Your SlideShare is downloading. ×
0
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Shipping ghg pw c final
Upcoming SlideShare
Loading in...5
×

Thanks for flagging this SlideShare!

Oops! An error has occurred.

×
Saving this for later? Get the SlideShare app to save on your phone or tablet. Read anywhere, anytime – even offline.
Text the download link to your phone
Standard text messaging rates apply

Shipping ghg pw c final

907

Published on

Published in: Business, Technology
0 Comments
1 Like
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total Views
907
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
69
Comments
0
Likes
1
Embeds 0
No embeds

Report content
Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
No notes for slide

Transcript

  • 1. www.pwc.com A game changer for the shipping industry industry? An analysis of the future impact of carbon regulations on environment and industryAn analysis prepared forthe ongoing discussionsin IMO and otherinternational foraregarding future globalregulations of carbonemissionsJune 2011
  • 2. This material was prepared by PricewaterhouseCoopers AS (PwC) for the specific use of the Norwegian Shipowners Association and is not to be used, distributed or relied upon by any third party without PwC’s prior written consent. This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PwC, its partners, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. © 2011 PricewaterhouseCoopers AS (N0rway) All rights reserved. “PricewaterhouseCoopers” refers to the (N0rway). network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. Contact: Team lead Ivar Strand: ivar.strand@no.pwc.comPwC 2
  • 3. Emerging policies are targeting CO2 emissions from shipping. The International Maritime Organization (IMO) have produced policy proposals, backed by research, on an international regulatory regime to manage CO2 emissions from shipping. Deliberations of the options are ongoing in IMO and in other international fora. The EU has also announced that it is examining the shipping industry’s role in . mitigating 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 possibleScope and market-based measures. Six of these proposal can be generalized to two basic market-based schemes based – a levy and an emissions trading scheme. The proposals differ in detail and in principle.objective The objective of this study is to clarify the policy options and their impacts on environment and industry. The details and variations in the existing proposals complicates comparison and could be masking the underlying objectives of the schemes. The ongoing dialogue between policymakers and industry actors could benefit from a consolidation of facts and analysis as the basis for deciding upon further action. The policy process has produced an impressive body of robust scientific and economic work undertaken under the auspices of the International Maritime Organization (IMO), the European Union (EU) and 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 market- based mechanisms. This includes crystallizing the impacts of key policy options and highlighting the trade-offs between policies. offs The scope of this study is to analyze the environmental and economic impact of market market- based instruments 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 has leveraged and built upon previous research. Other issues, for example administrative arrangements, are beyond 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 is commissioned by the Norwegian Shipowners Association. We have been working fully independently and the analysis is the responsibility of the teamPwC 3
  • 4. Summary ofPwC Key findings 4
  • 5. Summary of key findings Context Massive efficiency gains Considerable fuel cost increase Fuel cost increase would drive Dramatic reduction of fuel use required to reduce emissions to as fleet shifts to low-sulfur fuels efficiency gains and emissions since 2008 target levels Target and growth of emissions Fuel price 1990-2030 Fuel efficiency 1990-2030 Global fuel reduction 2008-2011 Metric tons CO 2 (million) USD per metric ton fuel ($2010) gram fuel/ton mile Fuel consumption Index 2000 1320 (International fleet) 1,0 3,3% 11 -30-40% p.a 1500 80% -1,25% 0,9 57% p.a. 1000 700 9 0,8 500 0,7 Emissions Distillate 7 Target Bunker 0 0 0,6 1990 2010 2030 1990 2010 2030 1990 2010 2030 2008 2009 2010 2011 A proposed 10% reduction of emissions Forthcoming low sulfur regulations are Fuel cost is estimated to drive 26 Speed reductions have reduced fuel below 2007 would require a reduction expected to drive fuel costs above percent efficiency gain, equivalent to consumption (and emissions) by 30 of 57 percent below business-as-usual US$1,300 per metric tonne by 2030 1.25 percent improved efficiency each percent globally since 2008. However, by 2030. from about US$600 today. The year and a break with historical trends. any emission reductions from speed increase in fuel costs under the sulfur The IMO proposals on market based reduction observed over the last three regulations is expected to raise fuel measures are aimed at reducing years are unlikely to be sustainable. As price to the point where currently emissions further to meet the target. freight rates rebound as a result of the known opportunities to improve fuel economic recovery, it is likely that efficiency would have been exhausted. speed may increase again. More measures may become available in the future with technological improvements – but significant uncertainties remain on this. PwC 5
  • 6. Summary of key findings Options Measures to put a price on carbon to Emissions Trading Scheme (ETS) proposals The Levy proposal is a centralized scheme, incentivize fuel efficiency and reduction of involve auction of certificates, submission at putting direct charges on fuel, and links to emissions ports, and trading in carbon markets carbon markets through a central entity Carbon emission from shipping fuel Conceptual model for shipping ETS Conceptual model for shipping Levy One tonne of fuel three tonnes of CO2* Central authority Central to allocate authority sets certificates(freely or and collects auction), and levy collect from ships Certificate Central owners authority A cost of carbon is expected to be added to the price of engages in (shipoperators/ fuel through a future market-based measure. owners) can market to Currently, for every tonne of fuel consumed, trade certificates purchase approximately three tonnes of CO2 are emitted. in market offsets The policy options and various design features for a Ships to acquire market-based measure for the shipping sector, and submit including how it is linked to these existing carbon certificates at port Ships to pay markets, will impact the price of carbon, the industry based upon levy on fuel and the environment. emissions from each voyage The two main market-based measures being considered are a levy and an emissions trading scheme An Emissions Trading Scheme (ETS) entails A levy can be imposed on fuel during sales based on (ETS), based on the principle that the shipping setting a cap for the aggregate emissions allowed to be the carbon content of fuel, or at a port based upon industry will respond to a price signal to encourage emitted in the system. Typically one unit of allowance emissions of a completed voyage. The levy increases emission reductions. permit its holder to emit a tonne of CO2. Ships are the cost to a ship voyage. If it is cheaper to reduce required to surrender an allowance unit for every emissions than to pay the levy, the ship-owner or In total, ten proposals have been submitted to the tonne of CO2 emitted during the voyage. Allowances charterer will prefer to do so. The proposal IMO for consideration as possible market-based can be issued for free, which can be based on past recommends that the proceeds are collected by an measures. Six of these proposal can be generalized to emissions, and/or through auctioning. Shipping international body and used to purchase carbon two basic market-based schemes – a levy and an companies can then trade these allowances in the credits to achieve an emissions reductions target. The emissions trading scheme. The remaining proposals carbon markets. If it is cheaper to reduce emissions levy would need to be set at a level sufficient to fund address a rebate mechanism applicable to any MBM than to buy an allowance, a company will do so and the purchase of sufficient carbon credits to meet the and technical measures such as efficiency index or sell any excess allowances; conversely, if it is cheaper target (and to include other contributions or costs of design standards. for a company to buy allowances than to reduce its administration). If the funds are mobilized for other *Actual relationship is between 3.09-3.17 varying with fuel emissions, then it will purchase an allowance for purposes than to purchase carbon credits the quality. We have assumed 3.13 throughout this study compliance. environmental outcome cannot be determined with 6 certainty. PwC
  • 7. Summary of key findings Impacts on the shipping industry A levy, or an ETS without any auction, would A levy and the ETS could achieve identical A higher levy, or auction under the ETS, would achieve the environmental outcome at the environmental outcomes mobilize more funds for a global climate fund lowest cost to the industry Carbon abatement options from Shipping Impacts of low-cost levy and ETS zero cost zero-auction Impact of high-cost levy and ETS 100% auction Metric tons C02 (million) 2000 Levy minimum + ETS with 100% large global fund auction = contributions = 1600 $152 Abated through $152 per metric ton fuel 26% efficiency gains per metric ton fuel Levy minimum ETS with 0% required to offsets auction = 1200 = Abated through $66 41 billion to 41 billion to $66 32% market-based per metric ton fuel global fund global fund per metric ton fuel measures 800 2,6 billion to 2,6 billion to global fund global fund 400 43% Remaining emissions 0 2010 2020 2030 With appropriate target setting and policy design, a A levy based on the purchase of CDM carbon credits A levy, or an ETS without auction wouldmobilize levy and the ETS can achieve identical outcomes. This would incur a cost of about $66 per metric tonne of US$3 billion annually by 2030. However, if a prime is achieved with the size of the levy set as a function of fuel to the industry by 2030. An ETS proposal with objective of a scheme is to raise revenues, the levy can a pre-determined abatement target on emissions and free allocation (i.e. 0% auction) would achieve the be increased beyond what is required to purchase the proceeds of the levy used to purchase the required same impact. The cost of purchasing carbon credits offsets. number of credits to meet the targets. through the proceeds of a levy scheme will be identical to the total costs for firms to purchase allowances to After accounting for the purchase of carbon credits, comply under an ETS. the auction proceeds and contribution to global climate fund are additional revenues raised. Under the ETS, allowances can be allocated freely or through auction. With auctioning, the industry incurs The ETS with 100 percent auction of allowances would additional cost as it has to purchase the allowances mobilize about US$41 billion annually by 2030. being auctioned. The greater the proportion of auctioning, the greater the cost to the industry. PwC 7
  • 8. Summary of key findings Impacts on the shipping industry Impact on cost base varies much Profit would be lost as a large The impact of carbon polices is Seaborne trade volumes would between vessels and could reach 9 share of the cost increase would dwarfed by trends in the fuel cost decline percent for a 3500 TEU container be absorbed by the industry Impact on fuel cost 2030 ($2010) Components of cost base per shiptype 2010-2030 Absorption of cost increase at 25 percent initial Impact of high-cost levy and ETS 100% auction with ETS 100% auction (daily costs) margin 1469 Capex Opex Fuel Carbon 152 618 Container Main Liner 8% 5% 78 % 9,0 % 71 % Loss of volume: Capesize Bulker 15 % 12 % 65 % 7,5 % 47 % • Short-sea to road and 699 VLCC 18 % 12 % 63 % 7,3 % rail 45 % • Deep-sea to local Handysize Product Tanker 16 % 19 % 58 % 6,7 % 38 % products which dont Handysize Bulker 17 % 20 % 57 % 6,6 % -74 % require ocean transport Carbon Bunker Sulfur New high base regs fuel case impact price impact Compared to the forthcoming The amount of carbon emissions for a The increases in voyage costs resulting As freight rates increase, especially in regulations which mandates lower ship is strongly linked to fuel from carbon pricing will lead to higher the short-term, the level of shipping sulfur content of fuel, carbon pricing is consumption, which as a proportion of rates. Freight rates and a ship’s profit activities may fall. Modal shift is a estimated to have a relatively small the cost base, differs substantially margin are determined by a multitude particularly relevant scenario for the impact on the cost to the industry. 80 across the ship segments. A container of factors, including the competitive short-sea freight segment where road percent of the expected increase in main liner has the largest share of fuel conditions, operational and transport is an option, for example in voyage costs for vessels will stem from cost, and therefore by extension carbon management efficiency of the ship and densely populated regions such as Asia, the sulfur regulations. costs. Smaller ships (handysize bulkers market conditions. A levy would lead Europe and North-America. Studies and tankers), with a proportionally to an increase of freight rates of from Europe indicate a severe impact A levy would result in an average larger capex and opex cost base, finds between 1-5 percent across common with fuel costs above $1000 per metric increase of voyage costs of about 5 carbon cost a smaller proportion of vessel types and goods. An ETS with tonne. percent. On the other extreme, an ETS their cost base. full auctioning would increase freight with full auctioning will result in an 11 rates between 7-9 percent. As freight rates increase, locally percent increase in voyage costs. A levy would result in an increase in the produced goods would become more total cost base between 3-4 percent Profits of the industry would fall. All competitive. The demand for across common vessel segments. An ship types will be able to pass-through international transport would decline ETS with auctioning would result in an some of their costs to their customers. as a consequence. However, these increase between 6-9 percent. The extent depends upon the goods impacts are likely to be a result of the being transported and the capacity in low-sulfur regulations rather than PwC the market. carbon costs.
  • 9. Bottom linePwC 9
  • 10. Three key issues will be addressed 1 Context What is the problem and why should it be addressed? How does this fit in with wider developments in the industry? What are the options? What models are 2 Options being proposed? What are the key parameters which policymakers need to decide? How much will it cost? How will different 3 Impact policy options impact costs? How will shipping profits be impacted? How will patterns of global trade change?PwC
  • 11. Section 1PwC Context 11
  • 12. 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 shipping There are about 100,000 ships weighing above 100 Gt, of which about half are sector. This is a larger share than aviation and rail sectors, but much less than cargo ships which constitutes the largest share of emissions. The container emissions from the road transport sector which is more than 6 times higher. fleet, which is the fastest moving and therefore more carbon-intensive segment of the industry, releases as much carbon as the city of Tokyo in a year. About 1050 million tonnes of carbon are emitted from the global shipping fleet every year. Most of this is international shipping, i.e. transport between This study is focused on “international shipping” which is the scope of the IMO countries and across oceans, which accounts for 870 million tonnes of carbon proposal. emissions. Emissions from global shipping less than road transport Most emissions are from cargo transport and more than aviation Figure 1.1: Global emissions of CO2 by sector Figure 1.2: Emissions and vessels by major fleet segments (contribution to total) 50% 80% Container 22 % Bulk 17 % Road Crude oil tanker 10 % transport; General cargo 9% 21 % Global Ferry 8% shipping; Miscellaneous 7% 3,3 % Service 5% Chemical tanker 5% Products tanker 4% Aviation; Vehicle 3% 1,9 % LNG tanker 2% Other dry 2% All other; 73 % Rail; 0,5 % Of fshore 2% Cruise 2% Roro 2% LPG tanker 1% Yacht 0% Other tanker 0% Source: IMO 2009 Source: IMO 2009 Buhaug et al. ,Notes: Estimates are from 2007 and based upon detailed assessments of vessel types, fuel consumption and size conducted by IMO in 2009. There is stated a 20 percent margin of error in the estimates. PwC 12
  • 13. Context Shipping is the most carbon efficient mode of transport Despite emissions levels, ships are overall the most carbon efficient mode of Vessel types also affect fuel efficiency. Smaller ships, which are often used in transport. coastal short-sea freight routes, are more carbon intensive than larger vessels. This, however, varies by type of goods. Heavy bulk cargos such as iron ore, coal However, compared to their direct competition of road and rail, they still and crude are more efficiently transported on ships. Shipping of lighter goods compare favorably on carbon emissions per tonne km travelled. and cargos, on the other hand, competes with rail and road. Airfreight is also used for high value-to-weight goods, especially if they are perishable or of a critical nature. Shipping is the most carbon efficient mode of transport Larger vessels are more carbon efficient Figure 1.3: Intermodal carbon efficiency compared Figure 1.4: Carbon efficiency of different vessels (examples) Large Average load Very large Ore Average Max load Shipping VLCC Range Suezmax Tanker Container 8000 TEU+ Rail Medium Bulk Handymax Panamax tanker Road Handymax product Container 5000-7999 TEU Air* Smaller Bulk Handy Coastal product 0 100 200 300 400 500 Container 1000-1999 TEU Vehicle carrier 0-3999ceu Grams C02/tonkm -30 -15 0 15 30 45 60 Grams C02/tonkm Source: IMO 2009: * 747-F PwC 13
  • 14. Massive efficiency gains required to reduce emissions Figure 1.5: Target and growth of emissionsAs the demand for maritime transport services derives from global economic Metric tons CO2 (million)growth and the need to carry international trade, trends in the shippingsector are closely interlinked with the movement of trade. 2000Economic 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-Siberian 100% morerailway. emissions if 3,3% unconstrained growthAs such, we expect a growth of seaborne trade of about 3,3 percent 1500 alongside growth inconsistent with the IMO 2009 scenario. Fuel consumption, and thereby seaborne tradeemissions, will also follow this growth scenario if nothing else changes. This 1053also constitutes the reference case for our further calculations. mtThe carbon intensity of the industry, however, may improve over time 57%through efficiency improvements in the sector. The degree of efficiencyimprovements will depend on a variety of factors, which include ongoing 1000technological improvements, reacting to the cost of fuel, and potentiallyfuture regulations in the shipping industry.We will discuss these impacts in the following sections. Target for reductions at 783 million tonnes 500 Emissions growth Target reduction 0 1990 2000 2010 2020 2030 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), and ), a 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.PwC 14
  • 15. Context Potential to reduce emissions is substantial through existing proposals The IMO has identified three wedges to reduce emissions. Figure 1.6: Abatement potential Volatility and increases in fuel costs (particularly from EU regulations on low-sulfur sulfur Metric tons C02 (million) The impact Abatement measures 1 fuels)are a strong driver for the shipping industry to improve its fuel efficiency. in 2030 Thus even in the absence of any intervention or regulation, the industry expects an 2000 improvement in the carbon intensity of the sector as a result of business-as- usual efficiency gains. An extensive scenario exercise by IMO in 2009 identified . these to be amount to a 14% reduction by 2030, which is higher than the fuel- Abated through business efficiency gains for the global fleet over the last decades. The IMO emissions 14% 248 as usual efficiency scenario for 2030 of about 1550 million tonnes of carbon takes account of these 1600 improvements improvements. Abated through mandated A current proposal within the IMO to introduce the energy efficiency design 12% 213 energy efficiency design 2 index (EEDI) to encourage design improvements for new ships is also expected to index (EEDI) result in carbon efficiency improvements for the sector beyond the business-as- - usual efficiency improvements. 1200 The use of market-based measures is a further set of proposals within the IMO 32% 592 Abated through market- 3 community to reduce the contribution of the shipping sector to carbon emissions based measures and is the focus of this study. The current proposals can potentially reduce emissions through two routes: a) by reducing emissions within the sector through responding to a price signal; and/or b) by making shipping companies pay for 800 emissions reduction in another sector. The scope for emissions reduction of market-based measures depends on the target based set. Analyses conducted for the IMO suggests that the range of targets being considered of up to 20% below 2007 emission levels. 400 43% 783 Political economy influences heavily on the actual level of target to be agreed. For Remaining emissions the purpose of our analysis we assume the target set by IMO expert group review of proposals of 10% below 2007 levels. For international shipping this translates into 783 million tonnes. We also assume that the process will only be implemented . from 2015. 0 The remaining emissions will depend on the compounded impact of the 2010 2015 2020 2025 2030 4 emissions reduction measures above. Sources: IMO 2009, 2010; PwC GHG Shipping model PwC 15
  • 16. Context Speed reductions have reduced fuel consumption by 30 percent globally since 2008 Speed reduction is an important fuel efficiency measure, highly influenced Despite the significant speed reduction observed, due to data unavailability it by a number of market factors. Ship operators respond to low rates, is difficult to conclude the impact on emissions since 2007, when the IMO overcapacity and higher fuel costs by reducing speeds. estimated emissions to be 870 million tonnes. A measurable decrease in total fuel consumption has been observed since Moreover, any emission reductions from speed reduction observed over the 2008, reflecting changes in operational patterns as a result of the increase in last three years are unlikely to be sustainable. The economic and trade boom fuel costs in recent years. leading up to 2008 followed by the deepest recession in decades is likely to impact the industry far greater than a ‘typical’ economic cycle. As freight rates The speed reductions are in the range of 14-16 percent over the three years rebound as a result of the economic recovery, it is likely that speed may across tankers, bulkers and containers; with the exception of iron ore increase again. bulkers which are less sensitive to fuel cost increases; and with the exception of ferries which operate scheduled services often subject to license requirements. Figure 1.7 Global fuel reduction estimate 2008-2011 More vessels in the market, Speed reductions across the Fuel consumption reduced but fewer are actually at fleet 2008-2011 by 30-40 percent 40 sea Vessels at sea Index Speed International fleet Index Fuel consumption Index 1,0 (Global fleet) 1,1 1,0 -6% -15% -30-40% 30-40 percent Not sustainable 0,9 reduction in Will increase again 1,0 0,9 0,8 carbon emissions if demand for 0,9 transport increases 0,7 since early 2008 0,8 0,8 0,6 2008 2009 2010 2011 2008 2009 2010 2011 2008 2009 2010 2011 Sources: PwC Shipping fuel model. Baseline fuel data from IMO 2009 (Buhaug); AISlive satelite datastreams Bloomberg. Coverage of about 25.000 vessels constituting about 65 percent of global fuel datastreams. consumption. Segmented by 24 vessel categories. The relationship between fuel consumption and speed has been assumed as a thi power relationship. Total for all vessels tonne kilometers expressed as square third relationship and is shown as upper line. Not accounted for fuel consumption at anchor or in ports. The figures incorporates t number of vessels on the market and those that are actually moving at sea at a given the date. Weekly data. PwC 16
  • 17. Context But speed reductions are very market sensitive and cannot be counted as reliable abatement measures Figure 1.8: Containership speed response to rate collapse, overcapacity, and higher costs 2008 2008-2011 There has been much volatility over the last few years in many of the factors that would induce response in speed. Demand for transport More ships entered the Rates dropped • The market for seaborne transport collapsed at the end of collapsed market 2008 upon reaching historical heights. Demand has since come back and increased since 2009. Singapore throughput Million Container fleet Vessels Container freight rates Index (Containers TEU) (index) 3 5000 12 • Many more ships were ordered at the end of the high cycle +12% 10 and these have been entering the market since. There was -25% 25% 4600 -75% 8 oversupply and rates dropped across most segments. 2,4 6 4200 4 2 • Fewer of the ships are utilized, meaning that they are at 1,8 3800 0 anchor and not at sea at a given day. 2008 2009 2010 2011 2008 2009 2010 2011 2008 2009 2010 2011 • Fuel costs have increased and are expected to increase further in the future due to both the: (i) market expectations; and (ii) The shift in fuel mix towards low- sulfur fuels. Fewer ships are utilized Fuel cost are higher Speed is lower Speed reduction will be most cost effective if there is overcapacity in the market (as for the last three years). If not, Utilization fleet Percent Bunker fuel USD/Ton Container speed Knots there will capital investments required to build new vessels (Container) (Rotterdam) (Average) to compensate for the drop in transport capacity. The 100 % 800 14 -9% 9% +200% dynamics are very volatile and hard to forecast. 600 -14% 13 90 % 400 12 Examples from the container fleet are shown on the right. 80 % 200 11 The container fleet has reduced speed by about 14 percent since early 2008. This is consistent across most other types 70 % 0 10 of vessels and the typical range of speed reductions over the 2008 2009 2010 2011 2008 2009 2010 2011 2008 2009 2010 2011 three years is about 14-16 percent. Sources: Singapore Port Authority, Lloyds, Hamburg Shipbrokers Association , Bloomberg AISlive datastreams PwC 17
  • 18. Context Low-sulfur fuel regulations will be a game changer sulfur This report is focused on carbon regulations, but other international Complying with these fuel sulfur reduction requirements will require change, environmental legislation are also likely to drive changes in the industry. In through the use of distillate or alternative fuel oils, LNG or gas-cleaning particular the IMO’s amendments to Annex VI of the MARPOL Convention technologies (scrubbers). LNG can only be used for newly built ships. This will in relation to SOx (sulfur oxides) reductions are expected to drive a have a strong upward pressure on fuel prices as distillates are historically 80-90% significant rise in average fuel costs over the coming years. These include: more expensive than traditional bunker fuel. There is also limited capacity at the refineries to produce distillate fuel and this is expected to create further price • The global limit for sulfur content in fuel will be reduced from 4.5% to pressure on the fuel. 3.5% effective from 1 January 2012; then gradually to 0.5% by 2020 (subject to a feasibility review). The price increase from the shift of fuel mix will create incentives for considerable fuel efficiency in the fleet. This will result in a much more significant impact to the • The limits applicable in Sulfur Emission Control Areas (SECAs) will be industry than the current proposals on carbon regulation. reduced from 1.5% to 1%, beginning on 1 July 2010; then further to 0.1 %, effective from 1 January 2015. The price levels corresponds to an underlying cost of crude oil of about US$115 per barrel ($2010). Increased use of low low-sulfur, more Fuel costs may remain high Much higher average fuel cost expensive fuel Figure 1.9: Fuel prices 1990-2030 Figure 1.10: Change in fuel mix of fleet Figure 1.11: Average fuel unit cost for fleet when USD per metric ton fuel using bunker and distillate ($2010) Share of f uel type used USD per metric ton f uel (2010$) Distillate 20 % 1200 1200 Bunker f uel 80% 900 900 80 % 96 % 150% 600 80 % 600 300 300 20 % 4% 0 0 2010 2020 2030 2010 2020 2030 1990 2000 2010 2020 2030 Sources: IMO 2010, Bloomberg, Bunker fuel projections from Annual Energy Outlook 2011 (Department of Energy US), Purvin Getz 2009. EMTS 2010. Assumes distillate at 60% higher than bunker+demand increase top-off at 20% from 2020. Similar to IMO 2010 expert group assumptions. Bunker costs historical shown at Singapore rate The production process from residual to distillate fuels also requires off rates. energy. 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. T distillate fuel burns The more efficiently at the ships, but not enough to offset the energy required in the refining process. PwC 18
  • 19. Context Higher fuel costs unlikely to result in sufficient efficiency improvements The extent to which fuel saving technologies are economically viable depends on All of these technologies (except solar on the Suezmax) are found to be profitable the capital and recurrent costs of implementation and the fuel savings potential at fuel prices of $900 a tonne. If all these measures can be implemented at the for each measure. same vessel – the resulting emissions reductions are estimated to exceed 50 percent. The figures below shows examples of two vessels where the efficiency options are exhausted below $900 per tonne a fuel. The vertical axis shows the cost In practice, there are many uncertainties and implementation constraints which below which the investment will be profitable. The horizontal axis shows the are not included in these estimates. Other measures, or stronger price incentives impact on the annual fuel consumption of the ship. may help to overcome these barriers, which is beyond the scope of this study. There are many ways to reduce fuel consumption of a typical Similar savings can be made by a Panamax bulker; and all these Suezmax tanker and increase profits options are profitable with $900 per tonne fuel Figure 1.12 Marginal cost of efficiency improvements at $900 fuel price in Figure 1.13 Marginal cost of efficiency improvements at $900 fuel price in 2030. Midrange estimates. W.o speed reduction. Suezmax tanker 2030. Midrange estimates. W.o speed reduction. Panamax bulker Marginal efficiency cost Savings as share of annual fuel Marginal efficiency cost Savings as share of annual fuel $/tonne fuel consumption for ship $/tonne fuel consumption 10% 20% 30% 40% 50% 400 60 0 Propellerrudderupgrade 40 Propellerrudderupgrade -20 20 Solar Towingkite 10% 20% 30% 40% 50% 0 -40 Propellerupgrade -20 WHR Speedcontrolpumps Towingkite Wind Engine Airlubrication METuning Propellerbushing reg Propellerbushing reg METuning -60 Common Rail -40 Wind Engine Propellerbushing req Bosscapfin Airlubrication Coating Weatherrouting Lighting Weatherrouting Hullbushing Speedcontrolpumps Bosscapfin -60 Hullbushing Common Rail Autopilot Coating -80 Autopilot -80 -100 -100 Sources: Project cost and abatement potential data in examples from IMO 2010 INF 61:18 ; Imarest (2010). We have converted this to fuel equivalents. PwC 19
  • 20. Context Success in the future fuel economy will require innovation and strategic shifts The fuel economy is an increasingly important component of the competitive The industry will respond strategically. dynamics in the of future shipping. We may see strategic shifts in the industry. Impacts may differ across main segments: Larger vessel types might be deployed, such as ultra large container vessels which have greater fuel efficiency per tonne mile than the smaller vessels. Short-sea shipping in densely populated regions face the most immediate threat More attention will be paid to address port infrastructure, which currently of modal shifts towards land-based transport. Studies indicate that a threshold has limitations on vessel sizes. level at about $1000 dollars/ton fuel will lead to significant modal shift and market volumes will be lost to land. The risk for environmental regulators is that this may Downward management of other cost components and further integration lead to higher total emissions as road and rail transport is less carbon efficient. of supply chains will rise in focus. Deep-sea shipping will face different dynamics, in particular the threat of Consolidation in the sector may also follow to exploit greater economies of increased competition from each other as fuel efficiency becomes a competitive scale. lever. Locally produced goods will also become more competitive as the freight costs of the distantly produced goods increases, leading to falls in seaborne trade volumes. Fuel efficiency forecast improve by 1,25% annually Efficiency gains will be outrun by increased fuel cost Figure 1.14: Fuel efficiency improvement 1990-2030 Figure 1.15: Fuel costs per tonne mile of transport 1990-2030 gram f uel/ton mile $ cents/ton mile 1 11 3,4% Fuel costs will increase 0,75 faster and outrun the Efficiency gains gains in efficiency -1,25% represents a break with 9 +95% 0,5 recent history 0,25 7 0 1990 2010 2030 1990 2000 2010 2020 2030 Sources: IMO 2009, 2010; AEO 2010, Fernley, UNCTAD 1990-2010 reports, EMTS 2010. Consistent with the BAU+EEDI scenarios presente on page 15 2010 presented PwC GHG Shipping models. PwC 20
  • 21. Section 2PwC Options 21
  • 22. Two main groups of market-based measures are being considered by the IMO basedThe two main market-based measures being considered are a levy and an emissions trading scheme (ETS), based on the principle tha the shipping industry will based thatrespond to a price signal to encourage emission reductions. In total, ten proposals have been submitted to the IMO for consi consideration as possible market-basedmeasures. Six of these proposal can be generalized to two basic market-based schemes – a levy and an emissions trading scheme. The remaining proposals address a basedrebate 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 pages. Proposal Scope and responsibility Expected source of Mechanism Revenue generation and allocation emissions reductions design features (Levy) GHG • All party ships engaged in international • Out-of-sector • Purchasing of • Fund used to offset GHG emissions from international Fund: MEPC trade and emissions from all marine fuels. project based shipping which exceed global reduction targets. Could also 60/4/8 • GHG contributions due when taking credits (CERs) be used to finance adaptation in developing countries, R&D, Denmark et bunkers are made to the Fund by bunker technical cooperation & administrative expenses of GHG al. fuel suppliers or shipowners. Fund. (Levy) LIS: • Direct payment to International GHG • In-sector • Revenue generated available for mitigation and adaption MEPC Fund through electronic accounts for • Out-of-sector (from activities. 60/4/37 individual ships. remaining proceeds) • Part refund to industry. Japan • Small ships may be excluded. (Levy) PSL: • Uniform emissions charge on all vessels • In-sector • No discussion regarding the use of funds generated. MEPC calling at all ports. • Out-of-sector (from 60/4/40 • Process enforced by Port State remaining proceeds) Jamaica authorities. Global ETS : • Applies to all CO2 emissions from the use • Primarily out-of-sect0r • Partial or full • A Fund would be established by the auctioning of allowances MEPC of fossil fuels by ships engaged in auctioning to be used for climate change mitigation and adaptation and 60/4/22 international shipping above a certain • Links to other R&D for shipping. Norway size threshold. ETS schemes Global ETS: • Ship operators would be responsible for • Primarily out-of-sector • Partial or full • Allowances could be allocated to national governments for MEPC complying with the system. Individual auctioning auctioning and therefore revenue generated would remain 60/4/26 UK ships would be the point of obligation. • Links to other with the governments to be used for a variety of ETS schemes (unspecified) purposes. Global ETS : • Applies to all ships above a threshold, • Primarily out-of-sector • Partial or full • The revenues could follow the principles laid out in the MEPC regardless of their flags. auctioning Danish proposal, with the final allocation of the revenues to 60/4/41 • Links to other be decided by the Parties taking into account the principle of France ETS schemes common but differentiated responsibilities and respective capabilities.PwC 22
  • 23. Both ETS and Levy models involve carbon markets and trading The levy proposal is a more centralized scheme which also ETS proposals resemble existing emissions trading schemes links to existing carbon market Figure 2.1 Conceptual models for shipping carbon market engagement Conceptual Central authority to allocate Central authority allowances (freely sets and collects or auction), and levy collect from ships Certificate Central owners authority (shipoperators/ engages in owners) can market to trade allowances purchase offsets in market Ships to acquire and submit emissions Ships to pay levy certificates based on fuel upon each voyagePwC 23
  • 24. ETS involves known implementation mechanisms but at a larger scaleFigure 2.2 Key issues for implementation of shipping ETS Simplified Mechanism Key risks and mitigation Risk of misallocation of free allowances due to: Central authority to allocate allowances (i) Much volatility in emissions due to speed and market fluctuations; and (freely or auction) to shipowners/operators. (ii) Lack of standardized information required to benchmark performance. Large number of owners, but less than number Large number of different vessel and engine configurations. of ships. About 100.000 ships may be covered The use of auction can mitigate misallocation. Better testing, piloting compared to about 12.000 sites under EU ETS. and/or technology to assess actual emissions can also improve information base. Portside collection of emissions certificates Risk of: for voyage. Each ship to submit certificates. (i) Excessive costs for monitoring, reporting, verification. This can be Certificates may be ultimately owned by mitigated by intelligent administrative systems or technology; and shipowner, operators or charterers. (ii) Fraud and corruption risks, e.g. bunker notes can be falsified, (iii) Avoidance of scheme through e.g. sea-to-sea transfers. Monitoring and verification checks. Technology or paper based. May require verification These can be mitigated by appropriate controls and/or technology. personnel. Owners of certificates can trade certificates in Risk of: carbon markets to optimize the economics of (i) Excessive price volatility. This can be mitigated by allowing for banking ships or fleet. and borrowing of certificates across phases; (ii) Risks of supply constraints of CDM credits. This can be mitigated by Certificates can also be acquired in the also allowing linkages to other markets; and marketplace if additional certificates are needed. (iii) Transaction and trading costs. This can be mitigated by developing efficient technology based marketplaces. Various trading strategies possible within design constraints of the ETS mechanisms.Source: MEPC 60 various proposals.PwC 24
  • 25. Levy involves simpler mechanisms but also has risksFigure 2.3 Key issues for implementation of shipping Levy Simplified Mechanism Key risks and mitigation Risk of setting wrong levels: setting a levy that is too low will lead to Central authority to set levy for 1+ years ahead insufficient funds to acquire required offsets; while setting a levy that is too based upon estimates of emissions and carbon high will tax the industry unduly. price in the future. This can be mitigated by having shorter levy phase (e.g. where the levy is updated every 1-2 years) coupled with an adjustment mechanism to reflect actual carbon prices. This needs to be balanced against the desire to provide longer term price stability. Collection at point of fuel sales. Levy to be Risk of: paid alongside fuelcharge. (i) Fraud and corruption risks. This can be mitigated by appropriate controls and/or technology; and About 400 bunkersales points. About 20% of (ii) Risk of leakage to fuel outside of scheme boundaries. This can be total sales at three ports: Singapore, Rotterdam mitigated by ensuring compliance at major centers, setting entry and Fujairah. requirements to major ports, or impose charge based upon emissions during voyage to be paid at port rather than fuel sales.** Monitoring and verification checks could be required. Central authority will engage in carbon markets to acquire CDM or similar credits to ensure offsets of emissions. Risk of: (i) The central authority, as a very large actor in the CDM market, may May engage in market from time-to-time to substantially affect prices in the CDM market or cause undue volatility. adjust portfolio or employ hedging strategies. This can be mitigated by spreading purchases over time and using intermediaries; (ii) Risks of supply constraints of CDM credits (similar to ETS).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 also resemble the Norwegian NOx fund currently in operation. wouldPwC 25
  • 26. Policy decisions and options on mechanism design affect the environmental andindustry outcomesThe policy decisions that underlie a market based measure and the mechanism designs heavily influences the outcomes of the sc 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 deta – linkage to another carbon market, detailallocation method and banking and borrowing.Figure 2.4 Policy decisions and options on market based design Core policy decisions Size of emissions Geographical ETS or levy target or cap coverage of scheme Linkage to another Levy Phasing over time carbon market Banking and Mechanism Use of proceeds borrowing allowances design ETS policy Allocation method options (auctioning) Cost of carbon Industry freight Environmental Outcomes Cost to industry Trade Cash flow rates outcome Profit impact on industryPwC 26
  • 27. Levy: Core principles and options  To be imposed globally on fuel during sales based on the carbon content of fuel. Core  Proceeds are collected by an international body and used to purchase carbon credits to achieve an emissions reductions target. principles  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. ship- of the levy (MEPC 60/4/8*)  The target for emission reductions would need to be determined. The central entity would purchase offsets required 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 pre pre- determined abatement target on emissions. The levy would need to be set at a level sufficient to fund the purchase of sufficient carbon credits to meet the target (and to include other contributions or costs of administration). The size of the levy is also a political decision and can be set smaller or higher than the amount required to ensure that emissions are offset. For example, the levy can also be set to mobilize funds for a global climate fund or other purposes in addition to the amount required for offsets. Variations would impact cost and environmental effectiveness. We analyze this in section 3.  Linking to other carbon markets would be an issue. The central entity would need markets to purchase carbon Policy options offsets in some markets and issues of linking would arise. The mechanism for linking would impact a.o costs.  Phasing of the levy would need to ensure that the levy overall track the price trends of a major carbon market to which there is a linkage. It is a design decision how often the levy is adjusted i.e 2-4 years. This is a trade-off between creating certainty in the price signal, and the risk of charging to much or to little.  There are also various options for use of proceeds (if funds are collected beyond the amount required for offsets). This includes possibilities of recycling revenues back to the industry through mechanisms which would target efficient ships (i.e Japanese proposal).  There are a number of implementation issues. For example, a levy can also be collected at port based upon emissions of a completed voyage instead of fuels sales. The environmental and compliance cost impacts would however be similar as for a fuel sales based levy. Difference would be in efficiency of implementation arrangements 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.PwC 27
  • 28. ETS: Core principles and options  Typically one unit of allowance permit its holder to emit a tonne of CO2. Ships are required to surrender an Core allowance unit for every tonne of CO2 emitted.  All allowances allocated through auctioning (100%). principles  Assumes linking to CDM market.  Shipping companies can then trade these allowances in the carbon markets. The market price is determined by of the ETS the demand and supply of the allowances. If it is cheaper to reduce emissions than to buy an allowance, a company will do so and sell any excess allowances; conversely, if it is cheaper for a company to buy allowances (MEPC 60/4/22*) than 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. The share of auctioning is a policy 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 allocation can be based upon be based on past emissions benchmarks (from ships) (known as ‘grandfathering’). The principles for this will need to be determined.  A decision on linking to other carbon markets is required. The base case assumes linking to the CDM market. 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. These features help to stabilise the price of an allowance, particularly across different phases of an ETS . Decisions on Policy options the mechanisms are required and have economic impacts.  There are also a number of implementation issues. For example, monitoring and verification arrangements will need 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 MEPC 60/4/26 United Kingdom; and MEPC 60/4/41 France.PwC 28
  • 29. Both carbon levy and ETS have their advantages and limitations Levy ETS Imperfect information means that the levy may not be set accurately to An emissions trading scheme imposes an absolute quantity cap which generate the desired environmental outcome, creating environmental can be managed in line with environmental requirements.Effectiveness uncertainty. However, it provides a clear price signal which will In practice, the mechanism design of the scheme can affect itsat reducing encourage long-term investment in fuel efficient vessels and effectiveness. For example, the level of auctioning vs. free allocation, theemissions equipment, as well as more efficient operational practices. duration of the commitment period and the ability to bank and borrow The IMO GHG Fund proposal sets the levy to meet a specified allowances can all affect the strategic response of participants. environmental target which provides greater environmental certainty. A clear fixed price signal is created which adds certainty to investment Price volatility, as seen in the EU ETS until 2009, provides a fragile basisPrice signal decisions. for investors looking to incorporate a long-term price for carbon intoconsistency Levy rates are subject to changes over time, but volatility would be their decision making. This is a particular issue for investment decisions constrained by the state within a set period. in relation to long life assets such as vessels.Revenue A carbon levy provides revenue generation. The revenues would be Auctioning of permits provides revenue generation. However, revenuesgeneration more stable and controlled centrally, rather than by the market. may be unstable as they are dependent on the price of the allowances. The implementation of a carbon levy scheme is relatively simple An ETS requires an administrative system to be put in place to manage compared to an ETS. Complexity depends on which entity the levy is and monitor compliance, particularly if auctioning is involved. MarketSimplicity imposed and the number of participants involved. participants may require training or a phasing-in period to familiarise with the scheme. Varies by region. For example, within the EU, new taxes need Varies by region. An ETS is likely to gain acceptance politically in EuropePolitical unanimity, whereas decisions on the ETS only need a (qualified) but there is currently little appetite for similar schemes in some othersentiment majority vote. regions.and Any form of carbon pricing may also face resistance from developing Any form of carbon pricing may also face resistance from developingacceptability countries regarding the sharing of responsibilities in the mitigation of countries regarding the sharing of responsibilities in the mitigation of climate change. climate change. GHG Fund - Denmark et al. : Purchases out-of-sector project credits sector Global ETS - Norway with levy funds to meet an emission reduction target. Global ETS - UKCurrent IMO LIS – Japan : Aimed at improving energy efficiency of ships with Global ETS - FranceProposals potential refunds for ‘good performance ships’. Port State Levy – Jamaica : Globally uniform emissions charge administered through Port State arrangements.PwC 29
  • 30. Section 3PwC Impacts 30
  • 31. Impacts The focus of our analysis is on the impact on the environment, shipping industry and trade 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 of the 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 the mechanism, will need to based reflect the balance of outcomes across these four areas. This section considers each in turn. Impact on the shipping Impact on seaborne trade Impact on the environment Administrative burdens industry volumes This first section considers how the This section will review the impact on The shipping industry is a The practicalities of implementation environmental outcome (assumed the shipping industry, focusing on the fundamental part of global and and the required administrative here mainly to be the amount of impacts on: regional trade. Drawing on results burden is considerable for both carbon emissions abated) is affected from the preceding section, as well as authorities and the industry. Key by the choice of policy instrument. 1) Cost base; and overall trends in trade, we will considerations include: consider in this section the 2) The implications on profits. implications on: 1) Governance of mechanism – parties required; This will be considered primarily at an 1) Overall trade levels; and industry level. 2) Administrative burden; and 2) Potential impacts on trade We will also consider the impacts routes or distribution of trade. 3) Monitoring, reporting and across different shipping segments, as verification requirements. there can be substantial variations within the industry. PwC 31
  • 32. Impacts Cost impacts will impact profits, transfer through freight rates and also impact trade volume The main impact of carbon pricing on the shipping industry is on cost and An industry level analysis can mask the true impact on a shipping company. profitability. There are two key sources of variation: A change in cost base as a result of increased cost of carbon will affect industry a) The amount of carbon emissions for a ship is strongly linked to fuel profitability, but the extent of this depends on demand and supply factors consumption, which differs substantially across the ship segments. The within the sector and relative to other transport modes, as well as levels and cost of carbon will therefore also vary for different ship types. patterns of global trade. b) The nature of the products being transported by different ship types may A key determinant is whether the ship is able to pass on the costs to its affect the freight rates, and the extent to which the cost of carbon can be customers in increased freight rates, therefore retaining the profits earned. passed on as increased freight rates. Our analysis first considers a top-down analysis for the industry, by considering Our analysis therefore also considers a bottom-up analysis by ship type. the impact of the cost of carbon on the industry’s cost base. This includes This looks at the impact of carbon cost on the cost base, the extent to which this looking at the impacts of changing policy options on the mechanism design can be passed onto the ship’s customers, and the associated implications for under a levy and an emissions trading scheme. profitability. 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 Local goods more competitive Cost of carbon Road and rail more competitive Seaborne trade Cost to industry Industry freight rates volumes Administrative burdens* Profit of shipping industry *Costs of administrative burdens are not analyzed PwC 32
  • 33. Impacts 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 all allocate below-the-line allowances freely or through 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 e entity can purchase sufficient offsets in the carbon 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 above 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 Tons C02 (million) Levy ETS 2000 Tonnes Co2 reduced at no cost Tonnes Co2 reduced at no cost 1600 1200 Firms to purchase allowances for tonne Central entity to purchase offset credits Emissions to be CO2 emitted above target line equivalent to emissions above target line offset 800 CO2 +10% for Target price global Allocated allowances to firms to emit climate fund tonnes of CO2 for emissions under target Remaining 400 line: emissions (i) freely, or; (ii) through auction up to 100% 0 2010 2015 2020 2025 2030 PwC 33
  • 34. Impacts Potential fuel efficiency gains may not all be realized in practice Low sulfur regulations are expected to drive fuel costs above US$1,000 per 2. For the purposes of this study we apply a conservative assumption about metric tonne, but current analysis on the technological potential for efficiency fuel efficiency savings of 26 percent by 2030. This is also consistent with the gains suggest that all efficiency measures will have been exhausted at that price IMO business as usual scenario (which assumes implementation of many of these level. With technological improvements on newer or currently undeveloped measures) and the effects of implementing a mandatory EEDI. technologies, e.g. solar, more measures may become available in the future. The figure below indicates the expected efficiency potential with respect to total Several studies have calculated these by estimating the marginal cost and emissions and the wedges for emission reductions discussed on page 15. potential for carbon reductions. They find most measures are economically viable with fuel cost of $1000 per metric tonne of fuel. Beyond that level, there The maximum efficiency potential is not enough to reach is little technological potential (known of today) that can be exploited. There are emissions target few studies which explicitly considers abatement potential at higher price levels. The most optimistic estimates show a carbon savings potential of 56 percent Figure 3.3 Impact of fuel efficiency on total emissions 2030 by 2030. This is equivalent to about 900 million tonnes of carbon annually in reduced emissions. Metric tons C02 (million) The shipping engineering community has expressed skepticisms about the 2000 practicalities of implementing these measures. Some technologies have been Total emissions in available for decades without being adopted, suggesting practical barriers exist. reference case Others are not possible to combine on the same vessel, and there are questions on the assumptions used in the calculations particularly on financing. 1600 Assumed efficiency There are two main implications of this: 26% gains (basecase) 1. There are insufficient information to estimate the impact of 1200 incremental carbon price on carbon abatement when fuel cost exceeds about $1000 per metric tonne. Maximum theoretical 56% In theory, an incremental carbon pricing in the sector is expected to lead to 800 efficiency potential Target (57%) further emissions reduction. However, based upon knowledge of current technologies, all abatement measures are expected to have been exhausted when fuel cost exceeds $1000 per metric tonne. Our results therefore assume that the 400 shipping industry would have to buy carbon credits to meet their regulatory obligations rather than invest in carbon reduction, i.e. there are no in-sector emissions reduction resulting from incremental carbon pricing. In the future it is likely that new technologies will emerge, especially if the cost of carbon 0 provides incentives for further R&D. 2010 2015 2020 2025 2030 Sources: Pwc GHG Shipping model. Various Marginal Abatement Cost (MAC) studies: IMO 2009; 2010 INF 61:18 ; SNAME (2010); CE DELFT 2009; DNV 2009. PwC 34
  • 35. Impacts 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 operati cost and profits of a ship. This is operating underpinned by the following assumptions. See the supplementary annex for further details. Forecast $ per ton fuel (2010$) We assume that the bunker fuel cost reaches $1320 a 1320 tonne on average for the fleet in 2030. Forecast from Fuel DOE/AEO 2010 used as the basis for bunker fuel. We 600 assume an increasing share of (more expensive) distillate in the fuel mix. 0 2010 2020 2030 We assume there are improvements in fuel efficiency, driven by technology, fuel cost and EEDI regulations. This leads to Efficiency & a 26 percent reduction in fuel consumption below business business- growth as-usual by 2030, against a growth in seaborne trade of 3,3 usual percent annually. Starting point is 870 mt CO2 emissions in 1,25% 2007. annual efficiency gains Forecast $ per CER (2010$) We have based our forecast on the CER price (carbon credits 44 for the CDM market). The estimate is based on the current Carbon CER-EUA spread and the May 2011 Point Carbon forecast EUA 20 for EUAs, and will be around US$31 by 2020 and US$44 by 2030. 0 2010 2020 2030 We have considered four key scenarios : 10% of 2007 We assume that the target will be set at 10 percent below 2007 levels (783 million 1: Levy, where funds are used to buy offsets tonnes). tonnes Policy to reach target abatement level emissions target scenarios 2. ETS without auction of allowances We have also included a 10% additional 3. ETS with 15% auction (as with the EU aviation regulations) contributions to a global climate fund as proposed by the key IMO proposals. 10% 4. ETS with 100% auction of allowances contributions to global climate fund PwC 35
  • 36. Impacts: Overview Bottom line is that levy and ETS can be designed to have identical impacts Figure 3.4: Summary of impacts by main options by 2030 ($2010) Proposals at face-value gives Low-impact variations gives balanced impact High-impact variations can also give unbalanced impacts result balanced result Levy minimum required to offsets = Levy minimum + ETS with 100% $66 auction = large global fund per metric ton contributions = ETS with 100% fuel $152 $152 auction = Levy minimum per metric ton ETS with 0% per metric ton $152 2,6 billion to required to fuel auction = fuel global fund offsets = per metric ton fuel $66 $66 per metric ton 41 billion to 41 billion to per metric ton global fund global fund fuel 41 billion to fuel global fund 2,6 billion to 2,6 billion to global fund global fund All models would give the same environmental impact= 592 millions tonnes CO2 abated Source: PwC GHG Shipping model PwC 36
  • 37. Impacts: Environmental effectiveness Environmental effectiveness is fundamentally determined by the emissions target There are three determinants of environmental outcome (i.e. the amount of 3. Geographical coverage and the risk of carbon leakage carbon emissions abated through the scheme). Current IMO proposals are intended to cover the entire shipping sector. Inability 1. Emissions cap or target to strike a deal, however, may lead to unilateral moves by key shipping regions to impose regional schemes, particularly in the EU. This has been observed in the The emissions cap or target, regardless of whether a levy or ETS is aviation industry where the sector joins the EU-ETS in 2012. operating, creates market scarcity of the amount of GHG emissions that ships can emit. Typically the target is set lower than the level needed for If a regional scheme is implemented, this can result in some degree of ‘carbon business-as-usual emissions. This is the core determinant of the leakage’, where more carbon is emitted outside the scheme as participants attempt environmental outcome. to re-direct activities to other jurisdictions. A stringent cap or target will create greater scarcity and result in higher In the context of shipping, this may be a danger for mechanisms that apply a prices or levies. Conversely, a weak cap will result in lower prices as carbon levy on fuel or require ETS compliance of ships docking within the EU. The companies have a reduced incentive to improve efficiency. applicability of this depends on the degree of substitutability of activities and how the scheme is implemented. For example, if a levy is applicable at the point of fuel 2. The size of a levy purchase, it is relatively easy for ships to refuel outside of the EU to avoid a carbon premium (currently ships are already taking advantage of the relative fuel costs Under a levy scheme, there are potentially further implications for the across different geographies). environmental outcome. The current levy proposal sets the size of the levy as a function of a pre-determined abatement target on emissions. This is the base case assumed for our analysis – we estimated that the cost of carbon per tonne of fuel is US$66 by 2030 to meet the abatement target of 10% reduction below 2007 levels (assuming CDM carbon credits used for compliance). However, the size of the levy could be politically influenced, and the amount of carbon credits purchased (i.e. the environmental outcome) will vary by the size of the levy. An extreme case would be if the funds are mobilized for other purposes than to purchase carbon credits – resulting in further unpredictability of the environmental outcome. PwC 37
  • 38. Impacts: Environmental effectiveness More ambitious abatement targets results in more expensive Levy - but no impact for ETS (100% auction) Figure 3.5: Impact on cost and environment of varying abatement target (2030) ($2010) Cost impact per tonne fuel fuel CO2 abated (million tonnes) Levy ETS 100% auction -10 % $66 $152 592 CO2 abated is a function of target level. -15 % $70 $152 635 Carbon abated is not affected by choice of Levy or ETS.Abatement target below 2007 levels -20 % $75 $152 679 -25 % $80 $152 722 -30 % $85 $152 766 Cost of ETS with 100% auction At 100% reduction target, the does not vary by target level as levy will = ETS with 100% companies still need to auction purchase the same number of carbon credits to meet their Source: PwC GHG Shipping model. obligations. PwC 38
  • 39. Impacts: Environmental effectiveness 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 Figure 3.6: Impact on cost and environment of varying size of levy (2030) ($2010) Deviation from abatement Cost impact per tonne fuel Carbon abated Global fund target (100% = Target of 10% (million contribution Contributions to a reduction below 2007 levels) tonnes) (US$ bn) global fund increases much and can be similar to auction proceeds under ETS. (Similar to ETS 232 % $152 592 41 100% auction) A higher level of contribution to the (Similar to ETS 133 % $87 Carbon abated does 592 12 global climate funds 15% auction)* not increase with a would increase the higher levy. contribution of the 110 % 651 shipping industry to climate change 100 % $66 592 2,6 mitigation. The funds could be used for R&D or climate change 90 % $59 533 2,4 adaptation. 80 % $52 474 2,1 Carbon abated decreases with Contributions to a 70 % $46 insufficient levy. 414 1,8 global fund falls with lower levy. 60 % $39 355 1,6 50 % $33 296 1,3 Source: PwC GHG Shipping model. * 15 percent auction is a proxy for an auction percentage similar to international aviation under EU ETS PwC 39
  • 40. Impacts: Costs Levy and ETS zero-auction imposes least cost on the industry auction 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 free allocation (i.e. 0% auction) would achieve the same impact. With auctioning, there is an additional cost to the industry as i has to purchase the allowances being it auctioned. The greater the proportion of auctioning, the greater the cost to the industry. If the shipping industry follows t practice in the EU ETS plans on aviation to the auction 15% of allowances – 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 sam rate. Levy costs will increase the fastest. An same ETS with free allowances follows the same pattern. The cost of an ETS with full auction will increase relatively less, but is higher throughout. 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) Cost impact per tonne fuel 2030 Over time 2015 2030 ETS with full auction starts $152 with a high auction cost component and increases ETS (100% auction) $152 74% with the rate of emissions $88 and carbon price growth. $87 ETS (15% auction) $87 207% $28 Levy increases very fast in $66 the beginning and growth Levy/ETS (0% auction) $66 222% rates will come closer to the $20 ETS in the long run 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 realisti benchmark. Aviation auction percentage assumed to be at 15% until 2020, 20%- realistic 2025; and 25% until 2030. All cost include 10% contribution to global climate fund. We do not make assumptions about furthe in-sector contributions due to lack of documented incremental in-sector further abatement potential at these levels of fuel cost. PwC 40
  • 41. Impacts: Costs Impact is dwarfed by trends in the fuel cost 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 is expected 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 assu sector assume that the shipping industry would have to buy credits rather than invest in fuel efficiency. In other words, in-sector emissions reduction resulting from incremental carbon pricing is unlikely. sector 80 percent of increase in fuel cost is due to sulfur effect Figure 3.8: Drivers of impact on fuel cost 2030 ($2010) Contribution to Share of total voyage cost 2030 increase 80% 9% 11% $86 $1469 $66 ETS auction: 6 % $618 5-11% Levy: 5 % +110% $699 Fuel 89-95% Max total Sulfur regulation Levy/ETS 0% auction Bunker base ETS 100% auction cost per metric tonne impact offsets fuel Source: PwC GHG Shipping model. PwC 41
  • 42. Impacts: Costs Auctioning allowances in the ETS increases revenue to the implementing authorities Within an ETS, a core design feature is determining how the carbon allowances Impact on sector: are allocated to the industry. Allowances can be allocated free to the participants or auctioned. Under 100% free ‘grandfathering’ allocation, each participant is allocated allowances based on historical emissions, rather than the reduction potential or The benefits of auctioning include: cost. A small number of participants may benefit if they are ‘over-allocated’ allowances especially if the cap is not strict enough, and can sell emission • Generation of revenue which can be used, for example, to fund mitigation allowances to make a profit. The problem is less likely under a strict cap. and adaptation in developing countries and/or R&D into green technology; and • Reduction of initial distortions within an ETS as it allows participants to Participants under a full auctioning scheme will purchase their allowances at the purchase their required number of allowances. auction based on their willingness to pay and quantity required. In practice, however, ‘grandfathering’ (allocation of allowances for free based on Most importantly the method of allocation affects the amount of revenue paid by historical emissions data) has often been the allocation method of choice, the industry as a whole. Under free allocation, allowances are traded within the particularly when schemes are initially set up to reduce the upfront cost to the industry (subject to assumptions about linking to external carbon markets) and industry. participants which are efficient in reducing emissions can profit from the scheme. Under full or partial auctioning, the revenue is collected by a central entity, which The EU ETS is gradually moving away from the free allocation of allowances that may or may not recycle the revenue back into the industry. Efficient participants took place in Phases I and II towards greater share of allowances being still have to pay under (full) auctioning when the revenue is not recycled back into auctioned. At least 50% of allowances will be auctioned from Phase III in 2013, the industry. compared to around 3% in Phase II. At an individual business level, there will also be a cashflow impact of auctioning. The aviation sector which will be included in the EU ETS from 2012 has Timing and volumes of purchases of allowances will need to be factored into cash relatively generous emissions caps (2012 emissions capped at 97% of average management. 2004-06 emissions, falling to 95% in 2013) and has 15% auctioning in 2012 (2013 onwards: to be negotiated). PwC 42
  • 43. Impacts: Costs 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 t this the cost, will in principle add to the fuel 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 t sector to support R&D or related the activities. The fund may also be used for other purposes. Range from $66 to $152 per tonne fuel in 2030 depending upon auction percentage Figure 3.11: ETS and size of auctions by 2030 ($2010) Cost impact per tonne fuel $66 $74 $83 $92 $100 $109 $118 $126 $135 $144 $152 Cost impact on +132% industry is highly dependent upon auction percentage Auction percentage 0% 50 % 100 % Total industry cost 29 bn 33 bn 36 bn 40 bn 44 bn 48 bn 52 bn 56 bn 59 bn 63 bn 67 bn Source: PwC GHG Shipping model. PwC 43
  • 44. Impacts: Costs Total outflows from industry may reach $67 billion by 2030, with contributions to a global climate fund reaching $41 billion Financial outflows from the sector are comprised of three cost components: After accounting for the purchase of carbon credits, the auction proceeds and contribution to global climate fund are additional revenues raised. These can - The amount required for carbon offsets be used in a number of ways: - Auction proceeds to authorities • Recycled back into the sector through investments in R&D and technology development funds; - Additional contribution to global climate fund (10%) • Additional financing to climate change mitigation or adaptation; These would increase over time driven by the increase in carbon price and abatement requirements over time. • Compensation to particular countries (e.g. least developed countries) for potential impact on the sector; and/or • Shared by national governments as additional proceeds to the states. Total outflows from sector range from $29 billion to $67 Proceeds from the scheme can raise additional revenues for billion by 2030* various uses Figure 3.9: Outflows from sector ($2010) Figure 3.10: Additional revenues raised from scheme ($2010) Increase Increase Outflows from shipping sector 2015-2030 Contributions from shipping** 2015-2030 2015 2020 2025 2030 2015 2020 2025 2030 ETS (100% auction) $29bn $38bn $51bn $67bn +134% $23bn $27bn $34bn $41bn +81% ETS (15% auction) $9bn $17bn $27bn $38bn +314% $3bn $6bn $10bn $12bn +276%Levy/ETS (0% auction) $7bn $12bn $19bn $29bn +334% $0,6bn $1,1bn $1,7bn $2,6bn +334% *Includes both offsets, auction contribution and 10 percent contribution to global climate fund, **Includes auction contribution and 10 percent contribution to global climate fund, CDM carbon CDM carbon price only. price only Source: PwC GHG Shipping model PwC 44
  • 45. Impacts: Costs Containers will see the highest impact These impacts may vary within the industry by vessel types. The main The amount of carbon emissions for a ship is strongly linked to fuel different types of ship in the world merchant fleet include: consumption, which as a proportion of the cost base, differs substantially across the ship segments. a) Container Ships, which carry most of the worlds manufactured goods and products, usually through scheduled liner services; A container main liner has the largest share of fuel cost, and therefore by extension carbon costs. Smaller ships (handysize bulkers and tankers), with a b) Bulk carriers, which transport raw materials such as iron ore and coal proportionally larger capex and opex cost base, finds carbon cost a smaller and vary from handysize (small) to capesize (large) bulkers; proportion of their cost base. c) Tankers, which are similar to bulk carriers but transport crude oil, Figure 3.12 demonstrates the impact of a carbon levy and ETS on the cost chemicals and petroleum products; and base across different ship types (based on US$66($152 per tonne of fuel as presented in the industry results). d) Passenger ships, which includes ferries and cruise. This is excluded from our analysis. Fuel most important component of cost base in Carbon cost a smaller share of cost base in 2030 2010 Figure 3.12: Components of cost base per shiptype 2010-2030 with Levy and ETS 100% auction (daily costs) 2030 2010 2030 Levy ETS 100% auction Capex Opex Fuel Carbon Carbon Container Main Liner 15 % 10 % 75 % 8% 6% 82 % 4,1 % 8% 5% 78 % 9,0 % Capesize Bulker 25 % 20 % 55 % 16 % 13 % 68 % 3,4 % 15 % 12 % 65 % 7,5 % VLCC 29 % 19 % 52 % 19 % 12 % 66 % 3,3 % 18 % 12 % 63 % 7,3 % Handysize Product 25 % 30 % 45 % 17 % 20 % 60 % 3,0 % 16 % 19 % 58 % 6,7 % Tanker Handysize Bulker 26 % 30 % 44 % 18 % 21 % 59 % 2,9 % 17 % 20 % 57 % 6,6 % 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. PwC 45
  • 46. Impacts: Costs 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 U US$2,500 per day in 2015; relatively small compared to fuel costs of around US$87,000 per day. Voyage costs, consisting of both fuel and carbon costs, will make up an i increasing share of the overall cost base, from nearly 75% of total costs today to around 86% in 2030. Voyage costs will reach 86 percent of total for a container liner with levy Figure 3.13: Increase in the daily voyage cost for a container main liner under a levy ($2010) (3500 TEU) Levy/ETS Voyage cost increase 0% auction +6% $ 162,000 +15% 4% Carbon +49% +30% $ 91,000 82% Fuel 6% Opex 8% Capex 2010 2015 2020 2025 2030 Source: PwC GHG Shipping models PwC 46
  • 47. Impacts: Costs Carbon cost is more significant under the ETS with full auction Figure 3.14 presents the contribution of an ETS to a container’s cost base until 2030, assuming that 100% of carbon allowance are auctioned. allowances Carbon costs are expected to be around US$10,700 per day in 2015; not insignificant compared to fuel costs of around US$87,00 per day. Voyage costs, consisting of US$87,000 both fuel and carbon costs, will make up an increasing share of the overall cost base, from nearly 75% of total costs today t around 87% in 2030. to Voyage costs will reach 87 percent of total for a container liner with ETS 100% auction Figure 3.14: Increase in the daily voyage cost for a container main liner under a ETS 100% auction($2010/3500 TEU) Levy$152/ ETS Voyage cost increase 100% auction +5% $ 171,000 +14% +44% 9% Carbon +37% $ 91,000 78% Fuel 5% Opex 8% Capex 2010 2015 2020 2025 2030 Source: PwC GHG Shipping models PwC 47
  • 48. Impacts 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 allowances are auctioned until 2020, 20% until 2025 and 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$8 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, from nearly 75% of total costs toda to around 86% in 2030. today Voyage costs could reach 86 percent of total costs for a container main liner Figure 3.15: Increase in the daily voyage cost for a container main liner under an ETS with 15% auctioning ($2010) 180 Levy$87/ ETS Voyage cost increase 15% auction +3% $ 165,000 +9% 160 5% Carbon +40% 140 120 +33% 100 $ 91,000 81% Fuel 80 60 40 20 6% Opex 8% Capex 0 2010 2015 2020 2025 2030 Source: PwC GHG Shipping models PwC 48
  • 49. Impacts: Profits Profitability impact determined by demand for goods transported and capacity in industry 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 the ability of shipowners to pass-through costs to the end customer, rather than allowing the increase in costs to reduce their own profits. The elastici of freight rates through elasticity with respect to fuel prices provides a measure of the percentage change in freight rates as a result of a 1% change in the ffuel 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 highigher fuel cost and that cannot be tested yet on 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 different product types. Elasticity is a statistical concept and the actual impact on profitability is dependent upon other factors wh which we will review on the following pages. The impact on rates is shown below. In the long-run the degree of substitutability between different forms of transport will be relevant. Importers have different m run 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 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 switch between air and sea freight as a result of carbon costs unlikely. Predicted rate impact depends upon impact of carbon price High demand and low capacity results in low profit impact on fuel cost Figure 3.16: Impact on profits under varying market conditions Figure 3.17: Impact on rates Rate impact Demand for commodity Levy ETS 100% auction Impact on0,96 Dirty bulk (iron ore) 5% 11,1 % profit Elastic Inelastic 0,30 Tanker 1,5 % 3,5 % High Low Medium Surplus shipping capacity 0,27 Clean bulk 1,3 % 3,1 % Low Medium High 0,20 Container 1% 2,3 % Source: PwC analysis. Data for elasticities from OECD 2008, 2009; Vivid Economics 2010. Long run elasticities determined th through econometric methods in these studies. Rate impacts calculated by team. PwC 49
  • 50. Impacts: Profits 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 fuel) would result in more profit loss. Examples of short term impacts Containers will absorb most of the cost And will see the hardest impact on the ETS with auction will increase the increases bottom line impacts Figure 3.18: Absorption of cost increase at 25 Figure 3.19: Daily loss of profit in 2030 with Levy Figure 3.20: Daily loss of profit in 2030 with ETS 100 percent initial margin with 25 percent initial margin on cost base percent auction and with 25 percent initial margin on cost ($2010) base ($2010) Both levy and ETS Levy/ETS 0% 0%-auction ETS 100%-auction Container 71 % -4 695 -10 879 Handysize bulker 47 % 2010 -512 -1 186 (clean) VLCC 45 % -1 976 -4 578 Handysize product -1 392 38 % -601 tanker Capesize bulker (dirty) -74 % 2 193 5 082 Source: PwC GHG Shipping models. PwC 50
  • 51. Impacts: Profits 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, oper operational and management efficiency of the ship and market conditions. To reflect this, our analysis presents a potential daily freight rate for a given level of fuel c 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 to illustrate 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 prop proportionate impact on profits is more significant compared to during periods of high profitability (e.g. during trade booms). For example, profit margin falls from 10% to 7% ( 30% fall) in the low freight rate scenario, (a but only 50% to 45% (a 10% fall) in the high freight rate scenario. Examples of short term impacts More impact with low rates Less impact with higher rates Figure 3.21: Profitability impact on a VLCC with 10 percent initial margin on Figure 3.22: Profitability impact on a VLCC with 50 percent initial margin on costbase, 2030 (Levy) costbase, 2030 (Levy) Share of rate 3,1% -1,6% +1,5% Share of rate 2,2% -0,7% +1,5% 10% 50% -$1500 daily margin -$2300 daily margin 49% of cost 66% of cost increase increase Initial Carbon Profit New rate Initial Carbon Profit New rate profit cost impact profit cost impact margin margin Source: PwC GHG shipping model. Notes: Detailed analysis is in the Annex ; Mark-up here is applied on freight rates relative t cost base (i.e. Freight rates = total cost base x (1+ mark-up)). Cost base= up to capex, opex and fuel) . Annual fuel efficiency gains accounted for. PwC 51
  • 52. Impacts: Profits 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 and general economic conditions, there through may 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 bulkers transporting goods in high demand such as iron ore to China, will pass on more than the cost incurred, and potentially gaini a profit in the process. gaining A further impact on profits, which is not explicitly considered in our analysis, is the impact on volume. As freight rates in increase, especially in the short-term, the level of shipping activities may fall. However, over the longer term, the potential impact is likely to be driven by more fundament factors such as trade levels and modal fundamental shift. This is discussed in our next section. Examples of short term impacts In a few markets for goods with inelastic demand like iron ore, Grain transports will see a reduction in profit there may be a markup on top of the cost increase Figure 3.23: Profitability impact on a Handysize Bulker (grain) with 25 percent Figure 3.24: Profitability impact on a Capesize Bulker (iron ore) with 25 percent initial initial margin on costbase, 2030 (Levy) margin on costbase, 2030 (Levy) Share of rate 2,8% +2,1% +4,9% Share of rate 2,5% -1,2% +1,3% Grain Iron +$2200 daily -$570 daily 174% of cost increase 53% of cost increase Initial profit Carbon Profit New rate Initial profit Carbon Profit New rate margin cost impact margin cost impact Source: PwC GHG shipping model. Notes: Detailed analysis is in the Annex ; Mark-up here is applied on freight rates relative t cost base (i.e. Freight rates = total cost base x (1+ mark-up)). Cost base= up to capex, opex and fuel) . Annual fuel efficiency gains accounted for. PwC 52
  • 53. Impacts: Profits Higher levy or ETS with full auction gives similar cost pass pass-through percentages, but higher $ impact on bottom line Examples of short term impacts More impact with low rates Less impact with higher rates Figure 3.25: Profitability impact on a VLCC with 10 percent initial margin on Figure 3.26: Profitability impact on a VLCC with 50 percent initial margin on costbase, 2030 (ETS 100%)) costbase, 2030 (ETS 100%) Share of rate 7,1% -3,6% +3,5% Share of rate 5,2% -1,7% +3,5% -$3500 daily -$5300 daily 10% 50% margin 49% of cost 66% of cost margin increase increase Initial Carbon Profit New rate Initial Carbon Profit New rate profit cost impact profit cost impact margin margin In a few markets for goods with inelastic demand like iron ore, Grain transports will see a reduction in profit there may be a markup on top of the cost increase Figure 3.27: Profitability impact on a Handysize Bulker (clean) with 25 percent Figure 3.28: Profitability impact on a Capesize Bulker (dirty) with 25 percent initial initial margin on costbase, 2030 (ETS 100%)) margin on costbase, 2030 (ETS 100%)) Share of rate 5,7% -2,7% +3% Share of rate 6,5% 4,5% +11,3% +$5100 daily Grain -$1200 daily Iron 174% of cost 53% of cost increase increase Initial Carbon Profit New rate Initial Carbon Profit New rate profit cost impact profit cost impact margin margin Source: PwC GHG shipping model. Notes: Detailed analysis is in the Annex ; Mark-up here is applied on freight rates relative t cost base (i.e. Freight rates = total cost base x (1+ mark-up)). Cost base= up to capex, opex and fuel) . Annual fuel efficiency gains accounted for. PwC 53
  • 54. Impacts Linking to another carbon market would affect the shipping carbon price An ETS is frequently linked to another carbon market Based on current IMO proposals, the CDM’s credits (CERs) are the most likely source of credits eligible to provide greater liquidity. This is achieved by for compliance in the shipping sector. The demand generated by a shipping carbon scheme (whether levy allowing the carbon credits or allowances from other or ETS) would generate ssignificant demand for CERs, which could substantially improve the prospects of market(s) to be eligible for compliance. This reduces more emission abatement projects in developing countries countries. the burden on the industry to meet all the required carbon abatement in-sector. The core levy proposal considered by the IMO (GHG Linking to one or more carbon markets can affect the shipping carbon price Fund) also involves linking to the carbon markets by basing the levy on the cost required to purchase Figure 3.29 Potential carbon markets to be linked carbon credits equal to the target set. There are three ways of linking: • Unilateral linking where credits or allowances from a carbon project credit mechanism (e.g. CDM or voluntary markets) or another ETS (e.g. EU ETS EU ETS) are eligible for compliance in the WCI* shipping ETS, but not vice versa; • Unilateral linking where shipping credits or California* allowances are eligible for compliance in the IMO CDM another ETS, but not vice versa; (Global) • Bi-lateral linking where allowances are interchangeable between the two ETS and can be used for compliance in both markets. Voluntary (Global) The EU ETS is currently the largest carbon market in the world followed by the Clean Development Mechanism (CDM). Emerging regional markets and the growing voluntary market can also provide a source of carbon credits. Each market’s credits New Zealand exhibit a different price and therefore linking with them will exert different price pressures on the * The Western Climate Initiative (WCI) and California’s ETS are due to commence in 2012. shipping allowance or levy. 54
  • 55. Impacts 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 future The Clean Development Mechanism (CDM) is the second largest carbon market market-based measure directed at the shipping industry. Currently, for every and operates under the Kyoto Protocol. Its credits (CERs) are the most likely tonne of fuel consumed, approximately three tonnes of CO2 are emitted. source of offsets for the shipping sector and are currently used for compliance in the EU ETS, NZ ETS and under the Kyoto Protocol. The additional cost for these emissions will depend on the price per tonne of CO2. The EU Emissions Trading System (EU ETS) is the largest carbon market The policy options and various design features for a market-based measure for the in the world and is the key policy instrument to enable the EU to meet its shipping sector, including how it is linked to these existing carbon markets, will international GHG emissions reduction target. Historically, the price of EUA impact the price of carbon, the industry and the environment. (allowance traded in the EU ETS) has experienced some volatility in response to economic conditions and policy decisions. However, as the future cap on emissions tighten in the future, the overall price trend is expected to be upwards. Expected increase of the price of allowances in two key benchmark A tonne of fuel emits three tonnes CO2 carbon markets Figure 3.30 Carbon emission from shipping fuel Figure 3.31 Prices for EU EUA and CER (CDM) credits and allowances EU ETS I & II One tonne of fuel three tonnes of CO2* 60 $ tonne allowance 41% EU price 50 pressures 6,1% 40 Prices for CDM 30 projects expected to be lower 20 EUA CER 2005 2010 2015 2020 2025 2030 Sources: Bloomberg EUA Spot, IETA forecast; CER Based on 2011 CER-EUA Spread, linear *Actual relationship is between 3.09-3.17 varying with a.o fuel quality. We have assumed 3.13 extrapolation to 2030 of PointCarbon EUA forecast to 2020, PwC inflation forecasts throughout this study PwC 55
  • 56. Impacts Banking and borrowing across ETS phases smooths price fluctuations Banking and borrowing have been raised but not discussed in detail in the Impact on sector: proposals to the IMO. These features help to stabilise the price of an allowance, particularly across different phases of an ETS. 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 new Borrowing: If the price begins to rise because the available allowances are regulation, but also its ability to manage compliance costs over time. expected to be short of the cap in that period, then the ability to borrow for future allowances increases supply can prevent a price spike. Price will rise incrementally Banking and borrowing are therefore important policy design features that have over time as more allowances are borrowed (rather than sharp spikes). implications on a ship’s cash-flow management. Banking: Likewise, if the available allowances are expected to be in excess of the Impact on environmental outcome: cap set, a shipping company can bank allowances to use in the future. This reduces supply and avoids a sharp fall in price. This avoids the price of an allowance being The level of banking and borrowing is also important to ensure the credibility of a devalued substantially towards the end of an ETS phase. Similarly, if a shipping scheme. Overgenerous limits on banking and borrowing can undermine the company believes meeting the future cap is substantially more costly, it may choose environmental effectiveness of a scheme within a given timeframe. to smooth its exposure over time by reducing emissions or purchasing credits now and bank them for the next phase. A ban on banking can lead to instability and falling prices These attributes therefore reduce price volatility by making allowances interchangeable over different phases, rather than experiencing sharp fluctuations Figure 3.32: EUA price crash during Phase 1 in prices during transition from one phase to the next. EUR per allowance/tonne CO2 The EUA price crashed in April 2006 as it became apparent that there had been an 30 over-allocation of allowances in Phase I. These allowances were not allowed to be banked into Phase II and therefore their price trended towards zero during 2007 as the ‘use-by’ date made them virtually worthless towards the end of Phase I. 20 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 prices of Phase II allowances as they can be carried over. 10 - des.05 des.06 des.07 PwC 56
  • 57. Impacts Impact on cashflow The impacts on costs and profits ultimately feed through to cash and managing this Banking & borrowing is critical for the day-to-day running of any company. Design features of both a levy and an ETS will have impacts on cashflow. The ability to bank credits into the next phase of an ETS allows companies to spend now and save in the future, for example if they expect future credit to cost Phasing of a levy substantially more. Under the current levy proposal, the levy should overall track the price trends of a Conversely, borrowing allowances from the next phase allows companies to meet major carbon market. Within a levy phase, there is no price volatility as the price is current obligations. fixed, and cash outflows can be managed relatively easily. However if the levy is set too high or too low, or because carbon prices deviate substantially from initial The level of banking and borrowing between phases may therefore also affect how expectations, there may be a substantial revision required in the levy when moving shipping companies manage their compliance strategy. Shipping companies may into the next phase. choose to hedge against future carbon price increases by purchasing credits today and banking them, especially if they have adequate free cash flow. Conversely, For example, if the price set during Phase I was too low to purchase the requisite during periods of tight cash flows, a shipping company may choose to borrow from number of project credits, this may need to be compensated for in Phase II the next phase to meet existing obligations. resulting in an overnight spike in the levy. Conversely, a levy price (and subsequent cashflows) 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) Figure 3.34: Conceptual illustration of cash flow impacts Steady increase in Phase I levy too low so Phase II lower as external contribution higher in Phase II carbon price dropped PwC 57
  • 58. Impact on trade volumes The cost increase will be absorbed by different actors in the transport value chain. The shipping industry will experience a reduction in profitability as a result. There are additional impacts resulting from the increased freight rates and these are discussed in theSeaborne trade volumes following section.will decline compared to Modal shift is a particularly relevant scenario for the short-sea freightbusiness as usual segment where road transport is an option. We would expect these impacts in the densely populated regions of Asia, Europe and North-America. Some limited impact may also be observed on the Asia-Europe voyages due to the Regional road trans-siberian railway. transport Road transport will increase as a consequence of increased freight rates for increases shipping. Studies from Europe indicate a severe impact with fuel costs above $1000 per metric tonne. CO2 emissions per tonne transported are higher for road transport than for shipping and as such net emissions will increase. As freight rates increase, locally produced goods will become more competitive. The demand for international transport will decline as a consequence. This loss of volume will impact the deep-sea segment of the fleet which transports goods across oceans and between continents. Producers for export will also be Global seaborne impacted. trade volumes The dynamics are complex and depends upon the ratio of freight costs to the declines cost of the goods, as well as the elasticity of demand and capacity of domestic producers.PwC 58
  • 59. Impacts There would be a modal shift to road transport for the short short-sea segments Freight cost increases would also impact the choice of transport modes. For Trade volumes could remain broadly unchanged, but the sources of goods may regional transports, road and rail transports are competing against shipping. vary. Locally produced goods may become more competitive vis-a-vis faraway Potential for modal shift has been analyzed in a number of studies on the producers, but so will goods from neighboring countries. Technically these still impact of low-sulfur regulations concerning Europe. These studies are highly count as trade, so it is more about a shift from faraway producers to closer sources specific about routes and transport corridor options and impacts vary greatly (not just local). depending upon local factors. Currently shipping is the most carbon efficient mode of transport, and a shift Some general principles may be transferable to other regions around the world. towards road transport may increase the carbon footprint of the products and These are indicated in the figure below. undermines the environmental impact of a carbon regulation. It is also important to note that if it does happen it is likely to be from the impact However, over the longer run, this depends on the relative improvements in of rising fuel cost due to sulfur regulations rather than carbon cost. The latter carbon efficiency of land vs. sea transport as there are substantial incentives by has a smaller impact on the total cost increase as have been shown above in this many countries to promote low carbon land vehicles. study. Modal shift is likely to happen, mostly stemming form the Specific findings from Europe increase in fuel cost Figure 3.35: General findings regarding modal shift • Fuel cost increase would transfer through freight rates • Impacts at low fuel price scenario at $500 per metric • Rate increases would decrease competitiveness of sea ton could give average volume loss of 15 percent transport • Volume loss at fuel cost of $1300 per metric ton may • In some instances, sea transport would become reach 22 percent uncompetitive and new patterns of transport would • Severe impacts for particular routes (i.e english channel) emerge 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. Source: EMTS 2010 PwC 59
  • 60. Impacts Future trade routes will shift eastwards Rise of the emerging economies Expected future growth of trade and shipping The patterns of global trade have shifted noticeably over the last twenty years. In The global economic recovery from 2010 will be dominated by growth in the 1990 the developed economies dominated the trade map. Europe was responsible emerging economies, in particular from fast-growing Asian countries like for over half of the world’s exports, but these were mostly intra-European flows. China, India and Indonesia. The last twenty years saw global manufacturing shift swiftly to lower cost PwC report on the ‘Future of world trade: Top 25 sea and air freight routes in countries, which boasted cheap labour and good trade links with which to provide 2030 finds that the divergence in economic growth prospects between emerging Western markets with cheap consumer goods. By 2009 the emerging economies, and developed economies is expected to be mirrored in future trade patterns. and developing Asia in particular, had gained significant share of world’s exports. Trade routes between emerging economies and developed economies and Imports into developing countries are also growing. Robust industrial growth has between emerging economies and other emerging economies are expected to boosted the demand for raw materials, and the emergence of middle classes has become more significant over the next twenty years. led to increased demand for finished products and consumer goods, and more diversified and sophisticated food items. The impact of unilateral action for regulating shipping by i.e the EU may be less effective as a consequence. Economic recovery will be dominated by growth in the 2030 is expected to see increased trade between China and emerging economies developed countries Figure 3.36: Top 25 sea and air freight bilateral trade pairs in 2009 Figure 3.37: Top 25 sea and air freight bilateral trade pairs in 2030 Size of bilateral trade flow (2009 USD million) Under 50,000 50,001 -100,000 100,000 100,001 -200,000 200,000 200,001-350,000 350,000 Source: PwC Economic Views: Future of world trade 350,001 + PwC 60
  • 61. Impacts 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, the The distribution of trade cost of fuel, time at sea, competition among carriers, corruption and piracy. Our analysis shows that the increase in freight rates as a result of the imposition of Export-orientated economies or countries dependent on imports are likely to be carbon pricing represents a relatively small increase in total shipping transport most affected when the cost of trade increases. The market shares of different costs. producers may therefore vary as a result of increase in shipping costs. Increased shipping cost raise the cost of carrying out trade, which may have an Studies have found that impact on the levels and distribution of trade. • Developing and least developed countries whose trade in price-sensitive The overall level of trade goods often comprises a significant component of their export potential might suffer disproportionately from an increase in trading costs (WTO, 2003). The Trade in some products is particularly affected by changes in maritime transport OECD identified several countries, mostly remote nations with very small costs, where transport costs as a proportion of the total cost is relatively high. markets, face such high transport costs that they affect most exports significantly. Figure 3.38: The impact of maritime transport costs on the cost of production Average ad valorem maritime transport costs of exports for Guam (48%), Nauru (40%), Christmas Islands (34%), Togo (29%), Guinea (25%), Tonga (22%), Sierra Product Ad valorem (%) MTC ($/tonne) Leone (21 %) and Pitcairn (17%) were found to be substantially higher than the Agriculture 10.89 80.64 average for developing countries of 7 % (OECD, 2008). Raw materials 24.16 32.59 • Directional imbalance in trade between countries implies that many carriers Crude oil 4.03 18.09 are forced to haul empty containers on their return trips, resulting in cost Manufactures 5.11 173.94 imbalance in one-directional and return shipping (Fuchsluger, 2000) . For Source: Maritime Transport Costs Database, WIT, Korinek & Sourdin (2009) example, 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 lower Trade levels in raw materials and agricultural products are therefore most likely to shipping rates to Asia (ibid). As carbon cost rise, the impact on freight rates may be affected by an increase in transport costs. A doubling in the cost of shipping for not be linear across different shipping routes, with some routes experiencing a agricultural goods is found to be associated with a 42% drop in trade on average disproportionate increase in their shipping costs. (OECD, 2008). PwC 61
  • 62. Impacts 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 on Our analysis finds that the cost of a market-based measure, with the assumed selected products and product markets. compliance cost of $66 per tonne of fuel, is equivalent to a 5% increase in the cost of fuel by 2030. The likely market shares impacts will therefore be around half of Looking at iron ore market in China, the study finds that a 10% rise in the cost of those outlined in Figure 3.38. This translates in to an increase in the imported bunker fuels is found to increase the average freight rate to China by around $3 price of iron of 0.71%, or $0.79 per tonne of iron, with an approximately similar per tonne of metal (2.7% increase in the cost per tonne of metal) . Iron ore decrease in the quantity of iron imported. exporters into China will suffer a fall in market shares and margins, while domestic producers stand to gain. Larger and closer producers (e.g. Australia) Figure 3.40: The impact of carbon costs on Chinese price of imported iron appear to be less affected while producers further away (e.g. Brazil) and smaller producers (e.g. India) tend to be affected more. Average added cost for Cost pass-through for sea Change in price of Change in price of sea importers ($ per tonneFigure 3.39: The change in market shares and profitability of iron ore exporters to of metal) importers (%) imported iron (per tonne) imported iron (%)China as result of a 10% increase in the cost of bunker fuel 1.53 51.7 0.79 0.71 Original market share in Change in margin ($ per Producer Change in market share China tonne of metal) Source: Vivid Economics (2009), PwC analysis. Australia 29.4% -0.90% -0.9 Assumes similar proportionate demand reaction between a 5% and 10% increase in fuel price. 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 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 and market 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 of a tonne of metal increases by 2.7% when bunker fuel costs rise by 10%. PwC 62
  • 63. Forbruket øker og henger nært sammen med øktAnnexvekst og velstandPwC
  • 64. Annex: Methodology Introduction These appendices relate to the PwC report “A game changer for the shipping industry: an analysis of the future impact of carb regulations on environment and carbon industry”. All results in this report are produced by the PwC GHG Shipping Model (hereafter “the model”). The timescale considered by th model is 2010 – 2030 with particular the focus on the time period from 2015, from when the IMO regulations are assumed to be in place. The model is supported by carbo price forecasts and based on a variety carbon of public data sources (see list of sources). The model follows a dual approach to estimate the impact of GHG regulations on the shipping sector: 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 direct modelling linkage: the cost of compliance per tonne of fuel consumed. This allows the total cost to industry, as well as the cost for individual market segments, to be calculated. These market segments are (along with the average sample size): Cost of compliance • Capesize Bulker (148,000 dwt) Industry-level Cost of Ship-level • Handysize Bulker (30,000 dwt) analysis compliance • Handysize Product Tanker (43,500 dwt) analysis • VLCC (304,000 dwt) • Container Main Liner (3,500 TEU) The scope of each part of the model component is presented below: PwC GHG Shipping Model Component Top-down Bottom-up Emissions / Abatement   Cost impact (USD)   Different allocation scenarios   Linkage with CER Market   Top-down Bottom-up Cost impact relative to other costs  Profit impact  An integrated overview of the model is presented overleaf. PwC 64 64
  • 65. Annex: Methodology Model overview BAU Emissions Core policy Size of emissions decisions target or cap ETS or levy Linkage to another Global price for carbon market CERs Allocation method Mechanism Levy ETS design policy options Abatement Costs Cost of carbon Capex Outcomes Industry freight Cost to industry rates Opex Key Profit impact on Core policy Design decisions options industry Fuel Costs Key inputs Outcomes PwC 65
  • 66. Annex: Methodology Overview The model overview shows that the modelling process is split into three Mechanism design options interacting modules, running across the industry-level and ship-level components of the model. Allocation method : The allocation method (free allowances versus auctioned allowances) does not affect the market price of carbon, since demand and supply • Core policy options for carbon remains unaffected. However, it does affect the cost to industry of the legislation, per tonne of fuel, and to a significant degree. We therefore consider • Mechanism design policy options both 100% free allocation and 100% auctioned alllowances as the two extreme cases, as well as one intermediate scenario (where the auction percentage was • Outcomes assumed to be 15% until 2020, 20%-2025; and 25% thereafter). 100% free allocation of allowances will deliver the same cost impact as a levy. The broad methodology and options considered for each factor within these modules is provided below. Afterwards, furter details on assumptions are given. Core policy decisions Industry freight Cost to industry rates Emissions target / cap : The total quantity of allowed emissions (“ the cap”) was set equal to the IMO 2010 expert group base case recommendation – this is equal to 90% of 2007 emissions (783 Mt CO2) Profit impact on industry ETS or levy : Throughout the main document, results for a levy are presented, Outcomes which are identical to the impacts of an ETS with 100% free allowances. In the sensitivity analysis, the auctioning assumption is relaxed and results considered. We have considered in our quantitative analysis two primary impacts of the proposed carbon pricing regulations on the shipping industry : Linkage to another carbon market : We assumed: 1) Cost base. The application of a carbon levy or introduction of a carbon ETS i. That under a levy, the funds raised will be used to purchase CER allowances. raises costs. These costs largely raise proportionately with fuel consumption. Our analysis considers the likely financial cost impact of regulatory scenarios ii. That under an ETS there is linkage with the CDM market, so shipping on both the whole industry, and individual market segments. companies can and will purchase CDM credits to meet their compliance obligations. 2) Profitability: The extent to which this cost affects industry profitability depends on whether shipowners can pass-though the cost impact to other parts of the value chain. Our analysis combines the cost impacts with information on the ability to pass-through costs for different market segments to estimate the likely profit impact on individual market segments. PwC 66
  • 67. Annex: Methodology Cost Modelling Assumptions This section provides details on our data sources and parameter choices. Operating costs Emissions Operating costs (opex) figures from 2009 are taken directly from Moore Stephens LLP OpCost 2010 for each ship type. These include crew, stores, repairs and BAU Emissions maintenance, insurance, administration, and drydocking costs. Emissions were modelled as a fixed by-product of fuel consumption, using a Capital costs carbon 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 outlined Capital costs (capex) estimates are taken from CE Delft (2010) which estimates in IMO 2009, following the growth assumptions outlined in Figure A.1. annual capital costs based on average purchase price by ship type (1992-2007), assuming a 25-year useful economic life and 9% rate of interest. Abatement Fuel Cost 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- We have assumed that following the onset of low-sulfur regulations (MARPOL VI of-sector abatement. This implies that abatement costs are always higher than annex), there will be a gradual phasing in of the low-sulfur fuels starting at 20 permit prices from other global ETSs (see discussion on slide 18). This contrasts percent in 2010, reaching 80 percent in 2020, and 96 percent in 2030. The with the IMO Expert group (2010) assumptions, which included a small degree of forecast for future fuel prices are based upon the US Department of Energy in-sector abatement. We have also included analysis of a scenario with an Review (2010). The price of low-sulfur fuel is 60 percent more expensive than abatement impact, but only at industry level given differing ship abatement bunker fuel (from AEO forecast), and 80 per cent more by 2030. The increase potentials. stems from the expected demand pressure and limited supply capacity in the markets. These assumptions are in line with the IMO (2010) study. There is much Costs uncertainty about future oil costs, and the difference between HFO and MGO have not been consistent in the past. A significant price increase on top-of-bunker fuel Costs are of four types: capital costs, operating costs, fuel costs and carbon costs. costs is however very probable. Our forecast is illustrated in Figure A.3 overleaf. 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 Comments 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 + impact 26% improvement from 2010 to 2030 implies annual rate of EEDI (Our assumed basecase is 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 Model PwC 67
  • 68. Annex: Methodology Further Assumptions Carbon prices Given the international nature of shipping, and the proposed role of the CDM market in meeting the shipping industry’s enviro environmental targets, our carbon price forecasts are based on CER allowance prices. In the absence of other public forecasts for CER prices, PwC created a price sce scenario for the EUA price then used the historical spread to translate this into a CER forecast. Specifically, we use the Point Carbon 2011-2020 projection (May 2011) of EUA prices over 2012 2020 2012-2020 and extrapolate to 2030. This seems broadly in line with market expectations 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 the trend in the carbon markets is increasing CER EUA-CER spreads. Figure A.4 illustrates our forecast. Cost of compliance / cost to industry The market price of carbon feeds directly into the cost of compliance for shipowners. Under the assumption that abatement cos are higher than the CER price, the sole costs determinants of the cost of compliance are the market price of carbon, the global climate fund contribution rate, and the all allocation method. The fund contribution rate is assumed to be a 10% mark-up on top of the levy, or ETS auction proceeds and allowance sales, as proposed by the IMO. up Under 100% auctioning of allowances, the cost of compliance is equal to the market price of carbon (per tonne of CO2), and un 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 compliance will 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 2025; 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). ETS (100% auction) $152 Forecast $ per ton fuel (2010$) Forecast $ per CER (2010$) 1320 44 ETS (15%auction) $87 600 20 ETS (0% auction) $66 0 0 2010 2020 2030 2010 2020 2030 Levy $66 Figure A.2 Figure A.3 Figure A.4 PwC 68
  • 69. Annex: Methodology Profit modelling To establish the impact of increased costs on segment profitability we have used data on pass pass-through ability, and make assumptions on freight rates. Figure A.5 below provides in detail the calculation process and assumptions made, given a 25% mark-up of freight rates on the cost base. The elas up elasticities of freight rates with respect to fuel costs are drawn from Vivid Economics (2010). Figure A.5: Daily profitability impact in 2030 on different ship types (assuming 25% mark mark-up) Handysize Product Ship Type Capesize Bulker Handysize Bulker VLCC Container Main Liner Tanker Daily cost of fuel, US$ 59,365 21,767 31,661 89,047 133,571 Capex and opex, US$ 25,163 13,490 20,502 42,280 22,417 Total cost base, US$ 84,528 35,257 52,163 131,327 155,988 Fuel price, forecast US$ 1,321 1,321 1,321 1,321 1,321 Daily fuel consumption, tonnes 45 16 24 67 101 Cost of carbon (per tonne of fuel), US$ 66 66 66 66 66 Daily cost of carbon, US$ 2,947 1,081 1,572 4,421 6,631 Elasticity of freight rates relative to fuel cost 0.98 0.26 0.30 0.30 0.20 Estimated daily freight rate, (implied by mark-up) 105,660 44,071 65,204 164,159 194,985 Change in freight rates due to impact of carbon 5141 569 971 2445 1936 cost, based on elasticity estimates Change in profits per day US$ 2,193 -512 512 -601 -1,976 -4,695 New mark-up after pass-through of costs 27% 23% 23% 23% 21% Source: PwC GHG Shipping model 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 mark- up)). This is a gross simplification of how the sector’s freight rates and profits are determined, and is intended to illustrate potential impacts only. PwC 69
  • 70. Annex: Methodology Profit mark-up sensitivity Holding the carbon price and all other factors equal, Figure A.8 below provides the impact of assuming the mark mark-up of profits on costs is 10% rather than 25%. The large share of fuel costs in the cost base and the high elasticity of freight rates with respect to fuel costs shows that pro profits can increase for capesize bulker with the increased carbon costs. Figure A.6: Daily profitability impact in 2030 on different ship types (assuming 10% mark mark-up) Handysize Product Ship Type Capesize Bulker Handysize Bulker VLCC Container Main Liner Tanker Daily cost of fuel, US$ 59,365 21,767 31,661 89,047 133,571 Capex and opex, US$ 25,163 13,490 20,502 42,280 22,417 Total cost base, US$ 84,528 35,257 52,163 131,327 155,988 Fuel price, forecast US$ 1,321 1,321 1,321 1,321 1,321 Daily fuel consumption, tonnes 45 16 24 67 101 Cost of carbon (per tonne of fuel), US$ 66 66 66 66 66 Daily cost of carbon, US$ 2,947 1,081 1,572 4,421 6,631 Elasticity of freight rates relative to fuel cost 0.98 0.26 0.30 0.30 0.20 Estimated daily freight rate, (implied by mark-up) 92,981 38,782 57,380 144,460 171,587 Change in freight rates due to impact of carbon 4524 501 855 2152 1704 cost, based on elasticity estimates Change in profits per day US$ 1,577 -580 580 -717 -2,269 -4,927 New mark-up after pass-through of costs 11% 8% 8% 8% 7% Source: PwC GHG Shipping model 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 mark- up)). This is a gross simplification of how the sector’s freight rates and profits are determined, and is intended to illustrate potential impacts only. PwC 70
  • 71. Annex Sources Carbon positive “Creating a voluntary Greenhouse gas trading experiment is good for the shipping industry and is 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 from international 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 Environmental Protection Agency (US) 2008 by RTI InternationalResearch Triangle Park, NC. Global Trade and 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 of 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 third ICAO Colloquium on Aviation and Climate Change” May 2010 International Maritime Organization Marine environment protection committee “Second IMO GHG Study 2009, 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 GHG EMISSIONS FROM SHIPS : Full report of the work undertaken by the Expert Group on Feasibility Study and Impact Assessment of possible Market Market-based Measures” August 2010 PwC 71
  • 72. Annex Sources International Maritime Organization Marine environment protection committee 61/INF.18 Marginal abatement costs and cost-effectiveness of energy effectiveness energy-efficiency measures. Submitted by the Institute of Marine Engineering, Science and Technology ((IMarEST) Korinek and Sourdin “Maritime transport costs and their impact on trade” August 2009 Organisation for Economic Co Co-operation and Development “Policy instruments to limit negative environmental impacts from increased international transport” November 2008 Organisation for Economic Co Co-operation and Development Directorate for science, technology and industry, Maritime transport committee “The role of changing transport costs and technology in industrial relocation” May 2005 Point Carbon “European Emissions Prices: A forecast – Where are prices going and why?” The Energy Lectures European May 2011 PwC “Future of world trade: Top 25 sea and air freight routes in 2030” March 2011 Future PwC and the International Emissions Trading Association “IETA’s sixth GHG Market Sentiment Survey” June 2011 Seas at Risk “Going slow to Reduce Emissions” January 2010 United Nations Conference on Trade and Development “Review of Maritime Transport” 2010 (+1995 (+1995-2009 reports) US Department of Energy “Annual Energy Outlook” 2011 Vivid Economics “Assessment of the economic impact of market market-based measures” August 2010 World Bank “Cities and climate change : An urgent agenda December 2010 Cities agenda” Also reference datasets from IMF WEO, Bloomberg and World Bank WDI. PwC 72
  • 73. Annex Glossary BAU Business as usual. EU ETS and EUA The European Emissions Trading Scheme, on which European Union Allowances are traded. BAU abatement The growth rate for seaborne transport minus expected growth rate of emissions, assuming efficiency gains. See also “reference case emissions”. Fuel costs Fuel consumed multiplied by the expected unit cost of fuel. At industry level this is expressed in yearly terms, and at ship level in daily terms. Capital expenditures The cost of purchasing and financing a ship (in this study). Fuel price The weighted average forecast price of bunker and distillate fuel (see methodology section). CDM and CER The UN Clean Development Mechanism which issues emissions allowances (Certified Emission Reductions) to certified abatement projects. In-sector abatement Carbon reductions that take place within the shipping sector. Compliance cost See cost to industry. MBM Market-based measures Contributions to global climate fund Contributions to an international fund, which may be established to provide financing for carbon abatement or impact MBM abatement. This refers to the carbon reductions resulting from adaptation purposes. implementation of the market-based measures (levy or an ETS) Abatement may occur out-of-sector or in-sector. Cost to industry The costs stemming from compliance with the regulations. The costs are defined as the sum of MBM abatement times by the carbon price, and Net emissions This is used to describe emissions generated by international any other sources of revenue such as ETS auction revenues and contributions to a shipping minus those emissions offset through carbon reduction projects global climate fund. These are the direct costs from compliance, i.e. paying the undertaken outside of the international maritime sector. levy or procuring the emissions certificate, and do not include any additional administrative burden. Operating costs The recurring expenses related to the operation of a ship (see methodology section). Costs per ton of carbon abated The total compliance cost divided by the MBM abatement. Out-of sector abatement Carbon reductions take place outside of the shipping sector, funded from the proceeds of a shipping carbon scheme. EEDI Energy Efficiency Design Index. Reference case emissions The scale of carbon emissions in the absence of EEDI abatement The emissions reductions stemming from the implementation regulations or any efficiency measures. of a mandatory Energy Efficiency Design Index. It is calculated as the growth rate for business as usual growth minus expected growth rate of emissions assuming Target emissions/Cap The objective for net emissions from the shipping sector. implementation of EEDI. The target is expected to be set by an appropriate international body such as the UNFCCC or IMO. ETS Emissions Trading Scheme. ETS auction costs The number of auctioned certificates for emissions below the target line multiplied by the carbon price (both in tC). PwC 73
  • 74. www.pwc.com

×