-auction ETS 100%-auction
Figure 3.19: Daily loss of profit in 2030 with Levywith 25 percent initial margin on cost base
Figure 3.20: Daily loss of profit in 2030 with ETS 100percent auction and with 25 percent initial margin on costbase ($2010)
Examples of short term impacts
50
2 193
-10 879
-1 186
-4 578
-1 392
5 082
Impact on profits are limited during periods of high freight rates (levy)
Freight rates and a ship’s profit margin are determined by a multitude of factors, including the competitive conditions, opership and market conditions. To reflect this, our analysis presents a potential daily freight rate for a given level of fuel cscenarios relative to cost base of 10% and 50%. This is clearly a gross simplification of how the sector’s freight rates andillustrate the potential impacts of carbon costs in the absence of other influencing factors.
During periods of low profitability (when freight rates are low because e.g. there is relative surplus in capacity), the propcompared to during periods of high profitability (e.g. during trade booms). For example, profit margin falls from 10% to 7% (but only 50% to 45% (a 10% fall) in the high freight rate scenario.
Figure 3.21: Profitability impact on a VLCC with 10 percent initial margin oncostbase, 2030 (Levy)
More impact with low rates
-1,6% +1,5%3,1%Share of rate
Impacts: Profits
PwC
Initialprofit
margin
Carboncost
Profitimpact
New rate
51
Source: PwC GHG shipping model. Notes: Detailed analysis is in the Annex ; Mark-up here is applied on freight rates relative tcapex, opex and fuel) . Annual fuel efficiency gains accounted for.
10%margin
49% of costincrease
-$2300 daily
Impact on profits are limited during periods of high freight rates (levy)
Freight rates and a ship’s profit margin are determined by a multitude of factors, including the competitive conditions, operational and management efficiency of theship and market conditions. To reflect this, our analysis presents a potential daily freight rate for a given level of fuel consumption, by considering two ‘profit mark-up’scenarios relative to cost base of 10% and 50%. This is clearly a gross simplification of how the sector’s freight rates and profits are determined, and is intended toillustrate the potential impacts of carbon costs in the absence of other influencing factors.
During periods of low profitability (when freight rates are low because e.g. there is relative surplus in capacity), the proportionate impact on profits is more significantcompared to during periods of high profitability (e.g. during trade booms). For example, profit margin falls from 10% to 7% (a 30% fall) in the low freight rate scenario,
Figure 3.22: Profitability impact on a VLCC with 50 percent initial margin oncostbase, 2030 (Levy)
Less impact with higher rates
2,2% -0,7% +1,5%Share of rate
Examples of short term impacts
Initialprofit
margin
Carboncost
Profitimpact
New rate
51
up here is applied on freight rates relative to cost base (i.e. Freight rates = total cost base x (1+ mark-up)). Cost base=
50%margin
66% of costincrease
-$1500 daily
Transportation of grain is less profitable than iron ore (levy)
All ship types will be able to pass-through some of their costs to their customers. However, depending on the market segment andmay be ships that are able to pass on in terms of freight rates more than the cost incurred, and potentially gaining a profittransporting goods in high demand such as iron ore to China, will pass on more than the cost incurred, and potentially gaini
A further impact on profits, which is not explicitly considered in our analysis, is the impact on volume. As freight rates inof shipping activities may fall. However, over the longer term, the potential impact is likely to be driven by more fundamentshift. This is discussed in our next section.
Figure 3.23: Profitability impact on a Handysize Bulker (grain) with 25 percentinitial margin on costbase, 2030 (Levy)
Grain transports will see a reduction in profit
-1,2% +1,3%2,5%Share of rate
Impacts: Profits
PwC
Initial profitmargin
Carboncost
Profitimpact
New rate
52
Grain
53% of costincrease
-$570 daily
Source: PwC GHG shipping model. Notes: Detailed analysis is in the Annex ; Mark-up here is applied on freight rates relative tcapex, opex and fuel) . Annual fuel efficiency gains accounted for.
Transportation of grain is less profitable than iron ore (levy)
through some of their costs to their customers. However, depending on the market segment and general economic conditions, theremay be ships that are able to pass on in terms of freight rates more than the cost incurred, and potentially gaining a profit in the process. For example, capesize bulkerstransporting goods in high demand such as iron ore to China, will pass on more than the cost incurred, and potentially gaining a profit in the process.
A further impact on profits, which is not explicitly considered in our analysis, is the impact on volume. As freight rates increase, especially in the short-term, the levelof shipping activities may fall. However, over the longer term, the potential impact is likely to be driven by more fundamental factors such as trade levels and modal
Figure 3.24: Profitability impact on a Capesize Bulker (iron ore) with 25 percent initialmargin on costbase, 2030 (Levy)
In a few markets for goods with inelastic demand like iron ore,there may be a markup on top of the cost increase
2,8% +2,1% +4,9%Share of rate
Examples of short term impacts
Initial profitmargin
Carboncost
Profitimpact
New rate
52
Iron
174% of costincrease
+$2200 daily
up here is applied on freight rates relative to cost base (i.e. Freight rates = total cost base x (1+ mark-up)). Cost base=
Higher levy or ETS with full auction gives similar cost passbut higher $ impact on bottom line
Impacts: Profits
Figure 3.25: Profitability impact on a VLCC with 10 percent initial margin oncostbase, 2030 (ETS 100%))
More impact with low rates
Initialprofit
margin
Carboncost
Profitimpact
New rate
10%margin
-3,6% +3,5%7,1%Share of rate
49% of costincrease
-$5300 daily
PwC 53
Figure 3.27: Profitability impact on a Handysize Bulker (clean) with 25 percentinitial margin on costbase, 2030 (ETS 100%))
Grain transports will see a reduction in profit
margin
Initialprofit
margin
Carboncost
Profitimpact
New rate
53% of costincrease
Grain
-2,7% +3%5,7%Share of rate
-$1200 daily
Source: PwC GHG shipping model. Notes: Detailed analysis is in the Annex ; Mark-up here is applied on freight rates relative tcapex, opex and fuel) . Annual fuel efficiency gains accounted for.
Higher levy or ETS with full auction gives similar cost pass-through percentages,
Figure 3.26: Profitability impact on a VLCC with 50 percent initial margin oncostbase, 2030 (ETS 100%)
Less impact with higher rates
Initialprofit
margin
Carboncost
Profitimpact
New rate
66% of costincrease
50%margin
-1,7% +3,5%5,2%Share of rate
-$3500 daily
Examples of short term impacts
53
Figure 3.28: Profitability impact on a Capesize Bulker (dirty) with 25 percent initialmargin on costbase, 2030 (ETS 100%))
In a few markets for goods with inelastic demand like iron ore,there may be a markup on top of the cost increase
margin
Initialprofit
margin
Carboncost
Profitimpact
New rate
174% of costincrease
Iron
4,5% +11,3%6,5%Share of rate
+$5100 daily
up here is applied on freight rates relative to cost base (i.e. Freight rates = total cost base x (1+ mark-up)). Cost base=
Based on current IMO proposals, the CDM’s credits (CERs) are the most likely source of credits eligiblefor compliance in the shipping sector. The demand generated by a shipping carbon scheme (whether levyor ETS) would generate smore emission abatement projects in developing countries
An ETS is frequently linked to another carbon marketto provide greater liquidity. This is achieved byallowing the carbon credits or allowances from othermarket(s) to be eligible for compliance. This reducesthe burden on the industry to meet all the requiredcarbon abatement in-sector.
The core levy proposal considered by the IMO (GHGFund) also involves linking to the carbon markets bybasing the levy on the cost required to purchasecarbon credits equal to the target set.
There are three ways of linking:
• Unilateral linking where credits or allowances
Linking to another carbon market would affect the shipping carbon price
Figure 3.29 Potential carbon markets
Linking to one or more carbon markets can affect the shipping carbon price
Impacts
54
• Unilateral linking where credits or allowancesfrom a carbon project credit mechanism (e.g.CDM or voluntary markets) or another ETS (e.g.EU ETS) are eligible for compliance in theshipping ETS, but not vice versa;
• Unilateral linking where shipping credits orallowances are eligible for compliance in theanother ETS, but not vice versa;
• Bi-lateral linking where allowances areinterchangeable between the two ETS and can beused for compliance in both markets.
The EU ETS is currently the largest carbon marketin the world followed by the Clean DevelopmentMechanism (CDM). Emerging regional marketsand the growing voluntary market can also providea source of carbon credits. Each market’s creditsexhibit a different price and therefore linking withthem will exert different price pressures on theshipping allowance or levy.
WCI*
California*
Voluntary(Global)
* The Western Climate Initiative (WCI) and California’s ETS are due to commence in 2012.
Based on current IMO proposals, the CDM’s credits (CERs) are the most likely source of credits eligiblethe shipping sector. The demand generated by a shipping carbon scheme (whether levy
ETS) would generate significant demand for CERs, which could substantially improve the prospects ofmore emission abatement projects in developing countries.
carbon market would affect the shipping carbon price
Figure 3.29 Potential carbon markets to be linked
Linking to one or more carbon markets can affect the shipping carbon price
54
EU ETS
New Zealand
CDM(Global)
IMO
The Western Climate Initiative (WCI) and California’s ETS are due to commence in 2012.
Linking to EU ETS will be more costly than global CDM markets
A cost of carbon is expected to be added to the price of fuel through a futuremarket-based measure directed at the shipping industry. Currently, for everytonne of fuel consumed, approximately three tonnes of CO2 are emitted.
The additional cost for these emissions will depend on the price per tonne ofCO2. The EU Emissions Trading System (EU ETS) is the largest carbon marketin the world and is the key policy instrument to enable the EU to meet itsinternational GHG emissions reduction target. Historically, the price of EUA(allowance traded in the EU ETS) has experienced some volatility in response toeconomic conditions and policy decisions. However, as the future cap onemissions tighten in the future, the overall price trend is expected to beupwards.
A tonne of fuel emits three tonnes CO2
Impacts
PwC
A tonne of fuel emits three tonnes CO2
Figure 3.30 Carbon emission from shipping fuel
One tonne of fuel three tonnes of CO2*
*Actual relationship is between 3.09-3.17 varying with a.o fuel quality. We have assumed 3.13throughout this study
55
Linking to EU ETS will be more costly than global CDM markets
The Clean Development Mechanism (CDM) is the second largest carbon marketand operates under the Kyoto Protocol. Its credits (CERs) are the most likelysource of offsets for the shipping sector and are currently used for compliance inthe EU ETS, NZ ETS and under the Kyoto Protocol.
The policy options and various design features for a market-based measure for theshipping sector, including how it is linked to these existing carbon markets, willimpact the price of carbon, the industry and the environment.
Expected increase of the price of allowances in two key benchmark
2005 2010 2015 2020 2025 2030
EUACER
Sources: Bloomberg EUA Spot, IETA forecast; CER Based on 2011 CER-EUA Spread, linearextrapolation to 2030 of PointCarbon EUA forecast to 2020, PwC inflation forecasts
Expected increase of the price of allowances in two key benchmarkcarbon markets
Figure 3.31 Prices for EU EUA and CER (CDM) credits and allowances
EU ETS I & II
20
30
40
50
60
$to
nne
allo
wance
6,1%
41%
Prices for CDMprojects expected
to be lower
EU pricepressures
55
Banking and borrowing have been raised but not discussed in detail in theproposals to the IMO. These features help to stabilise the price of an allowance,particularly across different phases of an ETS.
Borrowing: If the price begins to rise because the available allowances areexpected to be short of the cap in that period, then the ability to borrow for futureallowances increases supply can prevent a price spike. Price will rise incrementallyover time as more allowances are borrowed (rather than sharp spikes).
Banking: Likewise, if the available allowances are expected to be in excess of thecap set, a shipping company can bank allowances to use in the future. This reducessupply and avoids a sharp fall in price. This avoids the price of an allowance beingdevalued substantially towards the end of an ETS phase. Similarly, if a shippingcompany believes meeting the future cap is substantially more costly, it may chooseto smooth its exposure over time by reducing emissions or purchasing credits now
Banking and borrowing across ETS phases smooths price fluctuations
Impacts
PwC
to smooth its exposure over time by reducing emissions or purchasing credits nowand bank them for the next phase.
These attributes therefore reduce price volatility by making allowancesinterchangeable over different phases, rather than experiencing sharp fluctuationsin prices during transition from one phase to the next.
The EUA price crashed in April 2006 as it became apparent that there had been anover-allocation of allowances in Phase I. These allowances were not allowed to bebanked into Phase II and therefore their price trended towards zero during 2007 asthe ‘use-by’ date made them virtually worthless towards the end of Phase I.
Allowances can however be banked from Phase II to Phase III, but not borrowed.Expectations about a significantly tighter cap in Phase III helps sustain the pricesof Phase II allowances as they can be carried over.
56
Impact on sector:
Cashflow and financing management is a strategic issue for a shipping company.The industry would need to take into account not just the aggregated costs of a newregulation, but also its ability to manage compliance costs over time.
Banking and borrowing are therefore important policy design features that haveimplications on a ship’s cash-flow management.
Impact on environmental outcome:
The level of banking and borrowing is also important to ensure the credibility of ascheme. Overgenerous limits on banking and borrowing can undermine theenvironmental effectiveness of a scheme within a given timeframe.
Banking and borrowing across ETS phases smooths price fluctuations
56
Figure 3.32: EUA price crash during Phase 1
A ban on banking can lead to instability and falling prices
EU
Rper
allo
wance/t
onne
CO
2
-
10
20
30
des.05 des.06 des.07
Impact on cashflow
The impacts on costs and profits ultimately feed through to cash and managing thisis critical for the day-to-day running of any company. Design features of both a levyand an ETS will have impacts on cashflow.
Phasing of a levy
Under the current levy proposal, the levy should overall track the price trends of amajor carbon market. Within a levy phase, there is no price volatility as the price isfixed, and cash outflows can be managed relatively easily. However if the levy is settoo high or too low, or because carbon prices deviate substantially from initialexpectations, there may be a substantial revision required in the levy when movinginto the next phase.
For example, if the price set during Phase I was too low to purchase the requisitenumber of project credits, this may need to be compensated for in Phase IIresulting in an overnight spike in the levy. Conversely, a levy price (and subsequent
Impacts
PwC
resulting in an overnight spike in the levy. Conversely, a levy price (and subsequentcashflows) could be reduced if the cost of carbon credits fall.
Cash flows will be impacted immediately with each new phase;the extent depends on the external carbon price (and target)
Steady increase incontribution
Phase I levy too low sohigher in Phase II
Phase II lower as externalcarbon price dropped
Figure 3.34: Conceptual illustration of cash flow impacts
57
Banking & borrowing
The ability to bank credits into the next phase of an ETS allows companies to spendnow and save in the future, for example if they expect future credit to costsubstantially more.
Conversely, borrowing allowances from the next phase allows companies to meetcurrent obligations.
The level of banking and borrowing between phases may therefore also affect howshipping companies manage their compliance strategy. Shipping companies maychoose to hedge against future carbon price increases by purchasing credits todayand banking them, especially if they have adequate free cash flow. Conversely,during periods of tight cash flows, a shipping company may choose to borrow fromthe next phase to meet existing obligations.
Phase II lower as external
57
Impact on trade volumes
Seaborne trade volumeswill decline compared tobusiness as usual
Regional roadtransportincreases
The cost increase will be absorbed by different actors in the transport value chain. The shipping industry willexperience a reduction in profitability as a result.
There are additional impacts resulting from the increased freight rates and these are discussed in thefollowing section.
PwC 58
Global seabornetrade volumes
declines
Impact on trade volumes
The cost increase will be absorbed by different actors in the transport value chain. The shipping industry willexperience a reduction in profitability as a result.
There are additional impacts resulting from the increased freight rates and these are discussed in the
Modal shift is a particularly relevant scenario for the short-sea freightsegment where road transport is an option. We would expect these impacts inthe densely populated regions of Asia, Europe and North-America. Somelimited impact may also be observed on the Asia-Europe voyages due to thetrans-siberian railway.
Road transport will increase as a consequence of increased freight rates forshipping. Studies from Europe indicate a severe impact with fuel costs above$1000 per metric tonne. CO2 emissions per tonne transported are higher for
58
$1000 per metric tonne. CO2 emissions per tonne transported are higher forroad transport than for shipping and as such net emissions will increase.
Global seabornetrade volumes
As freight rates increase, locally produced goods will become more competitive.The demand for international transport will decline as a consequence. This lossof volume will impact the deep-sea segment of the fleet which transportsgoods across oceans and between continents. Producers for export will also beimpacted.
The dynamics are complex and depends upon the ratio of freight costs to thecost of the goods, as well as the elasticity of demand and capacity of domesticproducers.
There would be a modal shift to road transport for the short
Impacts
Freight cost increases would also impact the choice of transport modes. Forregional transports, road and rail transports are competing against shipping.Potential for modal shift has been analyzed in a number of studies on theimpact of low-sulfur regulations concerning Europe. These studies are highlyspecific about routes and transport corridor options and impacts vary greatlydepending upon local factors.
Some general principles may be transferable to other regions around the world.These are indicated in the figure below.
It is also important to note that if it does happen it is likely to be from the impactof rising fuel cost due to sulfur regulations rather than carbon cost. The latterhas a smaller impact on the total cost increase as have been shown above in thisstudy.
PwC 59
Figure 3.35: General findings regarding modal shift
Modal shift is likely to happen, mostly stemming form theincrease in fuel cost
• Fuel cost increase would transfer through freight rates• Rate increases would decrease competitiveness of sea
transport• In some instances, sea transport would become
uncompetitive and new patterns of transport wouldemerge
Source: EMTS 2010
There would be a modal shift to road transport for the short-sea segments
Trade volumes could remain broadly unchanged, but the sources of goods mayvary. Locally produced goods may become more competitive vis-a-vis farawayproducers, but so will goods from neighboring countries. Technically these stillcount as trade, so it is more about a shift from faraway producers to closer sources(not just local).
Currently shipping is the most carbon efficient mode of transport, and a shifttowards road transport may increase the carbon footprint of the products andundermines the environmental impact of a carbon regulation.
However, over the longer run, this depends on the relative improvements incarbon efficiency of land vs. sea transport as there are substantial incentives bymany countries to promote low carbon land vehicles.
59
• Impacts at low fuel price scenario at $500 per metricton could give average volume loss of 15 percent
• Volume loss at fuel cost of $1300 per metric ton mayreach 22 percent
• Severe impacts for particular routes (i.e english channel)at fuel costs above $1000 metric ton.
• Most volume loss on medium-range routes at 21 percent(400-750 km) for fuel cost at $500 per metric ton.
Specific findings from Europe
Future trade routes will shift eastwards
Rise of the emerging economies
The patterns of global trade have shifted noticeably over the last twenty years. In1990 the developed economies dominated the trade map. Europe was responsiblefor over half of the world’s exports, but these were mostly intra-European flows.
The last twenty years saw global manufacturing shift swiftly to lower costcountries, which boasted cheap labour and good trade links with which to provideWestern markets with cheap consumer goods. By 2009 the emerging economies,and developing Asia in particular, had gained significant share of world’s exports.
Imports into developing countries are also growing. Robust industrial growth hasboosted the demand for raw materials, and the emergence of middle classes hasled to increased demand for finished products and consumer goods, and morediversified and sophisticated food items.
Impacts
PwC
Figure 3.36: Top 25 sea and air freight bilateral trade pairs in 2009
Source: PwC Economic Views: Future of world trade
60
Size of bilateral tradeflow (2009 USD million)
Under 50,000
50,001 -100,000
100,001 -200,000
200,001-350,000
350,001 +
Economic recovery will be dominated by growth in theemerging economies
Expected future growth of trade and shipping
The global economic recovery from 2010 will be dominated by growth in theemerging economies, in particular from fast-growing Asian countries likeChina, India and Indonesia.
PwC report on the ‘Future of world trade: Top 25 sea and air freight routes in2030 finds that the divergence in economic growth prospects between emergingand developed economies is expected to be mirrored in future trade patterns.
Trade routes between emerging economies and developed economies andbetween emerging economies and other emerging economies are expected tobecome more significant over the next twenty years.
The impact of unilateral action for regulating shipping by i.e the EU may be lesseffective as a consequence.
Figure 3.37: Top 25 sea and air freight bilateral trade pairs in 2030
60
Size of bilateral tradeflow (2009 USD million)
50,000
100,000
200,000
350,000
2030 is expected to see increased trade between China anddeveloped countries
The impact of carbon pricing on trade and the role of the shipping industry
Maritime transport costs are affected by factors such as port infrastructure, thecost of fuel, time at sea, competition among carriers, corruption and piracy. Ouranalysis shows that the increase in freight rates as a result of the imposition ofcarbon pricing represents a relatively small increase in total shipping transportcosts.
Increased shipping cost raise the cost of carrying out trade, which may have animpact on the levels and distribution of trade.
The overall level of trade
Trade in some products is particularly affected by changes in maritime transportcosts, where transport costs as a proportion of the total cost is relatively high.
Figure 3.38: The impact of maritime transport costs on the cost of production
Impacts
PwC
Source: Maritime Transport Costs Database, WIT, Korinek & Sourdin (2009)
Trade levels in raw materials and agricultural products are therefore most likely tobe affected by an increase in transport costs. A doubling in the cost of shipping foragricultural goods is found to be associated with a 42% drop in trade on average(OECD, 2008).
61
Product Ad valorem (%) MTC ($/tonne)
Agriculture 10.89 80.64
Raw materials 24.16 32.59
Crude oil 4.03 18.09
Manufactures 5.11 173.94
The impact of carbon pricing on trade and the role of the shipping industry
The distribution of trade
Export-orientated economies or countries dependent on imports are likely to bemost affected when the cost of trade increases. The market shares of differentproducers may therefore vary as a result of increase in shipping costs.
Studies have found that
• Developing and least developed countries whose trade in price-sensitivegoods often comprises a significant component of their export potential mightsuffer disproportionately from an increase in trading costs (WTO, 2003). TheOECD identified several countries, mostly remote nations with very smallmarkets, face such high transport costs that they affect most exports significantly.Average ad valorem maritime transport costs of exports for Guam (48%), Nauru(40%), Christmas Islands (34%), Togo (29%), Guinea (25%), Tonga (22%), Sierra
61
(40%), Christmas Islands (34%), Togo (29%), Guinea (25%), Tonga (22%), SierraLeone (21 %) and Pitcairn (17%) were found to be substantially higher than theaverage for developing countries of 7 % (OECD, 2008).
• Directional imbalance in trade between countries implies that many carriersare forced to haul empty containers on their return trips, resulting in costimbalance in one-directional and return shipping (Fuchsluger, 2000) . Forexample, exports from the USA to selected Asia ports were found to be only one-third of the volume of those on the return trip, with correspondingly lowershipping rates to Asia (ibid). As carbon cost rise, the impact on freight rates maynot be linear across different shipping routes, with some routes experiencing adisproportionate increase in their shipping costs.
The impact of carbon pricing on trade and the role of the shipping industry
A study by Vivid Economics to the IMO (2009) looked at the potential impacts onselected products and product markets.
Looking at iron ore market in China, the study finds that a 10% rise in the cost ofbunker fuels is found to increase the average freight rate to China by around $3per tonne of metal (2.7% increase in the cost per tonne of metal) . Iron oreexporters into China will suffer a fall in market shares and margins, whiledomestic producers stand to gain. Larger and closer producers (e.g. Australia)appear to be less affected while producers further away (e.g. Brazil) and smallerproducers (e.g. India) tend to be affected more.
ProducerOriginal market share in
Change in market shareChange in margin ($ per
Figure 3.39: The change in market shares and profitability of iron ore exporters toChina as result of a 10% increase in the cost of bunker fuel
Impacts
PwC
Notes: Price per tonne of metal assumed is aroundUS$112.Source: Vivid Economics (2009)
This analysis shows that while there is a discernible impact on trade patterns andmarket shares of producers as a result of an increase in the cost of bunker fuel,the impact is relatively small. In the case of iron ore imports into China, the cost ofa tonne of metal increases by 2.7% when bunker fuel costs rise by 10%.
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ProducerChina
Change in market sharetonne of metal)
Australia 29.4% -0.90% -0.9
India 11.2% -6.50% -1.4
Brazil 8.3% -2.40% -4.1
South Africa 1.6% -0.90% -2.7
Iran 0.4% -0.40% -2.8
Rest of world 2.7% -2.70% -4.1
Domestic producers 46.0% +13.6% +1.6
The impact of carbon pricing on trade and the role of the shipping industry
Our analysis finds that the cost of a market-based measure, with the assumedcompliance cost of $66 per tonne of fuel, is equivalent to a 5% increase in the costof fuel by 2030. The likely market shares impacts will therefore be around half ofthose outlined in Figure 3.38. This translates in to an increase in the importedprice of iron of 0.71%, or $0.79 per tonne of iron, with an approximately similardecrease in the quantity of iron imported.
Average added cost forsea importers ($ per tonne
of metal)
Cost pass-through for seaimporters (%)
Change in price ofimported iron (per tonne)
Change in price ofimported iron (%)
1.53 51.7 0.79 0.71
Figure 3.40: The impact of carbon costs on Chinese price of imported iron
62
Source: Vivid Economics (2009), PwC analysis.
Assumes similar proportionate demand reaction between a 5% and 10% increase in fuel price.
Forbruket øker og henger nært sammen med øktvekst og velstandAnnex
PwC
Forbruket øker og henger nært sammen med økt
Introduction
These appendices relate to the PwC report “A game changer for the shipping industry: an analysis of the future impact of carbindustry”.
All results in this report are produced by the PwC GHG Shipping Model (hereafter “the model”). The timescale considered by thfocus on the time period from 2015, from when the IMO regulations are assumed to be in place. The model is supported by carboof public data sources (see list of sources). The model follows a dual approach to estimate the impact of GHG regulations on
1. Top-down industry-level analysis
2. Bottom-up ship-level analysis
In additional to a number of common data inputs, these analyses share a directmodelling linkage: the cost of compliance per tonne of fuel consumed. This allowsthe total cost to industry, as well as the cost for individual market segments, to becalculated. These market segments are (along with the average sample size):
Annex: Methodology
PwC
calculated. These market segments are (along with the average sample size):
• Capesize Bulker (148,000 dwt)• Handysize Bulker (30,000 dwt)• Handysize Product Tanker (43,500 dwt)• VLCC (304,000 dwt)• Container Main Liner (3,500 TEU)
The scope of each part of the model component is presented below:
An integrated overview of the model is presented overleaf.
PwC GHG Shipping Model Component Top-down Bottom-up
Emissions / Abatement
Cost impact (USD)
Different allocation scenarios
Linkage with CER Market
Cost impact relative to other costs
Profit impact
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These appendices relate to the PwC report “A game changer for the shipping industry: an analysis of the future impact of carbon regulations on environment and
All results in this report are produced by the PwC GHG Shipping Model (hereafter “the model”). The timescale considered by the model is 2010 – 2030 with particularfocus on the time period from 2015, from when the IMO regulations are assumed to be in place. The model is supported by carbon price forecasts and based on a varietyof public data sources (see list of sources). The model follows a dual approach to estimate the impact of GHG regulations on the shipping sector:
Cost of
64
Cost ofcompliance
Cost ofcompliance
Ship-levelanalysis
Industry-levelanalysis
Top-down Bottom-up
64
Model overview
Size of emissionstarget or cap
Linkage to anothercarbon market
Core policydecisions
Mechanism
Global price forCERs
BAU Emissions
Annex: Methodology
PwC
Opex
Capex
Fuel Costs
Cost to industry
Mechanismdesign policy
options
Outcomes
Cost of carbon
Abatement Costs
65
ETS or levy
Allocation method
Global price forCERs
ETSLevy
Key inputs
Profit impact onindustry
Industry freightrates
Core policydecisions
Outcomes
Designoptions
Key
ETSLevy
65
Overview
The model overview shows that the modelling process is split into threeinteracting modules, running across the industry-level and ship-level componentsof the model.
• Core policy options
• Mechanism design policy options
• Outcomes
The broad methodology and options considered for each factor within thesemodules is provided below. Afterwards, furter details on assumptions are given.
Core policy decisions
Annex: Methodology
PwC
Emissions target / cap : The total quantity of allowed emissions (“ the cap”) wasset equal to the IMO 2010 expert group base case recommendation – this is equalto 90% of 2007 emissions (783 Mt CO2)
ETS or levy : Throughout the main document, results for a levy are presented,which are identical to the impacts of an ETS with 100% free allowances. In thesensitivity analysis, the auctioning assumption is relaxed and results considered.
Linkage to another carbon market : We assumed:
i. That under a levy, the funds raised will be used to purchase CER allowances.
ii. That under an ETS there is linkage with the CDM market, so shippingcompanies can and will purchase CDM credits to meet their complianceobligations.
66
Mechanism design options
Allocation method : The allocation method (free allowances versus auctionedallowances) does not affect the market price of carbon, since demand and supplyfor carbon remains unaffected. However, it does affect the cost to industry of thelegislation, per tonne of fuel, and to a significant degree. We therefore considerboth 100% free allocation and 100% auctioned alllowances as the two extremecases, as well as one intermediate scenario (where the auction percentage wasassumed to be 15% until 2020, 20%-2025; and 25% thereafter). 100% freeallocation of allowances will deliver the same cost impact as a levy.
Cost to industryIndustry freight
rates
Outcomes
We have considered in our quantitative analysis two primary impacts of theproposed carbon pricing regulations on the shipping industry :
1) Cost base. The application of a carbon levy or introduction of a carbon ETSraises costs. These costs largely raise proportionately with fuel consumption.Our analysis considers the likely financial cost impact of regulatory scenarioson both the whole industry, and individual market segments.
2) Profitability: The extent to which this cost affects industry profitabilitydepends on whether shipowners can pass-though the cost impact to other partsof the value chain. Our analysis combines the cost impacts with information onthe ability to pass-through costs for different market segments to estimate thelikely profit impact on individual market segments.
Profit impact onindustry
66
Cost Modelling Assumptions
This section provides details on our data sources and parameter choices.
Emissions
BAU Emissions
Emissions were modelled as a fixed by-product of fuel consumption, using acarbon intensity of 3.13 tC per tonne of fuel (the actual coefficient is between 3.09-3.17 varying with fuel quality). Fuel consumption grew from the baselines outlinedin IMO 2009, following the growth assumptions outlined in Figure A.1.
Abatement
The difference between BAU Emissions and the emissions cap is the abatement.Our model has assumed that market-based measures would only bring about out-of-sector abatement. This implies that abatement costs are always higher thanpermit prices from other global ETSs (see discussion on slide 18). This contrastswith the IMO Expert group (2010) assumptions, which included a small degree of
Annex: Methodology
PwC
with the IMO Expert group (2010) assumptions, which included a small degree ofin-sector abatement. We have also included analysis of a scenario with anabatement impact, but only at industry level given differing ship abatementpotentials.
Costs
Costs are of four types: capital costs, operating costs, fuel costs and carbon costs.All figures were converted to $2010 dollars using PwC Macroeconomic Inflation.Forecasts (for future costs) or the US Consumer Price Index (for historical costs).
Data Value Source
Economic Growth 3.6% pa IPCC A1B scenario
Seaborne Transport Growth 3.3% pa IMO (2009) base case
Emissions growth 2.65% pa IMO (2009) base case
Fuel efficiency improvements 1.25% pa IMO (2009) base case + impactof EEDI (Ouris equal to the sum of the two)
Exchange Rate EUR : USD 1.33 2010 Period Average
Figure A1: Parameters used in the PwC GHG Shipping Model67
Operating costs
Operating costs (opex) figures from 2009 are taken directly from Moore StephensLLP OpCost 2010 for each ship type. These include crew, stores, repairs andmaintenance, insurance, administration, and drydocking costs.
Capital costs
Capital costs (capex) estimates are taken from CE Delft (2010) which estimatesannual capital costs based on average purchase price by ship type (1992-2007),assuming a 25-year useful economic life and 9% rate of interest.
Fuel Cost
We have assumed that following the onset of low-sulfur regulations (MARPOL VIannex), there will be a gradual phasing in of the low-sulfur fuels starting at 20percent in 2010, reaching 80 percent in 2020, and 96 percent in 2030. Theforecast for future fuel prices are based upon the US Department of Energyforecast for future fuel prices are based upon the US Department of EnergyReview (2010). The price of low-sulfur fuel is 60 percent more expensive thanbunker fuel (from AEO forecast), and 80 per cent more by 2030. The increasestems from the expected demand pressure and limited supply capacity in themarkets. These assumptions are in line with the IMO (2010) study. There is muchuncertainty about future oil costs, and the difference between HFO and MGO havenot been consistent in the past. A significant price increase on top-of-bunker fuelcosts is however very probable. Our forecast is illustrated in Figure A.3 overleaf.
Comments
scenario
IMO (2009) base case
IMO (2009) base case
IMO (2009) base case + impactof EEDI (Our assumed basecaseis equal to the sum of the two)
26% improvement from 2010 to 2030 implies annual rate
Period Average
67
Carbon prices
Given the international nature of shipping, and the proposed role of the CDM market in meeting the shipping industry’s enviroforecasts are based on CER allowance prices. In the absence of other public forecasts for CER prices, PwC created a price scehistorical spread to translate this into a CER forecast.
Specifically, we use the Point Carbon 2011-2020 projection (May 2011) of EUA prices over 2012expectations including recent PwC research of carbon market sentiment (the Sixth IETA GHG Market Sentiment Survey).
The CER price was created based on the relative EUA-CER spread for the first half of 2011 . A caveat to our results is that theEUA-CER spreads. Figure A.4 illustrates our forecast.
Cost of compliance / cost to industry
Further Assumptions
Annex: Methodology
PwC
The market price of carbon feeds directly into the cost of compliance for shipowners. Under the assumption that abatement cosdeterminants of the cost of compliance are the market price of carbon, the global climate fund contribution rate, and the allis assumed to be a 10% mark-up on top of the levy, or ETS auction proceeds and allowance sales, as proposed by the IMO.
Under 100% auctioning of allowances, the cost of compliance is equal to the market price of carbon (per tonne of CO2), and unthe cost of compliance is equal to a levy aiming to raise funds to offset emissions above the cap. For a given proportion ofwill sit between these two extremes. We have considered one such case, the “15% auctioning” case, which assumes an2025; and 25% thereafter). Figure A.2 illustrates the impact on outcome on the cost of compliance of altering the allocation method (per tonne of fuel).
$66
$66
$87
$152
Levy
ETS (0% auction)
ETS (15%auction)
ETS (100% auction) Forecast $ per ton fuel (2010$)
2010 2020
Figure A.2 Figure A.3
68
Given the international nature of shipping, and the proposed role of the CDM market in meeting the shipping industry’s environmental targets, our carbon priceforecasts are based on CER allowance prices. In the absence of other public forecasts for CER prices, PwC created a price scenario for the EUA price then used the
2020 projection (May 2011) of EUA prices over 2012-2020 and extrapolate to 2030. This seems broadly in line with marketexpectations including recent PwC research of carbon market sentiment (the Sixth IETA GHG Market Sentiment Survey).
CER spread for the first half of 2011 . A caveat to our results is that the trend in the carbon markets is increasing
The market price of carbon feeds directly into the cost of compliance for shipowners. Under the assumption that abatement costs are higher than the CER price, the soledeterminants of the cost of compliance are the market price of carbon, the global climate fund contribution rate, and the allocation method. The fund contribution rate
up on top of the levy, or ETS auction proceeds and allowance sales, as proposed by the IMO.
Under 100% auctioning of allowances, the cost of compliance is equal to the market price of carbon (per tonne of CO2), and under 100% free allocation of allowances,the cost of compliance is equal to a levy aiming to raise funds to offset emissions above the cap. For a given proportion of auctioned allowances, the cost of compliancewill sit between these two extremes. We have considered one such case, the “15% auctioning” case, which assumes an auction percentage of 15% until 2020, 20% to
Figure A.2 illustrates the impact on outcome on the cost of compliance of altering the allocation method (per tonne of fuel).
Forecast $ per ton fuel (2010$)
1320
600
02030
Forecast $ per CER (2010$)
2010 2020 2030
44
20
0
Figure A.4
68
To establish the impact of increased costs on segment profitability we have used data on passprovides in detail the calculation process and assumptions made, given a 25% mark-up of freight rates on the cost base. The elasfuel costs are drawn from Vivid Economics (2010).
Figure A.5: Daily profitability impact in 2030 on different ship types (assuming 25% mark
Ship Type Capesize Bulker Handysize Bulker
Daily cost of fuel, US$ 59,365 21,767
Capex and opex, US$ 25,163 13,490
Total cost base, US$ 84,528 35,257
Profit modelling
Annex: Methodology
PwC
Source: PwC GHG Shipping model
Fuel price, forecast US$ 1,321 1,321
Daily fuel consumption, tonnes 45 16
Cost of carbon (per tonne of fuel), US$ 66 66
Daily cost of carbon, US$ 2,947 1,081
Elasticity of freight rates relative to fuel cost 0.98 0.26
Estimated daily freight rate, (implied by mark-up) 105,660 44,071
Change in freight rates due to impact of carboncost, based on elasticity estimates
5141 569
Change in profits per day US$ 2,193 -512
New mark-up after pass-through of costs 27% 23%
Notes:(1) Mark-up here is applied on freight rates relative to cost base (i.e. Freight rates = total cost base x (1+ mark
up)). This is a gross simplification of how the sector’s freight rates and profits are determined, and is intendedto illustrate potential impacts only.
69
To establish the impact of increased costs on segment profitability we have used data on pass-through ability, and make assumptions on freight rates. Figure A.5 belowup of freight rates on the cost base. The elasticities of freight rates with respect to
Figure A.5: Daily profitability impact in 2030 on different ship types (assuming 25% mark-up)
Handysize BulkerHandysize Product
TankerVLCC Container Main Liner
21,767 31,661 89,047 133,571
13,490 20,502 42,280 22,417
35,257 52,163 131,327 155,988
1,321 1,321 1,321 1,321
16 24 67 101
66 66 66 66
1,081 1,572 4,421 6,631
0.26 0.30 0.30 0.20
44,071 65,204 164,159 194,985
569 971 2445 1936
512 -601 -1,976 -4,695
23% 23% 23% 21%
up here is applied on freight rates relative to cost base (i.e. Freight rates = total cost base x (1+ mark-up)). This is a gross simplification of how the sector’s freight rates and profits are determined, and is intended
69
Holding the carbon price and all other factors equal, Figure A.8 below provides the impact of assuming the marklarge share of fuel costs in the cost base and the high elasticity of freight rates with respect to fuel costs shows that proincreased carbon costs.
Figure A.6: Daily profitability impact in 2030 on different ship types (assuming 10% mark
Ship Type Capesize Bulker Handysize Bulker
Daily cost of fuel, US$ 59,365 21,767
Capex and opex, US$ 25,163 13,490
Total cost base, US$ 84,528 35,257
Profit mark-up sensitivity
Annex: Methodology
PwC
Source: PwC GHG Shipping model
Fuel price, forecast US$ 1,321 1,321
Daily fuel consumption, tonnes 45 16
Cost of carbon (per tonne of fuel), US$ 66 66
Daily cost of carbon, US$ 2,947 1,081
Elasticity of freight rates relative to fuel cost 0.98 0.26
Estimated daily freight rate, (implied by mark-up) 92,981 38,782
Change in freight rates due to impact of carboncost, based on elasticity estimates
4524 501
Change in profits per day US$ 1,577 -580
New mark-up after pass-through of costs 11% 8%
Notes:(1) Mark-up here is applied on freight rates relative to cost base (i.e. Freight rates = total cost base x (1+ mark
up)). This is a gross simplification of how the sector’s freight rates and profits are determined, and is intendedto illustrate potential impacts only.
70
Holding the carbon price and all other factors equal, Figure A.8 below provides the impact of assuming the mark-up of profits on costs is 10% rather than 25%. Thelarge share of fuel costs in the cost base and the high elasticity of freight rates with respect to fuel costs shows that profits can increase for capesize bulker with the
A.6: Daily profitability impact in 2030 on different ship types (assuming 10% mark-up)
Handysize BulkerHandysize Product
TankerVLCC Container Main Liner
21,767 31,661 89,047 133,571
13,490 20,502 42,280 22,417
35,257 52,163 131,327 155,988
1,321 1,321 1,321 1,321
16 24 67 101
66 66 66 66
1,081 1,572 4,421 6,631
0.26 0.30 0.30 0.20
38,782 57,380 144,460 171,587
501 855 2152 1704
580 -717 -2,269 -4,927
8% 8% 8% 7%
up here is applied on freight rates relative to cost base (i.e. Freight rates = total cost base x (1+ mark-up)). This is a gross simplification of how the sector’s freight rates and profits are determined, and is intended
70
Sources
Carbon positive “Creating a voluntary Greenhouse gas trading experiment is good for the shipping industry andis good for the environment ”October 2010
CE Delft et al “A Global Maritime Emissions Trading System: Design and Impacts on the Shipping Sector,Countries and Regions” January 2010
CE Delft et al “Technical support for European action to reducing Greenhouse Gas Emissions frominternational maritime transport” December 2009
DNV “Pathways to low carbon shipping. Abatement potential towards 2030” February 2010
Entec “Study To Review Assessments Undertaken Of The Revised MARPOL Annex VI Regulations” July 2010
Annex
PwC
Environmental Protection Agencyand Fuels Assessment Future Trends and Effects of Requiring Clean Fuels in the Marine Sector.
European Maritime Safety Agency (2010)compliance. EU DG Environment
Fuchsluger, J Maritime transport costs in South America. University of Karlsruhe, 2000
Gilbert et al “Shipping and climate change: Scope for unilateral action” August 2010
International Maritime Organization “Second IMO GHG Study 2009”
International Maritime Organization “Submission by the International Maritime Organization to the thirdICAO Colloquiumon Aviation and Climate Change” May 2010
International Maritime Organization Marine environment protection committee “Second IMO GHG Study2009, Update of the 2000 IMO GHG Study: Final report covering Phase 1 and Phase 2” April 2009
International Maritime Organization Marine environment protection committee “REDUCTION OF GHGEMISSIONS FROM SHIPS : Full report of the work undertaken by the Expert Group on Feasibility Study andImpact Assessment of possible Market
71
Carbon positive “Creating a voluntary Greenhouse gas trading experiment is good for the shipping industry andis good for the environment ”October 2010
“A Global Maritime Emissions Trading System: Design and Impacts on the Shipping Sector,Countries and Regions” January 2010
CE Delft et al “Technical support for European action to reducing Greenhouse Gas Emissions frominternational maritime transport” December 2009
DNV “Pathways to low carbon shipping. Abatement potential towards 2030” February 2010
“Study To Review Assessments Undertaken Of The Revised MARPOL Annex VI Regulations” July 2010
Agency (US) 2008 by RTI InternationalResearch Triangle Park, NC. Global Tradeand Fuels Assessment Future Trends and Effects of Requiring Clean Fuels in the Marine Sector.
European Maritime Safety Agency (2010) An assessment of available impact studies and alternative means ofcompliance. EU DG Environment
, J Maritime transport costs in South America. University of Karlsruhe, 2000
Gilbert et al “Shipping and climate change: Scope for unilateral action” August 2010
International Maritime Organization “Second IMO GHG Study 2009”
International Maritime Organization “Submission by the International Maritime Organization to the thirdICAO Colloquiumon Aviation and Climate Change” May 2010
International Maritime Organization Marine environment protection committee “Second IMO GHG Study2009, Update of the 2000 IMO GHG Study: Final report covering Phase 1 and Phase 2” April 2009
International Maritime Organization Marine environment protection committee “REDUCTION OF GHGEMISSIONS FROM SHIPS : Full report of the work undertaken by the Expert Group on Feasibility Study andImpact Assessment of possible Market-based Measures” August 2010
71
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International Maritime Organization Marine environment protection committee 61/INF.18abatement costs and cost-effectiveness of energyEngineering, Science and Technology (
Korinek and Sourdin “Maritime transport costs and their impact on trade” August 2009
Organisation for Economic Coimpacts from increased international transport” November 2008
Organisation for Economic CoMaritime transport committee “The role of changing transport costs and technology in industrial relocation”May 2005
Annex
PwC
Point Carbon “European Emissions Prices:May 2011
PwC “Future of world trade: Top 25 sea and air freight routes in 2030” March 2011
PwC and the International Emissions Trading Association “IETA’s sixth GHG Market Sentiment Survey” June2011
Seas at Risk “Going slow to Reduce Emissions” January 2010
United Nations Conference on Trade and Development “Review of Maritime Transport” 2010 (+1995reports)
US Department of Energy “Annual Energy Outlook” 2011
Vivid Economics “Assessment of the economic impact of market
World Bank “Cities and climate change : An urgent agenda
Also reference datasets from IMF WEO, Bloomberg and World Bank WDI.
72
International Maritime Organization Marine environment protection committee 61/INF.18 Marginaleffectiveness of energy-efficiency measures. Submitted by the Institute of Marine
Engineering, Science and Technology (IMarEST)
“Maritime transport costs and their impact on trade” August 2009
Organisation for Economic Co-operation and Development “Policy instruments to limit negative environmentalimpacts from increased international transport” November 2008
Organisation for Economic Co-operation and Development Directorate for science, technology and industry,Maritime transport committee “The role of changing transport costs and technology in industrial relocation”
European Emissions Prices: A forecast – Where are prices going and why?” The Energy Lectures
Future of world trade: Top 25 sea and air freight routes in 2030” March 2011
PwC and the International Emissions Trading Association “IETA’s sixth GHG Market Sentiment Survey” June
Seas at Risk “Going slow to Reduce Emissions” January 2010
United Nations Conference on Trade and Development “Review of Maritime Transport” 2010 (+1995-2009
US Department of Energy “Annual Energy Outlook” 2011
Vivid Economics “Assessment of the economic impact of market-based measures” August 2010
Cities and climate change : An urgent agenda” December 2010
Also reference datasets from IMF WEO, Bloomberg and World Bank WDI.
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BAU Business as usual.
BAU abatement The growth rate for seaborne transport minus expected growthrate of emissions, assuming efficiency gains. See also “reference case emissions”.
Capital expenditures The cost of purchasing and financing a ship (in thisstudy).
CDM and CER The UN Clean Development Mechanism which issues emissionsallowances (Certified Emission Reductions) to certified abatement projects.
Compliance cost See cost to industry.
Contributions to global climate fund Contributions to an international fund,which may be established to provide financing for carbon abatement or impactadaptation purposes.
Cost to industry The costs stemming from compliance with the regulations. Thecosts are defined as the sum of MBM abatement times by the carbon price, and
Glossary
Annex
PwC
costs are defined as the sum of MBM abatement times by the carbon price, andany other sources of revenue such as ETS auction revenues and contributions to aglobal climate fund. These are the direct costs from compliance, i.e. paying thelevy or procuring the emissions certificate, and do not include any additionaladministrative burden.
Costs per ton of carbon abated The total compliance cost divided by the MBMabatement.
EEDI Energy Efficiency Design Index.
EEDI abatement The emissions reductions stemming from the implementationof a mandatory Energy Efficiency Design Index. It is calculated as the growth ratefor business as usual growth minus expected growth rate of emissions assumingimplementation of EEDI.
ETS Emissions Trading Scheme.
ETS auction costs The number of auctioned certificates for emissions below thetarget line multiplied by the carbon price (both in tC).
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EU ETS and EUA The European Emissions Trading Scheme, on which EuropeanUnion Allowances are traded.
Fuel costs Fuel consumed multiplied by the expected unit cost of fuel. At industrylevel this is expressed in yearly terms, and at ship level in daily terms.
Fuel price The weighted average forecast price of bunker and distillate fuel (seemethodology section).
In-sector abatement Carbon reductions that take place within the shippingsector.
MBM Market-based measures
MBM abatement. This refers to the carbon reductions resulting fromimplementation of the market-based measures (levy or an ETS) Abatement mayoccur out-of-sector or in-sector.
Net emissions This is used to describe emissions generated by internationalshipping minus those emissions offset through carbon reduction projectsundertaken outside of the international maritime sector.
Operating costs The recurring expenses related to the operation of a ship (seemethodology section).
Out-of sector abatement Carbon reductions take place outside of the shippingsector, funded from the proceeds of a shipping carbon scheme.
Reference case emissions The scale of carbon emissions in the absence ofregulations or any efficiency measures.
Target emissions/Cap The objective for net emissions from the shipping sector.The target is expected to be set by an appropriate international body such as theUNFCCC or IMO.
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