Pass-through fees could disincentivize carriers from decarbonizing: shippers

Shippers are warning that their willingness to share the cost of decarbonizing maritime supply chains — estimated at more than $1 trillion — could disincentivize carriers from making the necessary changes to reduce carbon emissions.

Container lines have been clear that they will pass decarbonization costs on to customers, and shippers generally accept that they bear some responsibility for so-called Scope 3 emissions, but they harbor a deep mistrust of carriers when it comes to calculating and recovering those costs.

"Given past behavior — think low-sulfur fuel — shippers are fully expecting any increases in fuel costs to just be passed on as the 'mother of all BAFs' (bunker adjustment factors)," James Hookham, director of the Global Shippers Forum (GSF), told the Journal of Commerce. "This will just neuter the financial incentive on lines to change fuels, with the result that many shipping lines will carry on burning highly taxed conventional fuels at their customers' expense, just as we were expected to pay low-sulfur surcharges for ships using marine oil with a scrubber fitted."

Sea-Intelligence Maritime Analysis has estimated the cost of container shipping's compliance with the International Maritime Organization's 2020 low-sulfur fuel regulation was around $27 billion, proof of the industry's ability to absorb massive cost increases.

According to the International Energy Agency, however, the transition from fossil fuels to renewable energy sources will require an investment of $4 trillion by 2030 to put the world on track for net-zero emissions by 2050, three times what is being invested today. Tufton Investment Management put the cost of decarbonizing the shipping industry at more than $1 trillion, a price that will require both public and private investment with a solid regulatory framework.
Hookham said shippers will be keeping a close eye on pass-through charges, particularly if carriers take the same approach to recouping the cost of reducing emissions as they did with the IMO 2020 rules, applying charges via opaque BAFs, rather than assessing a separate, more transparent fee.

"Shippers will expect to know what they are paying for, over what time periods, and the paybacks they offer for their own carbon accounting," he said. "But the route map to net zero for shipping is still far from clear: which fuels, which propulsion technologies, which trade lanes? None of these have yet been answered."

Peter Sand, chief analyst at rate benchmarking platform Xeneta, said shippers' approaches to sustainability range widely, from wanting carriers to deliver a greener service with no added costs or surcharges, to wanting to pay more for a green option, such as buying sustainable fuel, a popular offering from forwarders and carriers. He added that there may be limits to what shippers can — or will — pay for decarbonization, particularly after more than two years of pandemic-induced disruption and record-high spot rates.

"But if you are willing to pay $6,000 or $18,000 per FEU during a supply chain crisis, you may also be willing to pay something for sustainability issues," he told the Journal of Commerce. "Whether that willingness to pay a premium amounts to a few bucks or hundreds of dollars on a global industry wide average is hard to say."

A survey by Boston Consulting Group released in mid-December found shippers were willing to pay an average premium of 3 percent for zero-carbon shipping — compared with less than 2 percent in 2021 — that would generate $10 billion to $20 billion in extra revenue for the shipping sector. This was far below the 10 to 15 percent premium needed to reach net-zero shipping targets by 2050, but the survey found 65 percent of shipping customers were willing to pay an even greater premium in the future.

Devil in the details

Tackling the decarbonization of maritime transport is as urgent as it is complex. Shipping's annual greenhouse gas (GHG) emissions increased by 9.6 percent in 2018 compared with 2012, and there are no indications that maritime shipping's emissions have peaked. According to the IMO, absent immediate action from the industry, carbon dioxide (CO2) emissions from shipping could rise as much as 50 percent by 2050.

Carriers regard pricing instruments as the most effective way to raise revenue to fund the industry decarbonization. The European Union, for example, included shipping in its Emissions Trading System (ETS) from Jan. 1, 2023. Sea-Intelligence believes the annual cost of shipping's compliance with the EU ETS could exceed $10 billion a year.

"The shipping industry seems utterly focussed on raising yet more money from its customers to fund this up front through carbon levies and other market-based measures," Hookham said, adding that this would not play well with shippers after watching carriers report record profits of almost half-a-trillion dollars over the past three years.

According to a December report from the International Transport Forum (ITF), an intergovernmental organization within the Organization for Economic Co-operation and Development (OECD), there were 68 carbon pricing schemes in operation worldwide in 2022, covering about 23 percent of global GHG emissions and split between explicit carbon taxes and emissions-trading schemes. Last year, those 68 schemes brought in revenues of about $84 billion, according to the ITF report.

However, Olaf Merk, who leads ports and shipping research at the ITF, cautioned that carbon pricing should not become simply another surcharge to be passed on to customers without real change in the behavior of shipping companies.

"That is why choosing the right design of the scheme is important," Merk told the Journal of Commerce in a recent interview. "We would favor a 'feebate' system in which the price gap between conventional fuels and zero-emission fuels is fully bridged to stimulate the uptake of zero-emission fuels and energy sources."

Under a "feebate" system, all ships emitting greenhouse gas emissions pay a levy that is used to subsidise zero-emission fuels and energy sources. Ships operating with zero emissions receive a rebate that covers the price difference between conventional fuels and zero-emission fuels or energy sources, with the rebate funded by increased levies for vessels that still burn fossil fuels.
"In addition, we think it is important that competition authorities build up their expertise on decarbonization of shipping, to make sure that they have the tools to assess future decarbonization surcharges," Merk added.

'Unspecified' solutions

Hookham said that although shippers are generally resigned to the inevitability of decarbonization-driven increases in freight rates, they want to see carriers step up their investment in low- and zero-emissions vessels, fuel, and related infrastructure before they start paying those higher prices.
"They will expect [carrier] shareholders to invest first and recover their investment over the lifetime of the assets, rather than get their customers to fund the green transition on a pay-as-you-go-basis," he said.

The shipping industry uses more than 300 million metric tons of fossil fuels every year, about 5 percent of global oil production, and there is still no clear pathway toward replacing that volume with renewable fuels. There is also no regulatory structure underpinning the development and production of zero-carbon fuels.

With no idea what fuels will be used by shipping, what the price per TEU will be, and when adequate supplies of those fuels will be available, Hookham said any surcharge would be based on vague and ill-defined costs.

"The prospect is for a surcharge being imposed to fund a so far unspecified solution, over an unspecified time period, with unspecified outcomes," he said. "This needs to be tackled on a route-by-route basis, and the green corridor approach seems to be the way to go — immediate start, limited risk exposure, able to attract supportive shippers to engage in real world trials, with open book accounting and sharing of lessons learned, all with government patronage at either end.

"We didn't electrify the railways overnight so expecting to transform the shipping industry everywhere at once is unrealistic," Hookham said.
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This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.