Navigating a new era of shipping environmental regulations

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Nikolaos Aidinis Antonopoulos:

Hello and welcome to the Platts Commodities Focus podcast by S&P Global Commodity Insights, where today we'll be talking about the freight markets, environmental regulations, and alternative fuels.

My name is Nikolaos Aidinis Antonopoulos from the Platts freight price assessment team here in London. With us today we have Mr. Peter Norfolk, our global director for shipping and freight markets, Mr. Fotios Katsoulas, our director of tanker freight and alternative fuels analytics, Miss Rowan Staden-Coats, the manager of the residual fuels pricing team, and Miss Marina Ledakis, our London-based freight price reporter.

As we set sail into today's discussion, let's take a moment to reflect on what has truly been a transformative year for the maritime industry. We witnessed significant shifts in environmental regulations that are reshaping the shipping landscape, especially in the west of Suez region. The expansion of the European Union's emissions trading system to include commercial shipping has made waves in the freight markets compelling vessels discharging in and or loading from European Union ports to offset an increasing percentage of their emissions.

Additionally, the industry has been gearing up for the upcoming fuel regulations, which promise to redefine our approach to sustainable shipping. And the horizon isn't just limited to the regulatory powerhouses of the European Union. We're on the brink of a new emissions control area in the Mediterranean, poised to revolutionize the marine fuel dynamics in the region. So grab your life jackets as we dive into these pivotal changes and explore what they mean for the future of the global shipping and freight markets.

Rowan, how has the gradual introduction of environmental regulations affected the supply and demand dynamics within the fuel markets in the recent months and what trends are you seeing?

 

Rowan Staden-Coats:

So, at the moment, we're in a period where the EU ETS has been extended to shipping for the last nearly 12 months now from the 1st of January 2024. But actually this regulation so far hasn't had a massive impact on the fuels that people are consuming. Because at present they can still offset their carbon emissions quite comfortably under the ETS trading system. So in 2024, that's been the preferred option rather than actually changing their emissions profile.

But with FuelEU Maritime coming in on January 1st things are looking like they're going to start changing, as the FuelEU Maritime regulation actually has limits on the GHG emissions intensity that you are allowed to emit rather than just being able to pay for emission allowances under the ETS. Coupled together, we are now starting to expect a much bigger impact on the change of the profile of the fuels that people are using.

From January 1st, people have to use lower GHG intensity fuels in EU waters in order to comply with the regulation. From January it's going to be 2% of emissions reduction based on a 2020 emissions baseline. In the immediate term, people are starting to look a lot more at biofuels as they're very easy drop-in fuels and they don't require any modifications to existing engines for heavy fuel oils or marine diesels, marine gas oils. But as those intensity targets increase over the years, which is planned under the regulation, people are going to have to start looking at more advanced green fuels in order to meet the requirements. At the same time, you have to surrender more carbon offsets under the ETS as the percentage increases and the number of emissions allowances in the ETS system decreases. Coupled together, that's when we're going to start seeing a major change. But so far everybody has continued really to use a similar profile of fuels as they have historically.

 

Nikolaos Aidinis Antonopoulos:

Very clear. Thanks a lot, Rowan. Marina, can you share your thoughts on how the EU ETS has reshaped the freight market this year? What have been the most significant changes that you've observed?

 

Marina Ledakis:

    Thank you, Nikos. The most important distinction we have to make is between dry freight and tanker markets. The dry freight specifically west of Suez is typically priced on a time charter basis, which simplifies the transactions. So the price is based on dollar per metric tons and any costs related to chartering a vessel are added to the charterers account, including EU ETS.

On the opposite side, when it comes to the tanker market that has been filled with significant disruptions, because of the nature of how ships are booked, so the transactions that occurred on a lump sum basis were adjusted more quickly than the ones generated on a base rate system. The prices of the base rates and the flat rates increased because of the carbon prices, but they were actually built for ships and not carbons. And the initial concept was for ship operators and charters to not exchange monetary values but allow charters to exchange EUAs. But this was challenging, especially for the small and medium-sized operators who struggled to secure these accounts of holding EUAs.

So this resulted to a quick fix for the industry to receive a lump sum payment on top of the shipping cost to cover those EUAs. And this disruption was also visible not only to the physical markets but to the FFA markets as well. We saw that many liquid benchmark that we were produced by Platts were at crossroads. So a response to that was to adapt and include both carbon accounted and exclusive rates to support the open interest on FFA contracts, which people engaged before the EU ETS was included in shipping.

Now from 2025, we plan to include carbon inclusive prices while at the same time launching two carbon exclusive metric ton contracts for UKC-UKC and UKC-US Gulf Coast for AFRAMAX. Finally, we expect that these regulations will have a bullish impact on both markets as they will incentivize the scrapping of the vessels that cannot compete with the ones that have lower carbon footprint. We also are not sure about the effect that the exports and imports from the EU will be, and this may lead to the further impact of cargo availability.

 

Nikolaos Aidinis Antonopoulos:

Thank you, Marina. Peter, in your view, what role do you think the regulatory landscape plays in shaping shipping and freight market fundamentals? Are there any unexpected challenges or opportunities that have arisen to do these regulations?

 

Peter Norfolk:

     Yeah, thanks Nikos. That's a great question. The regulations that impact maritime freight are extremely significant in shaping the way that markets evolve. And we saw that with IMO2020 for example, and now with the EU ETS and the forthcoming new legislation in 2025 that Rowan referred to. Regulations like this really do shape ship owner and ship operator behavior.

If you look at the evolution of the fleets over recent years in the order book, obviously we're looking at alternative fuels, we're looking at different engine types, we're looking at things like rotor sails being fitted to deep sea ships, so almost a reversal if you like, to wind power, which used to be the thing centuries ago. But it's always very challenging from a ship owner perspective anyway, to make an investment in what is an asset that can last you for 20, 25 years depending on your strategy of fleet ownership.

And freight spot markets are notoriously volatile. It is probably the most volatile commodity actually, freight, on a day-to-day basis. So to make these kind of long-term decisions around significant investments when you have disruption coming from regulations is extremely challenging for investors to handle. And I would say if we look at what's happened this year, you mentioned anything unexpected, and Marina really touched on it, is the way the different sectors have embraced this change with the EU ETS, and in particular on the tanker freight, towards the end of 2023, everyone didn't really know how they would account for the new costs associated with the EU ETS, but very quickly fixtures became largely all-inclusive of the carbon charge. And all of a sudden from a price reporting agency perspective, we were challenged with addressing that and reflecting that in our spot assessments.

As you know, we've done a huge amount of work over the last few months, and Marina touched on it as well, around evolving our assessments to reflect what's going on in the market. Shipping always reacts well and always very quickly actually to new unexpected challenges, but this is clearly a story that is really only just starting in many ways.

 

Nikolaos Aidinis Antonopoulos:

Thanks a lot, Peter. Foti, considering what Marina and Peter just mentioned, what medium-term impacts do you foresee from these regulations? Do you think we haven't yet seen the full impact as markets continue to evolve?

 

Fotios Katsoulas:

There is no doubt that [inaudible 00:09:06] regulation will proceed by getting implemented over the coming years. We say different targets to be met by 2030 and onwards. It's becoming very clear that we will see much more effort from the [inaudible 00:09:20] operators and other players in the market, including the services provided by sea brokers or consultants say towards that direction, so that we will see much more happening over the coming years.

As both Marina and Peter mentioned, this has been a very complicated market with totally different fundamentals and mechanisms based on the different vessel types and, of course, based on the regions covered. And as we will see over the coming years, there would be much more steps to be taken. We have to consider that our estimates currently suggest that alternative fuels will cover something like 8% of the global demand by 2030, so a significant but still a rather small portion of the global market.

And then by 2050 it's going to dominate the market by representing more than 57% of the global market of the global demand. We have to consider that some of the steps have to be taken very slowly due to the fact that we have a huge amount of the fleet being recently delivered over the past years. But at the same time we have facing some very significant steps towards this direction.

To give you an idea, over the past year we have seen significant changes in the order book of sectors like tankers, which they used to represent around 4% of the global capacity, something like 16 months ago let's say, and now it represents around 12%. Obviously, within a very short time we might see significant changes. We have to consider that some of the orders recently placed, they still referred to conventional bankers and of course a big portion refers to dual-fuel vessels, so LNG as well. But it's very clear that the regulation motivates decisions for investment in different alternative fuels with methanol [inaudible 00:11:15] to dominate the options by 2030 and from then onwards say ammonium and hydrogen to be taking a big portion of the market as well.

At the same time, we expect that some other regions might come and say follow the example of the European market. So there should be more regulation over the coming years that are going to affect the decisions to be taken and of course save the market.

 

Rowan Staden-Coats:

If I could just jump in there. Fotios's point about the different regions I think is a really important one to consider also for how the freight markets are adapting and where people are actually positioning their vessels, because Europe is one of the leading regions alongside Singapore in putting in these environmental regulations on shipping. And if you are a shipowner with a global fleet, when it comes to deadlines that mean certain vessels might be required to use more green fuels, such as bio-LNG or potentially methanol, you might need to consider repositioning the vessels within your fleet between the different regions because the global landscape is not equal and each region is looking at different types of regulations. So I think what Fotios just mentioned about the different regions, not only the different vessel classes but the different regions as well, is having an impact on what people might choose to do with their particular vessels.

 

Fotios Katsoulas:

And adding to that, we have to consider that the situation we face [inaudible 00:12:42] as a whole industry, so the volatility that we see in the market, which is related to other parameters like geopolitics, as we have seen during the current year, plays a very important role that might affect the normal operations of the industry, pushing the flows into different paths, different routes as it has been happening this year with vessels avoiding the Red Sea and traveling via the Cape of Good Hope, which obviously has an impact in terms of planning for the bunkering industry and everything that the ship operators had in mind in terms of where they would find the supplies required to cover their operations.

 

Nikolaos Aidinis Antonopoulos:

Thank you, Rowan and Fotios. These are some very interesting points you were making. And I'd like to get a little bit more clarity around those topics, especially in the sense that we have been hearing in the freight markets this idea of an emerging two-tiered market system, especially on the shipping side, on the freight side, which means that the most efficient, the most modern vessels will be trading on those areas that do see the most regulatory burden, let's say.

Whereas most of this tonnage that is not as modern and cannot compete efficiently when it comes to the carbon footprint of the asset will be constrained into those basins relatively under-regulated. One question that I might have, and please feel free to step in and answer that both Foti and Rowan, is when we link this with geopolitics, when we link this kind of two-tiered system with those vessels that are not as modern, they're not as efficient, is there anything to be said about the shadow fleet? Could we say potentially that the shadow fleet is a big risk for the freight markets because it involves, if not in the majority, let's say a small part of less efficient, less modern and higher risk assets as well?

 

Fotios Katsoulas:

Absolutely. There are many ways to approach this issue. First of all, we have to consider that in the long term having a very significant presence of the shadow fleet in sectors like tankers, we have an impact on the long-term performance of the market based on the fact that some of these vessels are relatively old. Bear in mind that they still say [inaudible 00:14:54] Russian cargos used to be around nine years old. They are now typically above 12 years, in some cases even above 16 years as an average. The life expectancy is affected and as Peter has mentioned, that some of these owners target to have a life expectancy of let's say 20 to 25 years.

In some cases this is affected. We have been seeing the scrap activity being relatively low over the past eight years due to the situation with the older units securing a high employment and high rates in many cases. And obviously these give same a very different ... they produce different balances for the market. So all of these decisions to step in and take an action towards alternative fuels might be related to the situation, especially as some of these fundamentals might be affected.

At the same time, it might create more opportunities in terms of the liquidity of some of these ship operators being increased, which would allow them to have much more capital to invest and much more options to consider. So it's a very complicated topic, but we have to consider anything happening in the market to consider possibly scenarios.

 

Nikolaos Aidinis Antonopoulos:

Thank you very much Foti and Rowan. Before we continue, I want to take a moment to tell you our listener about Platts Connect, the ultimate resource for those interested in the shipping and marine fuel markets we've been discussing. With a subscription, you'll have access to daily prices, news, analysis, market updates and more. And if you're specifically interested in our discussion on the impact of decarbonization policies on freight rates, be sure to check out the link included in the show notes.

Rowan, let's dive deeper into fuels. What's the current landscape for traditional bunker fuels now that the EU ETS and fuel regulations are in play?

 

Rowan Staden-Coats:

Thanks, Nikos. Yeah, so as I touched on earlier, so far there hasn't been a massive shift in consumption patterns in Europe. The bulk of the fleet are still operating on conventional fossil fuels of some kind, whether that's high sulfur fuel oils scrubbed down to 0.5 or whether that's VLSFO or marine gas oil. That's the current state of play, but people are increasingly looking towards alternatives, particularly those that they can access quickly, easily, and are readily available and that they trust in terms of safety considerations and performance.

As I mentioned earlier, FuelEU Maritime has a requirement on the actual reduction in greenhouse gas emission intensity. There are penalties if you don't comply, and those penalties are pretty hefty. So there is a lot of incentive to actually comply. And also when this is coupled with the other overlapping regulations, there really is momentum now from January to actually make some changes to your fuel profile.

The favorites at the moment are definitely those easy drop-in fuels like biofuels. A lot of players are experimenting with different blend ratios, with different feedstocks, and how those different options can service their fleet. UCOME as a second generation biofuel is a very popular one, particularly in Northwest Europe. That's largely because this regulation FuelEU Maritime is looking at emissions on a well-to-wake basis. So this is from the production of the fuel itself right through to when it is burnt and emissions are coming from the vessel. This is in comparison to a lot of the other regulations which focus on a tank-to-wake basis. So the emissions produced from burning that fuel. I think it's really important to focus on this well-to-wake scenario as well because that really does change the profile of the fuels that people can use.

Biofuel is definitely a very, very popular one. At the moment, generally people are looking at fairly low blend ratios and they're looking at blends predominantly with VLSFOs, a very low sulfur fuel oil, which is the IMO2020 compliant fuel. But people are experimenting with high sulfur as well, and also marine gas oil when they are in emission control areas. But typically people are looking at blend ratios between a B10, so that's 10% up to a B24, in most regions, but up to a B30 sometimes as well.

There isn't yet an agreed sweet spot in what is the blend ratio that you can use which complies with FuelEU Maritime because it depends on what that fuel is. It depends what your base fuel is and it depends what your biofuel is produced from as to where that blend ratio sweet spot comes. And that will also depend vessel to vessel and owner's preferences, but also where they can actually purchase the fuel. If they are a player, which they know that they're going to be doing fairly typical routes that pass through Rotterdam, for example, they know the availability is good there and they maybe can choose between different ones. Whereas if you're in a different location, perhaps in the Med where it's not quite so available yet, you might not have so much choice and you might have to adjust your blend ratios or your base fuel to accommodate for that at the moment.

But looking a little bit further out, Fotios also mentioned dual-fueled engines and whether we talk about LNG consumption quite a lot as a bunker fuel, but oftentimes that LNG is as part of a dual-fueled engine. Fossil LNG is going to help at the moment, it's going to be a medium-term or short-term solution in the next couple of years to help you be compliant to these regulations. But from the kind of mid-twenty-thirties, it's not going to cut it basically, and you're going to have to start looking towards synthetic LNG or bio-LNG in order to actually meet the requirements of the regulations there. Those are the two fuels that people are most comfortable with at the moment.

And shipping is an industry where, as Peter mentioned, there's a lot of capital investment and regulations change very quickly. People aren't sure necessarily where to commit if you're looking at the order book. Do you purchase a certain type of engine or a different one? And you're making decisions for several years into the future, and in that period of time, regulations can change. So at the moment people are looking quite short term in their decision making, but you have certain first movers who are looking at ammonia-methanol type engines that will see them through the duration of these regulations.

But then you have the question of fuel availability and safety and everything which comes at a later date. So there's a lot of things to balance. I would say as well on the fuel profile that people are using, under FuelEU Maritime, a really important thing that I think is going to be a very helpful tool for a lot of people in complying is the banking and borrowing system, but also the pooling mechanism. You can pool your vessel with other vessels under the regulation, so you can group together basically, and as a group, your emissions have to meet the target. So an underperforming vessel can benefit from being pooled with an over-compliant vessel. And in a similar way, the banking and borrowing, you can effectively borrow your compliance from future years, or if you are over-compliant in one year, you can then use that surplus at a later date as well, within some limits. But I think in the short term, people are definitely very interested in those options by pooling specifically with those highly compliant vessels that are maybe running on bio-LNG, for example.

 

Nikolaos Aidinis Antonopoulos:

This is very clear. Thanks a lot, Rowan. This especially combined with the latest expectations about the Mediterranean Emissions Control Area, right? I think it compounds the impact on the shipping market, especially on the daily earnings of those vessels. Less than two weeks ago, Marina launched the global [inaudible 00:22:43] Index, which tracks time charter equivalents for both non-eco and non-scrubber ships and eco vessels that are fitted with scrubbers. And I still remember you Rowan educating me on the subject of the ECA button. So would you like to very briefly describe what this is and how it will support profitability for those assets that are equipped with scrubbers, especially in the Med region?

 

Rowan Staden-Coats:

Sure. Yeah, so it's an interesting one. Prior to IMO2020, the vast majority of the fleet were running on high-sulfur fuel oil. Then IMO2020 regulation mandated that everybody used fuel of maximum 0.5% sulfur. Now in an ECA zone, your sulfur emissions are restricted to 0.1% sulfur. And in Northwest Europe, for example, which is an emissions control area for a very long time now people often use marine gas oil, which is already at that 0.1% sulfur cap.

But when vessels are running on high-sulfur fuel oil and are fitted with these scrubbers or exhaust cleaning systems, it is become apparent, or a lot of people are quite confident that they will be able to effectively ramp up their scrubber, so that it scrubs from high sulfur right down to 0.1% rather than just stopping at 0.5% sulfur. What we expect from this is that actually high-sulfur fuel oil demand is probably going to be fairly well sustained in the Mediterranean when that becomes an ECA in May next year.

Marine gas oil 0.1% ULSFO also is expected to see quite a big boost. And actually it's the VLSFO 0.5% which is going to really suffer because it's not compliant on its own and you don't burn that fuel if you have a scrubber. So you're either scrubber fitted or you're not. And if you're not, you have to use 0.1% sulfur fuel. But if you have a scrubber, you can effectively just ramp it up a notch so that you are now scrubbing down to a lower sulfur level.

 

Nikolaos Aidinis Antonopoulos:

Thanks a lot, Rowan. Fotios, shifting gears a bit, what alternative fuels are emerging in the maritime sector, from your perspective? How do you see the role developing in light of these regulations?

 

Fotios Katsoulas:

So at the moment we see that most of the recent events when they target solutions such as methanol, which is going to be the biggest portion of alternative fuels by 2030. The total market share of alternative fuels will represent something like 8% by 2030 and then close to 60% by 2050. But from 2030 onwards, we see ammonium and the hydrogen increasing much faster than methanol. And I also have to mention that this is also related to the [inaudible 00:25:29] types currently being more active in that direction with container ships leading the path at the moment, but the tankers and dry bulk carriers to take some steps over the coming decades as well.

 

Nikolaos Aidinis Antonopoulos:

Very clear. Thanks a lot, Foti. Marina, based on what Foti shared, what challenges do you think the industry faces in adopting these alternative fuels?

 

Marina Ledakis:

    Yes. So as the others mentioned, most likely we will not shift to a single fuel solution, but we have to consider also the toxicity that comes along with them, as well as the transportation difficulties associated with these fuels. So what I think is very important will be the significant infrastructure investment on the shore side. So for the ports to be able to support the adoption of the alternative fuels.

At the same time, it's very important to note that when a final investment decision is made by a ship owner, it needs around two to three years for the vessel to be delivered. And then the maiden voyage starts and then we have a trade-on horizon of 20 years, let's say, at the worst scenario. Then the choice fuel remains very uncertain, and this may lead to investors finding themselves with stranded assets where they will have committed themselves with hundreds of millions to investments that may not even yield the necessary cash flows, not even profit, let's say, due to the changing regulations. I think it's very challenging for the shipowners to make decisions on whether to build vessels with traditional fuels or the other fuels, such as LNG, ammonia, methanol, as they do not really know what the future will hold for them.

 

Nikolaos Aidinis Antonopoulos:

Super clear. Thanks a lot, Marina. Peter, reflecting on your extensive experience in both spot and freight forward agreements market, what key lessons have you learned while leading a price reporting team through significant regulatory changes?

 

Peter Norfolk:

     I think we've learned this year that when regulations come in, even though people know they're coming for a long time, when they actually hit and become effective, then things change very rapidly. And I think from the Platts point of view, when we are the custodians of benchmarks, when people are relying on our prices, both for physical deals and for forward FFA deals as well, we have to consult widely, listen to all of the voices in the market, whether they're charterers, whether they're brokers, shipowners, operators, and fundamentally remember that what we're trying to do is reflect today's market as accurately as possible and have a clear methodology behind that, so that when we are getting questions or challenges to the values that we publish, we have clear answers and people are confident that we are doing the right thing, even though sometimes it's the most difficult thing.

We've had to do a huge amount of work, launching lots of new assessments in a very short space of time, but it was the right thing to do. And by doing that, we're well set up to continue to reflect the markets accurately as we go into 2025.

 

Nikolaos Aidinis Antonopoulos:

Thanks a lot, Peter. As we wrap up today's discussion, it's evident that the shipping markets are navigating into a new era of regulation, one characterized by clear objectives and a more substantial financial impact. This shift is not just a challenge, it's an opportunity for the industry to evolve. From a market perspective we can aspire to see a more cohesive system of carbon pricing for shipping emissions, moving away from the fragmented region by region emissions trading landscape. This integrated approach could streamline compliance and foster innovation, ultimately steering us toward a more sustainable maritime future.

Thanks very much, Peter, Foti, Rowan, and Marina, for joining me in this conversation. And of course, thank you for listening. Let's continue to explore how we can collectively navigate these changes in the waters ahead. You can stay ahead of the evolution of energy and navigate the pathways to a low carbon global economy with a Platts Atlas of Energy Transition, your map to the sustainable commodity markets of the future. Explore the atlas by visiting spglobal.com/atlas. This Commodities Focus episode was produced by Felix Fernandez in London.