Skip to main content

A PRINCIPLED APPROACH

Monday, January 20, 2020 

Doubly dependent on fossil fuels, both for propulsion and as cargo, the shipping industry is more exposed to the risks of climate change than most other industrial sectors, not least from the very real possibility of assets becoming “stranded”, as the International Maritime Organization (IMO) implements its greenhouse gas (GHG) strategy and the world economy decarbonises.

No surprise then, that climate change is a hot topic at shipping conferences these days. Along with zero emission vessels (ZEVs), it was a key theme at Norshipping in June 2019 and again at London International Shipping Week in September. Industry bodies such as the Global Maritime Forum and the International Chamber of Shipping are also on the case, promoting the development of deep-sea ZEVs by 2030 and seeking engagement across supply chains to cut emissions.

Yet, recent research reports, such as Carbon Carriers, from Maritime Strategies International and A Sea Change from CDP (formerly the Carbon Disclosure Project) suggest few shipping companies have begun to assess the serious challenges they face from the transition to a low carbon economy.

By contrast, central bankers, such as the Bank of England’s Sarah Breeden, are extremely concerned about the risks of climate change, fearing that a sudden re-pricing of fossil fuel dependent assets could undermine the financial system. She describes the dangers as “foreseeable, far-reaching and for action today”. Financial firms, they believe, have a pivotal role to play in mitigating climate risks by steering capital towards companies that are addressing the threats they face, and away from those that are not.

But to do this, investors, lenders, advisors and other financial firms, including index providers and ratings agencies, need to be able to integrate climate risk fully into their decision-making processes. And that can only be achieved through access to better quality data.

This is the ethos behind the Poseidon Principles, the initiative announced in June by 11 ship-finance banks and supported by Lloyd’s Register, which commits the banks to measuring and disclosing the climate alignment of their ship-finance portfolios. And it is the basis for the major global corporate reporting framework published in 2017 by the Taskforce on Climate-related Financial Disclosures (TCFD) under the auspices of the G20’s Financial Stability Board.

TCFD recommendations

This framework, known as the TCFD recommendations, urges companies to identify the short- and longer-term risks and opportunities they face from climate change, gauge the resilience of their business strategy under at least two possible future climate and policy scenarios, and then use this information to make a set of 11 climate related disclosures to investors in their mainstream reports.

Implementation of the TCFD recommendations has, so far, been optional, but this is changing as policy makers and institutional investors put pressure on companies to become fully TCFD-aligned. One of the major announcements in the UK government’s Green Finance Strategy published in early July, for example, is the expectation that all listed companies and large asset owners will implement the TCFD recommendations by 2022. The government may introduce legislation if sufficient progress towards this goal has not been made by next year.

At the same time, governments from the UK, Norway and France to Fiji and the Marshall Islands are committing to complete decarbonisation of their economies by 2050 or sooner. The UK has also recently announced an ambitious Clean Maritime Plan, which calls for new vessels ordered for use in UK waters to have zero emission propulsion capability by 2025.

Climate change is thus shooting up the political and policy agenda. And with the physical impacts of climate change from extreme weather and rising sea levels also becoming increasingly evident, corporate procrastination is no longer an option.

The IMO’s greenhouse gas (GHG) strategy requires the shipping industry’s own emissions to be cut by at least 50% from 2008 levels by 2050, while achieving the goals of the Paris Agreement to keep mean global temperatures to less than 2°C above pre-industrial levels requires global energy-related emissions to peak by next year and worldwide demand for fossil fuels then to fall sharply.

According to the International Energy Agency’s World Energy Outlook 2018 (in its Sustainable Development Scenario), this would mean primary energy demand for coal and oil dropping by almost 60% and 30% respectively by 2040.

Scenarios

In this type of scenario, the MSI report referred to earlier concludes that earnings and asset prices for carbon carriers such as Capesize bulkers and VLCCs, would be “hammered” and the risk of these assets becoming completely stranded would be considerable. But, according to MSI, “discussion of these potentially disastrous demand-side dynamics is almost totally absent from the shipping industry.”

This seems to be borne out by the CDP report, which found that only four shipping companies are official supporters of the TCFD and that “board level oversight of climate issues is very low compared to other sectors”.

Yet, as the physical and policy risks increase, so do the climate-related fiduciary duties of company boards. Directors have a clear responsibility to ensure that climate change issues are being managed and that financially material information is disclosed to investors. Failure to do so risks potential personal liability.

Legal cases, in which investors seek damages from companies for losses caused by failure to disclose climate related risks, are already being heard in the courts (for example Abrahams v Commonwealth Bank of Australia).

And climate change litigation is likely to expand dramatically as more climate related laws come into force (now estimated to number around 1,500 world-wide) and as climate-related financial losses mount.

All of this points to the importance of company boards and management devoting far more time and resources to managing climate change risks. But another key reason to do so is availability of finance. Initiatives such as the Poseidon Principles will force shipowners and operators to focus on the need to reduce the carbon dependence of their operations or risk access to finance becoming scarcer than it already is. Banks signing up to the Poseidon Principles commit to publishing carbon intensity figures for their shipping portfolios each year beginning in 2020.

This will be measured as the average amount of CO2 emitted (in grams per deadweight tonne-nautical mile) across the assets in the portfolio, using vessel emissions data that shipowners will report to the IMO Data Collection System (DCS) via Flag States beginning next March.

Some have questioned whether the Poseidon Principles are merely another example of “greenwashing”. In fact, other things being equal, they should require the banks to reduce the carbon intensity of their portfolios each year and at a pace consistent with meeting the IMO’s emissions target.

They should therefore act as a ratchet, forcing the banks to channel new loans to ever lower-carbon shipping ventures. The Secretariat of the Poseidon Principles will produce downward sloping “decarbonisation trajectories” showing the appropriate level of carbon intensity permitted for each year and for each ship type and size class needed to achieve the IMO’s 2050 goal, taking into account the projected total transport demand for each sector.

If, as many expect, global sea-borne trade volumes double over the next 30 years, ships will, on average, need to become at least 75% more efficient than today, a far more onerous target than the IMO’s secondary goal of a 70% improvement in efficiency from 2008 levels. The Poseidon Principles should therefore help to align ship-finance with the IMO target. Shipowners could, of course, seek finance from lenders or investors not signed up to the Poseidon Principles. But if their business plans are not consistent with the IMO target, the risks to both shipowner and finance provider of a sharp drop in the value of the asset may prove unacceptably high.

Indeed, these risks may grow as the effects of climate change become more devastating, putting the IMO under pressure to strengthen its 2050 target and bring forward the goal of complete decarbonisation.

In the 1950s, philosopher, physician and Nobel Peace Prize winner Albert Schweitzer wrote: “Man has lost the capacity to foresee and forestall, he will end by destroying the world.” His words were echoed, famously, by Rachel Carson in Silent Spring, her seminal 1962 book about the effects of pesticides on the environment. Integrating the TCFD recommendations into corporate governance and business processes is an important first step for shipowners — and their investors —to take to show that, in the context of climate change, Schweitzer’s fears will not be realised.

Reader Comments (0)

There are currently no comments on this article. Why not be the first and leave your thoughts below.

Leave Your Comment

Please keep your comment on topic, any inappropriate comments may be removed.

Return to index

Web Analytics