By aligning incentives between shiponwers and charterters, profitable energy-saving measures will be taken to reduce CO2 emissions.
Estimates show that existing technologies and operational measures could reduce CO2 emissions from shipping by 300 million metric tonnes (mmt) by 2030 with negative cost (Figure 1). The single biggest barrier to realizing the opportunity of reducing CO2 emissions cost effectively is the financial incentive structure that does not reward investments in energy efficiency technologies. In the shipping industry, the ship owner controls capital spending including energy related investments, while the charterer bears the fuel costs. The EcoShip fund (EcoShip) will break the split incentives by offering financial incentives to both owners and charterers, providing a market-level return and substantial environmental benefits. EcoShip will work with both the ship owner and the charterer when the owner leases a ship to the charterer.
Category of the action
Building efficiency: Physical Action
What actions do you propose?
EcoShip will work with the private equity and impact investing industry to make investment that benefits both the environment and the bottom line of investors. EcoShip finances shipowners to retrofit technologies on ships. As an incentive, EcoShip provides owners with a cash flow that guarantees them with a 12% annual return. In exchange, EcoShip has the exclusive right on returns of the retrofit technology on the owner’s ship. To entice charterers into the game, EcoShip agrees to split cash flows with them. The cash flow, generated through projected fuel savings, is calculated based on annual fuel consumption of a ship (as documented on the bunker delivery note of the ship or BDN) and the expected efficiency gains of the retrofitted technology. An independent third party verifies the BDN and approves the annual fuel savings. The structure of EcoShip is characterized in Figure 2.
Figure 2: Structure of the EcoShip Fund
As an example, I calculated the free cash flow (FCF) and the Internal Rate of Return (IRR) of applying the water flow optimization technology to a 150,000 deadweight bulk carrier. The annual fuel consumption of a bulk carrier of that size was obtained from the International Maritime Organization’s 2nd GHG report (source, in pdf); the cost and efficiency improvement potential came from one of my prior analyses (source, in pdf). The fuel cost is $700 per ton, which is quite conservative, even more so after 2015 when the industry will gradually shift to marine fuels with substantially lower sulfur (source). The EcoShip is assumed to take 75% of the free cash flow while the charterers receives the rest.
Figure 3 illustrates the cash outlay and inflows. EcoShip yields about 30% IRR, along with a saving of more than 10 thousand tons of CO2 in nine years. A scenario analysis, with different fuel cost forecasts and split ratios between EcoShip and charterers, is assessed to estimate the sensitivity of the fund return to these two key variables. The result is convincing, as a 20% IRR seems to be a floor of the annual return, shown in Figure 4.
Figure 3: Free cash flow analysis
Figure 4: Sensitivity analysis
There are quite a few risks involved. The shipping industry is dramatized by the frequent boom and bust. The Great Recession, coinciding with a record new delivery ordered when international trade were booming, nearly sank the entire industry. Some sectors of the business, such as containerships, has yet recovered to its pre-recession level. Yet, the suppressed new ship prices and the warming world economy seems to sketch a rosier industry prospect. With more mandatory regulations kicking in to improve the energy efficiency of shipping and demand cleaner but pricier fuels used by ships, a business model built on saving fuels and reducing CO2 emissions will become more viable.
Who will take these actions?
Where will these actions be taken?
First domestically (US), then quickly scale up to the international arena
How much will emissions be reduced or sequestered vs. business as usual levels?
Approximately 150 mmt of CO2 emissions, or 70% of CO2 emissions from fossil fuel consumption in Germany, could be reduced by 2020 if the split incentive structure inhibiting investment in energy efficiency technologies is addressed through this scalable solution.
What are other key benefits?
About 2.6 mmt of SOx emissions, equivalent to 27% of SOx emissions from the U.S. power generations, could be reduced as well.
What are the proposal’s costs?
Overcoming the current incentive structure that prevents investment in energy-efficiency would lead to $5 billion of fuel savings for ship owners and charterers by 2020.
The term of this fund will be 10 years.
The International Maritime Organization, (2009), The Second GHG Report
The International Council on Clean Transportation (2011), Reducing GHG from Ships
The International Council on Clean Transportation (2011), The Energy Efficiency Design Index from new Ships
Carbon War Room and University of College London (2014), Financial Models fro Shipping Retrofits
Society of Naval Architects and Marine Engineers (2010), The Marginal Abatement Costs and Cost-effectiveness of Energy-efficiency Measures