Legal firm Clyde & Co has published the third in its comprehensive series on the scope of the International Maritime Organization’s Sulphur Cap from January 1st 2020 and the options available to shipowners.
Beth Bradley, Benjamin Bryant and Ioanna Tsekoura noted that parts 1 and 2 of the series explored the scope of Regulation 14.1.3, provided an analysis of the contractual, penal and coverage risks which face owners and charterers, and explored the challenges to compliance and enforcement faced by different parties. Part 3 explores the different compliance options available to shipping companies. It also discusses a number of funding methods that companies might consider in order to meet the considerable costs of compliance, and provides concluding recommendations.
What options are available to shipping companies?
Clyde said that larger companies should explore combined solutions to maximize efficiency. “Tough calls may also need to be made if the age or efficiency of a vessel does not merit the heavy investment required; scrapping remains a final option”, the authors said.
Annex VI permits the installation of exhaust gas cleaning systems (scrubbers), to clean heavy fuel oil (HFO) to the required level, whether open-loop (which discharges sulphur-saturated wash water and waste back into the sea after cleaning) or closed-loop (whereby the by-products are retained in tanks on-board and later disposed of), or of hybrid design. Clyde noted that “owners should be wary that open-loop scrubbers have already been heavily criticized on environmental grounds”. Singapore, China, Belgium, California and Fujairah in the UAE, among others, have banned their use with the potential that more countries will follow suit.
The main advantage of scrubber installation is the ability to continue to burn cheaper high sulphur fuel, with fuel price differentials projected to be at their widest on 1 January 2020. In theory, this will allow owners to attract a charter premium, and to offer more favourable rates on mid-to-long term charters. Based on current oil price differentials, scrubbers offer an estimated payback time of around two to four years. Economically, this solution might most benefit vessels with larger engines, such as containerships.
The main disadvantage is that up-front installation costs are between $1.5 to $2m per unit. Further, installation reduces cargo space and requires extra crew training.
Clyde said that owners considering scrubbers should ensure that they order units and book space in advance, to factor in reduced shipyard capacity, installation time, and potential manufacture shortages ahead of January 1st 2020. “Larger companies might consider negotiating options for further purchase of scrubbers at guaranteed prices”, ideally on a vessel-by-vessel basis, the authors said.
BIMCO has announced that a standard Scrubber clause is due to be published around March – April 2019. The clause is likely to address installation cost sharing between owners and charterers, with formulas potentially reflecting the life of the scrubber or the remaining duration of the charterparty. The clause might also deal with scrubber breakdown, and impose requirements for the carriage of a reserve of LSFO to avoid off-hire. Clyde said that parties should ensure that any such clause accurately reflected the parties’ obligations in light of the particular characteristics of the scrubber type chosen.
Low Sulphur Fuel Oils
LSFO remained an attractive short-term solution for many companies, the main advantage being the absence of an initial investment, said Clyde. The disadvantages include ongoing issues of compatibility, quality and availability facing the industry, especially in light of the IMO’s refusal to consider an experience building phase.
Clyde noted that, while no mandatory bunker licensing scheme currently existed for ratifying states, owners and time charterers could avail themselves of information published by an increasing number of port states that confirmed the identities of licensed bunker operators.
As of January 1st 2019, an amendment to Annex VI now requires bunker delivery notes to include a signed and certified declaration by the supplier that the sulphur content of the fuel supplied either does not exceed Annex VI-stipulated limits, or alternatively the purchaser’s specified limit value, where the owner has notified the supplier that it is using an equivalent means of compliance, such as a scrubber. Clyde said that the amendment did not impose any additional obligation on suppliers to ensure that owners are complying with Annex VI, provided notification is given. “The risk when bunkering non-compliant fuel, therefore, remains firmly with owners”, said the authors.
Burning Liquid Natural Gas (LNG) is a third viable alternative. Advantages include a more consistent fuel specification for bunkering purposes, and the production of 25% less carbon dioxide and negligible amounts of sulphur oxides, rendering LNG compatible with IMO 2050 commitments. The main disadvantage is the initial cost of retrofitting LNG-burning engines, which comes in at between $25m and $30m, with an estimated payback of four to seven years. Additionally, Clyde noted that, notwithstanding recent state initiatives by Singapore, South Korea and China, global LNG infrastructure was still comparatively underdeveloped, “with a dearth of supply sources and time-chartered LNG vessels”.
LNG also has a lower energy density than petroleum, requiring higher volumes to propel a vessel, while being susceptible to “methane slippage”, the occurrence of which would negate all environmental benefits of using it in the first place.
Methanol was another viable alternative fuel. Its advantages were that it could be transported in chemical product tanks at atmospheric temperature and pressure, easily stored, and could be produced from a range of products including natural gas, coal and renewables. However like LNG, methanol suffered from a lower energy density than petroleum, requiring the burning of higher volumes. Additionally, relatively little had been invested into developing methanol as a commercially viable fuel source, and as such there was little global bunkering infrastructure. Similar problems applied to other alternatives such as Liquid Petroleum Gas, hydrogen, ammonia and Biofuel.
A number of wind propulsion models, including rotor sails and rigid wings, were currently being piloted within the industry. Advantages included the potential for carbon-neutrality, low fuel costs and minimal greenhouse gas emission. Wind-power could also be combined with other low-emission solutions such as hydrogen fuel-cells, slow steaming and improved hull design, to achieve sufficient power while significantly reducing emissions output. Clyde said that presently, however the cost remained too high to render wind power commercially viable, with conversion to a three-rig sail system estimated at $10m. Structural limitations also existed for certain types of vessels.
Sale or Scrapping
Given the significant investment required, vessels nearing the end of their lifespan night not be worth retrofitting. Owners should consider a fleet renewal plan, failing which the sale, or if necessary, the scrapping of older vessels.
Where cash or the sale of assets was not available to meet the initial investment required for retrofitting, Clyde said that owners might wish to explore additional debt capacity on existing vessels, in addition to their eligibility for green loan facilities and localised port authority subsidies and incentives. Larger shipping companies could consider the issue of bonds. Unit leasing or financing agreements also existed
Time charterers should consider the inclusion of a fuel cost recovery mechanism in their freight rate calculations, using variables such as fuel price, load factors and trade imbalances to calculate a surcharge. To ensure customer retention, carriers should strive to make calculations as transparent as possible, ideally using mechanisms capable of external validation.
Criticism had already been voiced by shippers, to whom the cost would be passed. Owners in voyage charter fixtures might wish to negotiate bunker adjustment factor clauses into their charterparties.
In conclusion, the authors said that Regulation 14.1.3 was now less than one year away, and was likely to have a dramatic effect on the shipping industry. Owners and charterers could best protect themselves best by:
- Reviewing and renegotiating charterparty terms as suggested in this series, to ensure correct allocation of cost and risk ahead of 1 January 2020. This should include the consideration of the BIMCO standard-wording clauses discussed above, amended where necessary.
- Exploring and determining the funding options that best suit the size and age of their fleets and acting upon their decisions pre-emptively.
- Developing a fuel strategy which includes a risk management plan for the sourcing of compliant fuel, as part of a broader implementation plan.