Shipping GHG PWC Final

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A game changer for the shipping industry industry?

An analysis of the future impact of carbon regulations on environment and industry
An analysis prepared for the ongoing discussions in IMO and other international fora regarding future global regulations of carbon emissions June 2011
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 PwCs 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.com
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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 industrys role in . mitigating climate change, potential through inclusion in the existing EU Emissions Trading Scheme (ETS).
Scope and objective
In total, ten proposals have been submitted to the IMO for consideration as possible 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. 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 marketbased 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 marketbased 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 team
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Summary of
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Key findings
Summary of key findings
Context
Massive efficiency gains required to reduce emissions to target levels
Target and growth of emissions
Considerable fuel cost increase as fleet shifts to low-sulfur fuels

Fuel price 1990-2030
Fuel cost increase would drive efficiency gains

Fuel efficiency 1990-2030
Dramatic reduction of fuel use and emissions since 2008

Global fuel reduction 2008-2011
Metric tons CO 2 (million) 2000

3,3% p.a 57%
USD per metric ton fuel ($2010) 1320

80%
gram fuel/ton mile 11
Fuel consumption (International fleet)

-30-40%
Index 1,0 0,9
1500 1000 500 0
-1,25% p.a.
700
0,8 0,7 0,6
Emissions Target
Distillate Bunker
7 0 1990 2010 2030 2008 2009 2010
1990
2010
2030
1990
2010
2030
2011
A proposed 10% reduction of emissions below 2007 would require a reduction of 57 percent below business-as-usual by 2030.
Forthcoming low sulfur regulations are expected to drive fuel costs above US$1,300 per metric tonne by 2030 from about US$600 today. The increase in fuel costs under the sulfur regulations is expected to raise fuel price to the point where currently known opportunities to improve fuel efficiency would have been exhausted. More measures may become available in the future with technological improvements but significant uncertainties remain on this.
Fuel cost is estimated to drive 26 percent efficiency gain, equivalent to 1.25 percent improved efficiency each year and a break with historical trends. The IMO proposals on market based measures are aimed at reducing emissions further to meet the target.
Speed reductions have reduced fuel consumption (and emissions) by 30 percent globally since 2008. However, any emission reductions from speed reduction observed over the last three years are unlikely to be sustainable. As freight rates rebound as a result of the economic recovery, it is likely that speed may increase again.
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Options
Measures to put a price on carbon to incentivize fuel efficiency and reduction of emissions
Carbon emission from shipping fuel One tonne of fuel three tonnes of CO2*
Emissions Trading Scheme (ETS) proposals involve auction of certificates, submission at ports, and trading in carbon markets
Conceptual model for shipping ETS Central authority to allocate certificates(freely or auction), and collect from ships
The Levy proposal is a centralized scheme, putting direct charges on fuel, and links to carbon markets through a central entity
Conceptual model for shipping Levy Central authority sets and collects levy
A cost of carbon is expected to be added to the price of fuel through a future market-based measure. Currently, for every tonne of fuel consumed, approximately three tonnes of CO2 are emitted. The policy options and various design features for a market-based measure for the shipping sector, including how it is linked to these existing carbon markets, will impact the price of carbon, the industry and the environment. The two main market-based measures being considered are a levy and an emissions trading scheme (ETS), based on the principle that the shipping industry will respond to a price signal to encourage emission reductions. In total, ten proposals have been submitted to the IMO for consideration as possible market-based measures. 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 rebate mechanism applicable to any MBM and technical measures such as efficiency index or design standards.
*Actual relationship is between 3.09-3.17 varying with fuel quality. We have assumed 3.13 throughout this study Ships to acquire and submit certificates at port based upon emissions from each voyage
Certificate owners (shipoperators/ owners) can trade certificates in market
Central authority engages in market to purchase offsets
Ships to pay levy on fuel
An Emissions Trading Scheme (ETS) entails setting a cap for the aggregate emissions allowed to be emitted in the system. Typically one unit of allowance permit its holder to emit a tonne of CO2. Ships are required to surrender an allowance unit for every tonne of CO2 emitted during the voyage. Allowances can be issued for free, which can be based on past emissions, and/or through auctioning. Shipping companies can then trade these allowances in the carbon markets. 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 than to reduce its emissions, then it will purchase an allowance for compliance.
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A levy can be imposed on fuel during sales based on the carbon content of fuel, or at a port based upon emissions of a completed voyage. 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. The proposal recommends that the proceeds are collected by an international body and used to purchase carbon credits to achieve an emissions reductions target. 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). If the funds are mobilized for other purposes than to purchase carbon credits the environmental outcome cannot be determined with certainty.
Impacts on the shipping industry

A levy and the ETS could achieve identical environmental outcomes
Carbon abatement options from Shipping
A levy, or an ETS without any auction, would achieve the environmental outcome at the lowest cost to the industry
Impacts of low-cost levy and ETS zero cost zero-auction
A higher levy, or auction under the ETS, would mobilize more funds for a global climate fund
Impact of high-cost levy and ETS 100% auction
Metric tons C02 (million) 2000

ETS with 100% auction = $152 per metric ton fuel ETS with 0% auction = $66 per metric ton fuel Levy minimum required to offsets = $66 per metric ton fuel 2,6 billion to global fund Levy minimum + large global fund contributions = $152 per metric ton fuel
1600
26%
1200
Abated through efficiency gains
32%
800
Abated through market-based measures
41 billion to global fund
41 billion to global fund
2,6 billion to global fund
400
43%
Remaining emissions
0 2010 2020 2030 With appropriate target setting and policy design, a levy and the ETS can achieve identical outcomes. This is achieved with the size of the levy set as a function of a pre-determined abatement target on emissions and the proceeds of the levy used to purchase the required number of credits to meet the targets.
A levy based on the purchase of CDM carbon credits would incur a cost of about $66 per metric tonne of fuel to the industry by 2030. An ETS proposal with free allocation (i.e. 0% auction) would achieve the same impact. The cost of purchasing carbon credits through the proceeds of a levy scheme will be identical to the total costs for firms to purchase allowances to comply under an ETS. Under the ETS, allowances can be allocated freely or through auction. With auctioning, the industry incurs additional cost as it has to purchase the allowances being auctioned. The greater the proportion of auctioning, the greater the cost to the industry.
A levy, or an ETS without auction wouldmobilize US$3 billion annually by 2030. However, if a prime objective of a scheme is to raise revenues, the levy can be increased beyond what is required to purchase offsets. After accounting for the purchase of carbon credits, the auction proceeds and contribution to global climate fund are additional revenues raised. The ETS with 100 percent auction of allowances would mobilize about US$41 billion annually by 2030.
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Impacts on the shipping industry

The impact of carbon polices is dwarfed by trends in the fuel cost
Impact on fuel cost 2030 ($2010)
Impact on cost base varies much between vessels and could reach 9 percent for a 3500 TEU container
Components of cost base per shiptype 2010-2030 with ETS 100% auction (daily costs)
Profit would be lost as a large share of the cost increase would be absorbed by the industry
Absorption of cost increase at 25 percent initial margin Carbon
Seaborne trade volumes would decline

Impact of high-cost levy and ETS 100% auction
152 618
1469
Capex
Opex
Fuel
Container Main Liner Capesize Bulker
8%
5%
78 %
9,0 % 7,5 % 7,3 % 6,7 % 6,6 %
71 % 47 % 45 % 38 % -74 %
15 % 12 % 65 % 18 % 12 % 63 % 16 % 19 % 58 % 17 % 20 % 57 %
699
VLCC Handysize Product Tanker Handysize Bulker
Loss of volume: Short-sea to road and rail Deep-sea to local products which dont require ocean transport
Bunker base
Sulfur regs impact
Carbon high case impact
New fuel price
Compared to the forthcoming regulations which mandates lower sulfur content of fuel, carbon pricing is estimated to have a relatively small impact on the cost to the industry. 80 percent of the expected increase in voyage costs for vessels will stem from the sulfur regulations. A levy would result in an average increase of voyage costs of about 5 percent. On the other extreme, an ETS with full auctioning will result in an 11 percent increase in voyage costs.
The amount of carbon emissions for a ship is strongly linked to fuel consumption, which as a proportion of the cost base, differs substantially across the ship segments. 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 proportionally larger capex and opex cost base, finds carbon cost a smaller proportion of their cost base. A levy would result in an increase in the total cost base between 3-4 percent across common vessel segments. An ETS with auctioning would result in an increase between 6-9 percent.
The increases in voyage costs resulting from carbon pricing will lead to higher rates. Freight rates and a ships profit margin are determined by a multitude of factors, including the competitive conditions, operational and management efficiency of the ship and market conditions. A levy would lead to an increase of freight rates of between 1-5 percent across common vessel types and goods. An ETS with full auctioning would increase freight rates between 7-9 percent. Profits of the industry would fall. All ship types will be able to pass-through some of their costs to their customers. The extent depends upon the goods being transported and the capacity in the market.
As freight rates increase, especially in the short-term, the level of shipping activities may fall. Modal shift is a particularly relevant scenario for the short-sea freight segment where road transport is an option, for example in densely populated regions such as Asia, Europe and North-America. Studies from Europe indicate a severe impact with fuel costs above $1000 per metric tonne. As freight rates increase, locally produced goods would become more competitive. The demand for international transport would decline as a consequence. However, these impacts are likely to be a result of the low-sulfur regulations rather than carbon costs.
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Bottom line
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Three key issues will be addressed
1 Context 2 Options 3 Impact

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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 being proposed? What are the key parameters which policymakers need to decide? How much will it cost? How will different policy options impact costs? How will shipping profits be impacted? How will patterns of global trade change?
Section 1
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Context
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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 sector. This is a larger share than aviation and rail sectors, but much less than emissions from the road transport sector which is more than 6 times higher. 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 countries and across oceans, which accounts for 870 million tonnes of carbon emissions.
There are about 100,000 ships weighing above 100 Gt, of which about half are cargo ships which constitutes the largest share of emissions. The container 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. This study is focused on international shipping which is the scope of the IMO proposal.
Emissions from global shipping less than road transport and more than aviation
Figure 1.1: Global emissions of CO2 by sector
Most emissions are from cargo transport

Figure 1.2: Emissions and vessels by major fleet segments (contribution to total) 50%
Container Bulk Crude oil tanker General cargo Ferry Miscellaneous Service Chemical tanker Products tanker Vehicle LNG tanker Other dry Of fshore Cruise Roro LPG tanker Yacht Other tanker 22 % 17 % 10 % 9% 8% 7% 5% 5% 4% 3% 2% 2% 2% 2% 2% 1% 0% 0%
80%
Road transport; 21 %
Global shipping; 3,3 % Aviation; 1,9 %
All other; 73 %
Rail; 0,5 %
Source: IMO 2009
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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.
Context
Shipping is the most carbon efficient mode of transport
Despite emissions levels, ships are overall the most carbon efficient mode of transport. This, however, varies by type of goods. Heavy bulk cargos such as iron ore, coal and crude are more efficiently transported on ships. Shipping of lighter goods 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.
Vessel types also affect fuel efficiency. Smaller ships, which are often used in coastal short-sea freight routes, are more carbon intensive than larger vessels. However, compared to their direct competition of road and rail, they still compare favorably on carbon emissions per tonne km travelled.
Shipping is the most carbon efficient mode of transport

Figure 1.3: Intermodal carbon efficiency compared
Larger vessels are more carbon efficient

Figure 1.4: Carbon efficiency of different vessels (examples)
Large Very large Ore VLCC Suezmax Tanker Container 8000 TEU+ Medium Bulk Handymax Panamax tanker Handymax product Container 5000-7999 TEU Smaller Bulk Handy Coastal product Container 1000-1999 TEU Vehicle carrier 0-3999ceu -30 -15 0 15 30 45 60
Average load Max load
Shipping
Average Range
Rail
Road
Air*
100
200
300
400
500
Grams C02/tonkm
Source: IMO 2009: * 747-F
Grams C02/tonkm
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Massive efficiency gains required to reduce emissions

Figure 1.5: Target and growth of emissions As the demand for maritime transport services derives from global economic growth and the need to carry international trade, trends in the shipping sector are closely interlinked with the movement of trade. Economic growth and globalization will continue to drive the levels of seaborne trade, however future scenarios by the IMO suggest that some trade might shift away from sea to land for example onto the Trans-Siberian railway. As such, we expect a growth of seaborne trade of about 3,3 percent consistent with the IMO 2009 scenario. Fuel consumption, and thereby emissions, will also follow this growth scenario if nothing else changes. This also constitutes the reference case for our further calculations. The carbon intensity of the industry, however, may improve over time through efficiency improvements in the sector. The degree of efficiency improvements will depend on a variety of factors, which include ongoing technological improvements, reacting to the cost of fuel, and potentially future regulations in the shipping industry. We will discuss these impacts in the following sections.
500 Emissions growth Target reduction Metric tons CO2 (million) 2000
3,3%
1500
1053 mt 57%
1000
100% more emissions if unconstrained growth alongside growth in seaborne trade
Target for reductions at 783 million tonnes
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.
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Context
Potential to reduce emissions is substantial through existing proposals

The IMO has identified three wedges to reduce emissions. Volatility and increases in fuel costs (particularly from EU regulations on low-sulfur sulfur fuels)are a strong driver for the shipping industry to improve its fuel efficiency. Thus even in the absence of any intervention or regulation, the industry expects an improvement in the carbon intensity of the sector as a result of business-asusual 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 fuelefficiency gains for the global fleet over the last decades. The IMO emissions scenario for 2030 of about 1550 million tonnes of carbon takes account of these improvements. A current proposal within the IMO to introduce the energy efficiency design index (EEDI) to encourage design improvements for new ships is also expected to result in carbon efficiency improvements for the sector beyond the business-asusual efficiency improvements. The use of market-based measures is a further set of proposals within the IMO community to reduce the contribution of the shipping sector to carbon emissions 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 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. Political economy influences heavily on the actual level of target to be agreed. For 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.
Figure 1.6: Abatement potential

The impact in 2030
Abatement measures
14%
1600
248
Abated through business as usual efficiency improvements Abated through mandated energy efficiency design index (EEDI)
12%
213
1200
32%
592 Abated through marketbased measures
800
400
43%
783 Remaining emissions
0 2010 2015 2020 2025 2030
The remaining emissions will depend on the compounded impact of the emissions reduction measures above.
Sources: IMO 2009, 2010; PwC GHG Shipping model
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Context
Speed reductions have reduced fuel consumption by 30 percent globally since 2008
Speed reduction is an important fuel efficiency measure, highly influenced by a number of market factors. Ship operators respond to low rates, overcapacity and higher fuel costs by reducing speeds. A measurable decrease in total fuel consumption has been observed since 2008, reflecting changes in operational patterns as a result of the increase in fuel costs in recent years. The speed reductions are in the range of 14-16 percent over the three years across tankers, bulkers and containers; with the exception of iron ore bulkers which are less sensitive to fuel cost increases; and with the exception of ferries which operate scheduled services often subject to license requirements. Despite the significant speed reduction observed, due to data unavailability it is difficult to conclude the impact on emissions since 2007, when the IMO estimated emissions to be 870 million tonnes. Moreover, any emission reductions from speed reduction observed over the last three years are unlikely to be sustainable. The economic and trade boom 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 rebound as a result of the economic recovery, it is likely that speed may increase again.
Figure 1.7 Global fuel reduction estimate 2008-2011

More vessels in the market, but fewer are actually at sea
Vessels at sea
-6%
Speed reductions across the fleet 2008-2011

Speed International fleet
-15%
Fuel consumption reduced by 30-40 percent 40

Fuel consumption (Global fleet)
-30-40%
Index 1,1 1,0 0,9 0,8
Index 1,0
Index 1,0 0,9 0,8 0,7 0,6
0,9
30-40 percent reduction in carbon emissions since early 2008
Not sustainable Will increase again if demand for transport increases
0,8 2008 2009 2010 2011 2008 2009 2010
2008
2009
2010
2011
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.
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Context
But speed reductions are very market sensitive and cannot be counted as reliable abatement measures
There has been much volatility over the last few years in many of the factors that would induce response in speed. The market for seaborne transport collapsed at the end of 2008 upon reaching historical heights. Demand has since come back and increased since 2009. Many more ships were ordered at the end of the high cycle and these have been entering the market since. There was oversupply and rates dropped across most segments. Fewer of the ships are utilized, meaning that they are at anchor and not at sea at a given day. 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 lowsulfur fuels. Speed reduction will be most cost effective if there is overcapacity in the market (as for the last three years). If not, there will capital investments required to build new vessels to compensate for the drop in transport capacity. The dynamics are very volatile and hard to forecast. Examples from the container fleet are shown on the right. The container fleet has reduced speed by about 14 percent since early 2008. This is consistent across most other types of vessels and the typical range of speed reductions over the three years is about 14-16 percent. Figure 1.8: Containership speed response to rate collapse, overcapacity, and higher costs 2008 2008-2011 Demand for transport collapsed
Singapore throughput (Containers TEU)
-25% 25%
More ships entered the market

Million 3
+12%
Rates dropped
Container freight rates (index) Index 12 10 8 6 4 2 0 2011
Container fleet
Vessels 5000 4600
-75%
2,4 4200 1,8 2008 2009 2010 2011 2008 2009 2010 2011 3800
2008
2009
2010
Fewer ships are utilized

Utilization fleet (Container)
-9% 9%
Fuel cost are higher

Bunker fuel (Rotterdam)
+200%
Speed is lower
Container speed (Average)
-14%
Percent 100 % 90 % 80 % 70 %
USD/Ton 800 600 400 200 0
Knots 14 13 12 11 10
2008 2009 2010 2011
2008
2009
2010
2011
2008
2009
2010
2011
Sources: Singapore Port Authority, Lloyds, Hamburg Shipbrokers Association , Bloomberg AISlive datastreams
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Context
Low-sulfur fuel regulations will be a game changer sulfur

This report is focused on carbon regulations, but other international environmental legislation are also likely to drive changes in the industry. In particular the IMOs amendments to Annex VI of the MARPOL Convention in relation to SOx (sulfur oxides) reductions are expected to drive a significant rise in average fuel costs over the coming years. These include: The global limit for sulfur content in fuel will be reduced from 4.5% to 3.5% effective from 1 January 2012; then gradually to 0.5% by 2020 (subject to a feasibility review). The limits applicable in Sulfur Emission Control Areas (SECAs) will be reduced from 1.5% to 1%, beginning on 1 July 2010; then further to 0.1 %, effective from 1 January 2015. Complying with these fuel sulfur reduction requirements will require change, through the use of distillate or alternative fuel oils, LNG or gas-cleaning technologies (scrubbers). LNG can only be used for newly built ships. This will have a strong upward pressure on fuel prices as distillates are historically 80-90% 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 pressure on the fuel. 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 industry than the current proposals on carbon regulation. The price levels corresponds to an underlying cost of crude oil of about US$115 per barrel ($2010).
Fuel costs may remain high

Figure 1.9: Fuel prices 1990-2030
USD per metric ton fuel ($2010) Distillate Bunker f uel 1200
Increased use of low low-sulfur, more expensive fuel

Figure 1.10: Change in fuel mix of fleet
Share of f uel type used 20 %
Much higher average fuel cost

Figure 1.11: Average fuel unit cost for fleet when using bunker and distillate
USD per metric ton f uel (2010$) 1200
80%
900 600 300 20 % 4% 0 1990 2000 2010 2020 2030 2010 2020 2030 80 % 80 % 96 %
900
150%
600 300 0 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. 18 PwC
Context
Higher fuel costs unlikely to result in sufficient efficiency improvements

The extent to which fuel saving technologies are economically viable depends on the capital and recurrent costs of implementation and the fuel savings potential for each measure. 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 below which the investment will be profitable. The horizontal axis shows the impact on the annual fuel consumption of the ship. All of these technologies (except solar on the Suezmax) are found to be profitable at fuel prices of $900 a tonne. If all these measures can be implemented at the same vessel the resulting emissions reductions are estimated to exceed 50 percent. In practice, there are many uncertainties and implementation constraints which are not included in these estimates. Other measures, or stronger price incentives 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 Suezmax tanker and increase profits Figure 1.12 Marginal cost of efficiency improvements at $900 fuel price in 2030. Midrange estimates. W.o speed reduction. Suezmax tanker
Marginal efficiency cost $/tonne fuel 400 60 Savings as share of annual fuel consumption for ship
Similar savings can be made by a Panamax bulker; and all these options are profitable with $900 per tonne fuel Figure 1.13 Marginal cost of efficiency improvements at $900 fuel price in 2030. Midrange estimates. W.o speed reduction. Panamax bulker
Marginal efficiency cost $/tonne fuel 10% 20% 30% Savings as share of annual fuel consumption 40% 50%
0
Propellerrudderupgrade
40
Propellerrudderupgrade Solar
20
10% 20% 30% 40%
Propellerupgrade
-20
50%
0
WHR
-40
Wind Engine
Towingkite
-20
Propellerbushing reg Propellerbushing req Wind Engine
-40
Weatherrouting
METuning Speedcontrolpumps
-60
Weatherrouting
Propellerbushing reg
Airlubrication
Hullbushing
-80 -100
Autopilot
-80
-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. 19 PwC
Autopilot
-60
Coating Bosscapfin
Common Rail
Hullbushing
Bosscapfin Coating
Lighting
Airlubrication
Speedcontrolpumps METuning Common Rail
Towingkite
Context
Success in the future fuel economy will require innovation and strategic shifts
The fuel economy is an increasingly important component of the competitive dynamics in the of future shipping. We may see strategic shifts in the industry. Impacts may differ across main segments: Short-sea shipping in densely populated regions face the most immediate threat of modal shifts towards land-based transport. Studies indicate that a threshold 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 lead to higher total emissions as road and rail transport is less carbon efficient. Deep-sea shipping will face different dynamics, in particular the threat of increased competition from each other as fuel efficiency becomes a competitive 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. The industry will respond strategically. Larger vessel types might be deployed, such as ultra large container vessels which have greater fuel efficiency per tonne mile than the smaller vessels. More attention will be paid to address port infrastructure, which currently has limitations on vessel sizes. Downward management of other cost components and further integration of supply chains will rise in focus. Consolidation in the sector may also follow to exploit greater economies of scale.
Fuel efficiency forecast improve by 1,25% annually

Figure 1.14: Fuel efficiency improvement 1990-2030
gram f uel/ton mile
Efficiency gains will be outrun by increased fuel cost

Figure 1.15: Fuel costs per tonne mile of transport 1990-2030
$ cents/ton mile 1
11
3,4% Efficiency gains represents a break with recent history
Fuel costs will increase 0,75 faster and outrun the gains in efficiency +95%
0,5 0,25 0
-1,25%
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.
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Section 2
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Options
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Two main groups of market-based measures are being considered by the IMO based
The 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 that respond to a price signal to encourage emission reductions. In total, ten proposals have been submitted to the IMO for consi consideration as possible market-based measures. 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 based rebate 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 (Levy) GHG Fund: MEPC 60/4/8 Denmark et al. (Levy) LIS: MEPC 60/4/37 Japan (Levy) PSL: MEPC 60/4/40 Jamaica Global ETS : MEPC 60/4/22 Norway Global ETS: MEPC 60/4/26 UK Global ETS : MEPC 60/4/41 France Scope and responsibility All party ships engaged in international trade and emissions from all marine fuels. GHG contributions due when taking bunkers are made to the Fund by bunker fuel suppliers or shipowners. Direct payment to International GHG Fund through electronic accounts for individual ships. Small ships may be excluded. Uniform emissions charge on all vessels calling at all ports. Process enforced by Port State authorities. Applies to all CO2 emissions from the use of fossil fuels by ships engaged in international shipping above a certain size threshold. Ship operators would be responsible for complying with the system. Individual ships would be the point of obligation. Applies to all ships above a threshold, regardless of their flags. In-sector Out-of-sector (from remaining proceeds) Primarily out-of-sect0r Partial or full auctioning Links to other ETS schemes Primarily out-of-sector Partial or full auctioning Links to other ETS schemes Primarily out-of-sector Partial or full auctioning Links to other ETS schemes
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Expected source of emissions reductions Out-of-sector
Mechanism design features Purchasing of project based credits (CERs)
Revenue generation and allocation Fund used to offset GHG emissions from international shipping which exceed global reduction targets. Could also be used to finance adaptation in developing countries, R&D, technical cooperation & administrative expenses of GHG Fund. Revenue generated available for mitigation and adaption activities. Part refund to industry. No discussion regarding the use of funds generated.
In-sector Out-of-sector (from remaining proceeds)
A Fund would be established by the auctioning of allowances to be used for climate change mitigation and adaptation and R&D for shipping. Allowances could be allocated to national governments for auctioning and therefore revenue generated would remain with the governments to be used for a variety of (unspecified) purposes. The revenues could follow the principles laid out in the Danish proposal, with the final allocation of the revenues to be decided by the Parties taking into account the principle of common but differentiated responsibilities and respective capabilities.
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Both ETS and Levy models involve carbon markets and trading
The levy proposal is a more centralized scheme which also links to existing carbon market
Conceptual
ETS proposals resemble existing emissions trading schemes

Figure 2.1 Conceptual models for shipping carbon market engagement
Central authority to allocate allowances (freely or auction), and collect from ships
Central authority sets and collects levy
Certificate owners (shipoperators/ owners) can trade allowances in market
Central authority engages in market to purchase offsets
Ships to acquire and submit emissions certificates based upon each voyage
Ships to pay levy on fuel
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ETS involves known implementation mechanisms but at a larger scale

Figure 2.2 Key issues for implementation of shipping ETS Mechanism Key risks and mitigation Risk of misallocation of free allowances due to: (i) Much volatility in emissions due to speed and market fluctuations; and (ii) Lack of standardized information required to benchmark performance. Large number of different vessel and engine configurations. The use of auction can mitigate misallocation. Better testing, piloting and/or technology to assess actual emissions can also improve information base. Simplified
Central authority to allocate allowances (freely or auction) to shipowners/operators. Large number of owners, but less than number of ships. About 100.000 ships may be covered compared to about 12.000 sites under EU ETS.
Portside collection of emissions certificates for voyage. Each ship to submit certificates. Certificates may be ultimately owned by shipowner, operators or charterers. Monitoring and verification checks. Technology or paper based. May require verification personnel.
Risk of: (i) Excessive costs for monitoring, reporting, verification. This can be mitigated by intelligent administrative systems or technology; and (ii) Fraud and corruption risks, e.g. bunker notes can be falsified, (iii) Avoidance of scheme through e.g. sea-to-sea transfers. These can be mitigated by appropriate controls and/or technology.
Owners of certificates can trade certificates in carbon markets to optimize the economics of ships or fleet. Certificates can also be acquired in the marketplace if additional certificates are needed. Various trading strategies possible within design constraints of the ETS mechanisms.
Risk of: (i) Excessive price volatility. This can be mitigated by allowing for banking and borrowing of certificates across phases; (ii) Risks of supply constraints of CDM credits. This can be mitigated by also allowing linkages to other markets; and (iii) Transaction and trading costs. This can be mitigated by developing efficient technology based marketplaces.
Source: MEPC 60 various proposals.
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Levy involves simpler mechanisms but also has risks

Figure 2.3 Key issues for implementation of shipping Levy Mechanism Key risks and mitigation Risk of setting wrong levels: setting a levy that is too low will lead to insufficient funds to acquire required offsets; while setting a levy that is too high will tax the industry unduly. 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. Simplified
Central authority to set levy for 1+ years ahead based upon estimates of emissions and carbon price in the future.
Collection at point of fuel sales. Levy to be paid alongside fuelcharge. About 400 bunkersales points. About 20% of total sales at three ports: Singapore, Rotterdam and Fujairah. 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. May engage in market from time-to-time to adjust portfolio or employ hedging strategies.
Risk of: (i) Fraud and corruption risks. This can be mitigated by appropriate controls and/or technology; and (ii) Risk of leakage to fuel outside of scheme boundaries. This can be mitigated by ensuring compliance at major centers, setting entry requirements to major ports, or impose charge based upon emissions during voyage to be paid at port rather than fuel sales.**
Risk of: (i) The central authority, as a very large actor in the CDM market, may substantially affect prices in the CDM market or cause undue volatility. 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. would
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Policy decisions and options on mechanism design affect the environmental and industry outcomes
The 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 how these decisions affect the outcomes; for the industry and the environmental. Our analysis will look at three options in deta linkage to another carbon market, detail allocation method and banking and borrowing. Figure 2.4 Policy decisions and options on market based design
Core policy decisions
Size of emissions target or cap Linkage to another carbon market
ETS or levy
Geographical coverage of scheme Phasing over time Banking and borrowing allowances Allocation method (auctioning) Use of proceeds
Levy
Mechanism design policy options
ETS
Cost of carbon
Outcomes
Cost to industry
Industry freight rates Profit impact on industry
Trade
Cash flow
Environmental outcome
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Levy: Core principles and options
Core principles of the levy

(MEPC 60/4/8*)
To be imposed globally on fuel during sales based on the carbon content of fuel. Proceeds are collected by an international body and used to purchase carbon credits to achieve an emissions reductions target. The levy increases the cost to a ship voyage. If it is cheaper to reduce emissions than to pay the levy, the ship shipowner or charterer will prefer to do so.
Policy options
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 predetermined 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 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 60/4/37 Japan; and MEPC 60/4/40 Jamaica.
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ETS: Core principles and options
Core principles of the ETS

(MEPC 60/4/22*)
Typically one unit of allowance permit its holder to emit a tonne of CO2. Ships are required to surrender an allowance unit for every tonne of CO2 emitted. All allowances allocated through auctioning (100%). Assumes linking to CDM market. Shipping companies can then trade these allowances in the carbon markets. The market price is determined by 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 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 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.
Policy options
* 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.
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Both carbon levy and ETS have their advantages and limitations
Levy Imperfect information means that the levy may not be set accurately to generate the desired environmental outcome, creating environmental uncertainty. However, it provides a clear price signal which will encourage long-term investment in fuel efficient vessels and equipment, as well as more efficient operational practices. The IMO GHG Fund proposal sets the levy to meet a specified environmental target which provides greater environmental certainty. Price signal consistency Revenue generation A clear fixed price signal is created which adds certainty to investment decisions. Levy rates are subject to changes over time, but volatility would be constrained by the state within a set period. A carbon levy provides revenue generation. The revenues would be more stable and controlled centrally, rather than by the market. The implementation of a carbon levy scheme is relatively simple compared to an ETS. Complexity depends on which entity the levy is imposed and the number of participants involved. Varies by region. For example, within the EU, new taxes need unanimity, whereas decisions on the ETS only need a (qualified) majority vote. Any form of carbon pricing may also face resistance from developing countries regarding the sharing of responsibilities in the mitigation of climate change. GHG Fund - Denmark et al. : Purchases out-of-sector project credits sector with levy funds to meet an emission reduction target. Current IMO Proposals LIS Japan : Aimed at improving energy efficiency of ships with potential refunds for good performance ships. Port State Levy Jamaica : Globally uniform emissions charge administered through Port State arrangements.
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ETS An emissions trading scheme imposes an absolute quantity cap which can be managed in line with environmental requirements. In practice, the mechanism design of the scheme can affect its effectiveness. For example, the level of auctioning vs. free allocation, the duration of the commitment period and the ability to bank and borrow allowances can all affect the strategic response of participants. Price volatility, as seen in the EU ETS until 2009, provides a fragile basis for investors looking to incorporate a long-term price for carbon into their decision making. This is a particular issue for investment decisions in relation to long life assets such as vessels. Auctioning of permits provides revenue generation. However, revenues may be unstable as they are dependent on the price of the allowances. An ETS requires an administrative system to be put in place to manage and monitor compliance, particularly if auctioning is involved. Market participants may require training or a phasing-in period to familiarise with the scheme. Varies by region. An ETS is likely to gain acceptance politically in Europe but there is currently little appetite for similar schemes in some other regions. Any form of carbon pricing may also face resistance from developing countries regarding the sharing of responsibilities in the mitigation of climate change. Global ETS - Norway Global ETS - UK Global ETS - France
Effectiveness at reducing emissions
Simplicity
Political sentiment and acceptability
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Section 3
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Impacts
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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 environment

This first section considers how the environmental outcome (assumed here mainly to be the amount of carbon emissions abated) is affected by the choice of policy instrument.
Impact on the shipping industry
Impact on seaborne trade volumes
Administrative burdens
The practicalities of implementation and the required administrative burden is considerable for both authorities and the industry. Key considerations include: 1) 2) 3) Governance of mechanism parties required; Administrative burden; and Monitoring, reporting and verification requirements.
This section will review the impact on The shipping industry is a the shipping industry, focusing on the fundamental part of global and impacts on: regional trade. Drawing on results from the preceding section, as well as 1) Cost base; and overall trends in trade, we will consider in this section the 2) The implications on profits. implications on: This will be considered primarily at an 1) industry level. 2) We will also consider the impacts across different shipping segments, as there can be substantial variations within the industry. Overall trade levels; and Potential impacts on trade routes or distribution of trade.
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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 profitability. A change in cost base as a result of increased cost of carbon will affect industry profitability, but the extent of this depends on demand and supply factors within the sector and relative to other transport modes, as well as levels and patterns of global trade. A key determinant is whether the ship is able to pass on the costs to its customers in increased freight rates, therefore retaining the profits earned. Our analysis first considers a top-down analysis for the industry, by considering the impact of the cost of carbon on the industrys cost base. This includes looking at the impacts of changing policy options on the mechanism design under a levy and an emissions trading scheme. An industry level analysis can mask the true impact on a shipping company. There are two key sources of variation: a) The amount of carbon emissions for a ship is strongly linked to fuel consumption, which differs substantially across the ship segments. The cost of carbon will therefore also vary for different ship types. The nature of the products being transported by different ship types may affect the freight rates, and the extent to which the cost of carbon can be passed on as increased freight rates.
b)
Our analysis therefore also considers a bottom-up analysis by ship type. This looks at the impact of carbon cost on the cost base, the extent to which this can be passed onto the ships customers, and the associated implications for 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 Cost to industry Administrative burdens*

Profit of shipping industry
*Costs of administrative burdens are not analyzed
Road and rail more competitive Industry freight rates Seaborne trade volumes
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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) 2000
ETS
Levy
1600
Tonnes Co2 reduced at no cost
Tonnes Co2 reduced at no cost
1200
Emissions to be offset
800
Firms to purchase allowances for tonne CO2 emitted above target line
Central entity to purchase offset credits equivalent to emissions above target line CO2 price +10% for global climate fund
Target Remaining emissions Allocated allowances to firms to emit tonnes of CO2 for emissions under target line: (i) freely, or; (ii) through auction up to 100%
400
0 2010 2015 2020 2025 2030
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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 metric tonne, but current analysis on the technological potential for efficiency gains suggest that all efficiency measures will have been exhausted at that price level. With technological improvements on newer or currently undeveloped technologies, e.g. solar, more measures may become available in the future. Several studies have calculated these by estimating the marginal cost and 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 is little technological potential (known of today) that can be exploited. There are few studies which explicitly considers abatement potential at higher price levels. The most optimistic estimates show a carbon savings potential of 56 percent by 2030. This is equivalent to about 900 million tonnes of carbon annually in reduced emissions. The shipping engineering community has expressed skepticisms about the practicalities of implementing these measures. Some technologies have been available for decades without being adopted, suggesting practical barriers exist. Others are not possible to combine on the same vessel, and there are questions on the assumptions used in the calculations particularly on financing. There are two main implications of this: 1. There are insufficient information to estimate the impact of incremental carbon price on carbon abatement when fuel cost exceeds about $1000 per metric tonne. In theory, an incremental carbon pricing in the sector is expected to lead to 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 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 provides incentives for further R&D.
1200
2. For the purposes of this study we apply a conservative assumption about fuel efficiency savings of 26 percent by 2030. This is also consistent with the IMO business as usual scenario (which assumes implementation of many of these measures) and the effects of implementing a mandatory EEDI. The figure below indicates the expected efficiency potential with respect to total emissions and the wedges for emission reductions discussed on page 15. The maximum efficiency potential is not enough to reach emissions target Figure 3.3 Impact of fuel efficiency on total emissions 2030
Total emissions in reference case

1600
26%
Assumed efficiency gains (basecase)
800
56% Target (57%)
Maximum theoretical efficiency potential
400
0 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.
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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. We assume that the bunker fuel cost reaches $1320 a tonne on average for the fleet in 2030. Forecast from DOE/AEO 2010 used as the basis for bunker fuel. We assume an increasing share of (more expensive) distillate in the fuel mix.
2010
Forecast $ per ton fuel (2010$) 1320

600 0
Fuel
2020
2030
Efficiency & growth
We assume there are improvements in fuel efficiency, driven by technology, fuel cost and EEDI regulations. This leads to a 26 percent reduction in fuel consumption below business businessas-usual by 2030, against a growth in seaborne trade of 3,3 usual percent annually. Starting point is 870 mt CO2 emissions in 2007. We have based our forecast on the CER price (carbon credits for the CDM market). The estimate is based on the current CER-EUA spread and the May 2011 Point Carbon forecast EUA for EUAs, and will be around US$31 by 2020 and US$44 by 2030.
2010
1,25%
annual efficiency gains
Forecast $ per CER (2010$) 44
20 0 2020 2030
Carbon
We have considered four key scenarios :
Policy scenarios
1: Levy, where funds are used to buy offsets to reach target abatement 2. ETS without auction of allowances 3. ETS with 15% auction (as with the EU aviation regulations) 4. ETS with 100% auction of allowances
We assume that the target will be set at 10 percent below 2007 levels (783 million tonnes). tonnes We have also included a 10% additional contributions to a global climate fund as proposed by the key IMO proposals.
10% of 2007
level emissions target
10%
contributions to global climate fund
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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 unbalanced impacts
Low-impact variations gives balanced impact result
High-impact variations can also give balanced result
Levy minimum required to offsets =
$66
ETS with 100% auction = per metric ton fuel 2,6 billion to global fund ETS with 0% auction =
ETS with 100% auction = Levy minimum required to offsets =
$152
per metric ton fuel 41 billion to global fund
Levy minimum + large global fund contributions =
$152
$152
$66
per metric ton fuel 2,6 billion to global fund
$66
per metric ton fuel 2,6 billion to global fund
All models would give the same environmental impact=
592 millions tonnes

CO2 abated
Source: PwC GHG Shipping model
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Impacts: Environmental effectiveness
Environmental effectiveness is fundamentally determined by the emissions target

There are three determinants of environmental outcome (i.e. the amount of carbon emissions abated through the scheme). 1. Emissions cap or target The emissions cap or target, regardless of whether a levy or ETS is 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 business-as-usual emissions. This is the core determinant of the environmental outcome. A stringent cap or target will create greater scarcity and result in higher prices or levies. Conversely, a weak cap will result in lower prices as companies have a reduced incentive to improve efficiency. 2. The size of a levy Under a levy scheme, there are potentially further implications for the 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. 3. Geographical coverage and the risk of carbon leakage Current IMO proposals are intended to cover the entire shipping sector. Inability 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 aviation industry where the sector joins the EU-ETS in 2012. If a regional scheme is implemented, this can result in some degree of carbon leakage, where more carbon is emitted outside the scheme as participants attempt to re-direct activities to other jurisdictions. In the context of shipping, this may be a danger for mechanisms that apply a carbon levy on fuel or require ETS compliance of ships docking within the EU. The 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 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 across different geographies).
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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) CO2 abated (million tonnes)
Cost impact per tonne fuel fuel
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
At 100% reduction target, the levy will = ETS with 100% auction
Source: PwC GHG Shipping model.
Cost of ETS with 100% auction does not vary by target level as companies still need to purchase the same number of carbon credits to meet their obligations.
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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) ($2010)
Deviation from abatement target (100% = Target of 10% reduction below 2007 levels)
Cost impact per tonne fuel
Carbon abated (million tonnes)
Global fund contribution (US$ bn)
(Similar to ETS 100% auction) (Similar to ETS 15% auction)*
Contributions to a global fund increases much and can be similar to auction proceeds under ETS. A higher level of contribution to the global climate funds would increase the contribution of the shipping industry to climate change mitigation. The funds could be used for R&D or climate change adaptation.
232 % 133 % 110 % 100 % 90 % 80 % 70 % 60 % 50 % $66 $59 $52 $46 $39 $33 $87
$152
592
41 12
Carbon abated does not increase with a higher levy.
592 651 592 533 474 414 355 296
2,6 2,4 2,1 1,8 1,6 1,3
Carbon abated decreases with insufficient levy.
Contributions to a global fund falls with lower levy.
Source: PwC GHG Shipping model. * 15 percent auction is a proxy for an auction percentage similar to international aviation under EU ETS
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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

2015
Over time
2030
$152
ETS (100% auction)
$152
$88
74%
ETS with full auction starts with a high auction cost component and increases with the rate of emissions and carbon price growth.
$87
ETS (15% auction)
$87
$28
207%
$66
Levy/ETS (0% auction)
$66
$20
222%
Levy increases very fast in the beginning and growth rates will come closer to the 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.
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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 increase 80% 9% 11% Share of total voyage cost 2030
$86 $618 $66
$1469
ETS auction: 6 % Levy: 5 % 5-11%
+110%
$699
Fuel 89-95%
Bunker base
Sulfur regulation impact
Levy/ETS 0% auction offsets
ETS 100% auction
Max total cost per metric tonne fuel
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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 are allocated to the industry. Allowances can be allocated free to the participants or auctioned. The benefits of auctioning include: Generation of revenue which can be used, for example, to fund mitigation 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 purchase their required number of allowances. In practice, however, grandfathering (allocation of allowances for free based on historical emissions data) has often been the allocation method of choice, particularly when schemes are initially set up to reduce the upfront cost to the industry. The EU ETS is gradually moving away from the free allocation of allowances that took place in Phases I and II towards greater share of allowances being auctioned. At least 50% of allowances will be auctioned from Phase III in 2013, compared to around 3% in Phase II. The aviation sector which will be included in the EU ETS from 2012 has relatively generous emissions caps (2012 emissions capped at 97% of average 2004-06 emissions, falling to 95% in 2013) and has 15% auctioning in 2012 (2013 onwards: to be negotiated).
Impact on sector: Under 100% free grandfathering allocation, each participant is allocated allowances based on historical emissions, rather than the reduction potential or 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 allowances to make a profit. The problem is less likely under a strict cap. Participants under a full auctioning scheme will purchase their allowances at the auction based on their willingness to pay and quantity required. Most importantly the method of allocation affects the amount of revenue paid by the industry as a whole. Under free allocation, allowances are traded within the industry (subject to assumptions about linking to external carbon markets) and 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 may or may not recycle the revenue back into the industry. Efficient participants still have to pay under (full) auctioning when the revenue is not recycled back into the industry. At an individual business level, there will also be a cashflow impact of auctioning. Timing and volumes of purchases of allowances will need to be factored into cash management.
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42
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
+132%
Cost impact on 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
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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: The amount required for carbon offsets Auction proceeds to authorities Additional contribution to global climate fund (10%) After accounting for the purchase of carbon credits, the auction proceeds and contribution to global climate fund are additional revenues raised. These can be used in a number of ways: Recycled back into the sector through investments in R&D and technology development funds; Additional financing to climate change mitigation or adaptation; 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.
These would increase over time driven by the increase in carbon price and abatement requirements over time.
Total outflows from sector range from $29 billion to $67 billion by 2030*
Figure 3.9: Outflows from sector ($2010) Outflows from shipping sector 2015
ETS (100% auction) $29bn
Proceeds from the scheme can raise additional revenues for various uses
Figure 3.10: Additional revenues raised from scheme ($2010) Increase 2015-2030 2030
$41bn
Increase 2015-2030 2030

$67bn
Contributions from shipping** 2015 2020

$27bn
2020
$38bn
2025
$51bn
2025
$34bn
+134%
$23bn
+81%
ETS (15% auction)
$9bn
$17bn
$27bn
$38bn +314%
$3bn $0,6bn
$6bn
$10bn
$12bn
+276% +334%
Levy/ETS (0% auction)
$7bn
$12bn
$19bn
$29bn
+334%
$1,1bn
$1,7bn
$2,6bn
*Includes both offsets, auction contribution and 10 percent contribution to global climate fund, CDM carbon price only.
**Includes auction contribution and 10 percent contribution to global climate fund, CDM carbon price only 44 Source: PwC GHG Shipping model
PwC
Impacts: Costs
Containers will see the highest impact

These impacts may vary within the industry by vessel types. The main different types of ship in the world merchant fleet include: a) b) c) Container Ships, which carry most of the world's manufactured goods and products, usually through scheduled liner services; Bulk carriers, which transport raw materials such as iron ore and coal and vary from handysize (small) to capesize (large) bulkers; Tankers, which are similar to bulk carriers but transport crude oil, chemicals and petroleum products; and The amount of carbon emissions for a ship is strongly linked to fuel consumption, which as a proportion of the cost base, differs substantially across the ship segments. 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 proportionally larger capex and opex cost base, finds carbon cost a smaller proportion of their cost base. Figure 3.12 demonstrates the impact of a carbon levy and ETS on the cost 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 2010
Carbon cost a smaller share of cost base in 2030
Figure 3.12: Components of cost base per shiptype 2010-2030 with Levy and ETS 100% auction (daily costs) 2030 2010 Levy Capex
Container Main Liner Capesize Bulker VLCC Handysize Product Tanker Handysize Bulker 15 % 25 % 29 % 25 % 26 %
2030 ETS 100% auction Carbon

8% 6% 82 % 4,1 % 3,4 % 3,3 % 3,0 % 2,9 % 8% 5% 78 %
Opex
10 % 20 % 19 % 30 % 30 %
Fuel
75 % 55 % 52 % 45 % 44 %
Carbon
9,0 % 7,5 % 7,3 % 6,7 % 6,6 %
16 % 13 % 68 % 19 % 12 % 66 % 17 % 20 % 60 % 18 % 21 % 59 %
15 % 12 % 65 % 18 % 12 % 63 % 16 % 19 % 58 % 17 % 20 % 57 %
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.
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Impacts: Costs
Carbon levy represents a small share of the increase in voyage costs

Figure 3.13 presents contribution of the levy to a containers 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 0% auction
Voyage cost increase +15% +49% +6% $ 162,000 4% Carbon
+30% $ 91,000
82% Fuel
6% Opex 8% Capex
2010
Source: PwC GHG Shipping models
2015
2020
2025
2030
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Impacts: Costs
Carbon cost is more significant under the ETS with full auction
Figure 3.14 presents the contribution of an ETS to a containers 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 100% auction
Voyage cost increase +14% +44% +5% $ 171,000 9% Carbon
+37%
$ 91,000
78% Fuel
5% Opex 8% Capex
2010
2015
2020
2025
2030
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47
Impacts
Mid-range alternative with aviation style auction

Figure 3.15 presents the contribution of an ETS to a containers 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 15% auction 160 140 120 100 80 60 40 20 0 2010
Voyage cost increase
+9% +40%
+3%
$ 165,000
5% Carbon
+33% $ 91,000
81% Fuel
6% Opex 8% Capex
2015 2020 2025 2030
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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 f fuel 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 hig higher 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.
High demand and low capacity results in low profit impact

Figure 3.16: Impact on profits under varying market conditions Demand for commodity Impact on 0,96 profit
Predicted rate impact depends upon impact of carbon price on fuel cost
Figure 3.17: Impact on rates Rate impact Levy
Dirty bulk (iron ore) 5%
ETS 100% auction

11,1 %
Elastic
Inelastic
Tanker 1,5 % 3,5 %
Surplus shipping capacity
0,30 High
Low
Medium
Clean bulk 1,3 % 3,1 %
0,27 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.
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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 increases

Figure 3.18: Absorption of cost increase at 25 percent initial margin Both levy and ETS
And will see the hardest impact on the bottom line

Figure 3.19: Daily loss of profit in 2030 with Levy with 25 percent initial margin on cost base ($2010) Levy/ETS 0% 0%-auction
ETS with auction will increase the impacts

Figure 3.20: Daily loss of profit in 2030 with ETS 100 percent auction and with 25 percent initial margin on cost base ($2010) ETS 100%-auction
Container
71 %
-4 695
-10 879
Handysize bulker (clean)
47 % 2010
-512
-1 186
VLCC
45 %
-1 976
-4 578
Handysize product tanker
38 %
-601
-1 392
Capesize bulker (dirty)
-74 %
2 193
5 082
Source: PwC GHG Shipping models.
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Impacts: Profits
Impact on profits are limited during periods of high freight rates (levy)
Freight rates and a ships 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 sectors 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

Figure 3.21: Profitability impact on a VLCC with 10 percent initial margin on costbase, 2030 (Levy) Share of rate 10% margin 3,1% -1,6% +1,5%
Less impact with higher rates

Figure 3.22: Profitability impact on a VLCC with 50 percent initial margin on costbase, 2030 (Levy) Share of rate 50% margin 2,2% -0,7% +1,5% -$1500 daily
-$2300 daily
49% of cost increase
66% of cost increase
Initial profit margin
Carbon cost
Profit impact
New rate
Carbon cost
Profit impact
New rate
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. 51 PwC
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
Grain transports will see a reduction in profit

Figure 3.23: Profitability impact on a Handysize Bulker (grain) with 25 percent initial margin on costbase, 2030 (Levy) Share of rate Grain -$570 daily 2,5% -1,2% +1,3%
In a few markets for goods with inelastic demand like iron ore, there may be a markup on top of the cost increase
Figure 3.24: Profitability impact on a Capesize Bulker (iron ore) with 25 percent initial margin on costbase, 2030 (Levy) Share of rate 2,8% +2,1% +4,9%
Iron
+$2200 daily
174% of cost increase 53% of cost increase
Carbon cost
Profit impact
New rate
Initial profit Carbon margin cost
Profit impact
New rate
Impacts: Profits
Higher levy or ETS with full auction gives similar cost pass pass-through percentages, Examples of short term impacts but higher $ impact on bottom line
More impact with low rates
Figure 3.25: Profitability impact on a VLCC with 10 percent initial margin on costbase, 2030 (ETS 100%)) Share of rate 10% margin 7,1% -3,6% +3,5% -$5300 daily 49% of cost increase
Less impact with higher rates

Figure 3.26: Profitability impact on a VLCC with 50 percent initial margin on costbase, 2030 (ETS 100%) Share of rate 50% margin 5,2% -1,7% +3,5% -$3500 daily 66% of cost increase
Carbon cost
Profit impact
New rate
Carbon cost
Profit impact
New rate
Grain transports will see a reduction in profit

Figure 3.27: Profitability impact on a Handysize Bulker (clean) with 25 percent initial margin on costbase, 2030 (ETS 100%)) Share of rate Grain 5,7% -2,7% +3%
In a few markets for goods with inelastic demand like iron ore, there may be a markup on top of the cost increase
Figure 3.28: Profitability impact on a Capesize Bulker (dirty) with 25 percent initial margin on costbase, 2030 (ETS 100%)) Share of rate -$1200 daily 53% of cost increase Iron 6,5% 4,5% +11,3% +$5100 daily 174% of cost increase
Carbon cost
Profit impact
New rate
Carbon cost
Profit impact
New rate
Impacts
Linking to another carbon market would affect the shipping carbon price
An ETS is frequently linked to another carbon market to provide greater liquidity. This is achieved by allowing the carbon credits or allowances from other market(s) to be eligible for compliance. This reduces the burden on the industry to meet all the required carbon abatement in-sector. The core levy proposal considered by the IMO (GHG Fund) also involves linking to the carbon markets by basing the levy on the cost required to purchase 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) are eligible for compliance in the shipping ETS, but not vice versa; Unilateral linking where shipping credits or allowances are eligible for compliance in the another ETS, but not vice versa; Bi-lateral linking where allowances are interchangeable between the two ETS and can be used for compliance in both markets. 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 markets credits exhibit a different price and therefore linking with them will exert different price pressures on the shipping allowance or levy.
Based on current IMO proposals, the CDMs credits (CERs) are the most likely source of credits eligible for compliance in the shipping sector. The demand generated by a shipping carbon scheme (whether levy or ETS) would generate s significant demand for CERs, which could substantially improve the prospects of more emission abatement projects in developing countries countries.
Linking to one or more carbon markets can affect the shipping carbon price Figure 3.29 Potential carbon markets to be linked
EU ETS WCI* California*
IMO
CDM (Global)
Voluntary (Global)
New Zealand
* The Western Climate Initiative (WCI) and Californias ETS are due to commence in 2012.
54
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 market-based measure directed at the shipping industry. Currently, for every tonne of fuel consumed, approximately three tonnes of CO2 are emitted. 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 in the world and is the key policy instrument to enable the EU to meet its international GHG emissions reduction target. Historically, the price of EUA (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. The Clean Development Mechanism (CDM) is the second largest carbon market and operates under the Kyoto Protocol. Its credits (CERs) are the most likely 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 policy options and various design features for a market-based measure for the shipping sector, including how it is linked to these existing carbon markets, will impact the price of carbon, the industry and the environment.
A tonne of fuel emits three tonnes CO2 Figure 3.30 Carbon emission from shipping fuel
Expected increase of the price of allowances in two key benchmark carbon markets Figure 3.31 Prices for EU EUA and CER (CDM) credits and allowances EU ETS I & II $ tonne allowance
One tonne of fuel
three tonnes of CO2*
60 50 40 30 20
EUA CER 2005 2010 2015 2020 2025 2030
41% 6,1%
EU price pressures Prices for CDM projects expected to be lower
*Actual relationship is between 3.09-3.17 varying with a.o fuel quality. We have assumed 3.13 throughout this study
Sources: Bloomberg EUA Spot, IETA forecast; CER Based on 2011 CER-EUA Spread, linear extrapolation to 2030 of PointCarbon EUA forecast to 2020, PwC inflation forecasts 55
PwC
Impacts
Banking and borrowing across ETS phases smooths price fluctuations
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. Borrowing: If the price begins to rise because the available allowances are 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 over time as more allowances are borrowed (rather than sharp spikes). Banking: Likewise, if the available allowances are expected to be in excess of the 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 devalued substantially towards the end of an ETS phase. Similarly, if a shipping company believes meeting the future cap is substantially more costly, it may choose to smooth its exposure over time by reducing emissions or purchasing credits now and bank them for the next phase. These attributes therefore reduce price volatility by making allowances interchangeable over different phases, rather than experiencing sharp fluctuations in prices during transition from one phase to the next. The EUA price crashed in April 2006 as it became apparent that there had been an 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. 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.
Impact on sector: 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 regulation, but also its ability to manage compliance costs over time. Banking and borrowing are therefore important policy design features that have implications on a ships cash-flow management. Impact on environmental outcome: The level of banking and borrowing is also important to ensure the credibility of a scheme. Overgenerous limits on banking and borrowing can undermine the environmental effectiveness of a scheme within a given timeframe. A ban on banking can lead to instability and falling prices Figure 3.32: EUA price crash during Phase 1 EUR per allowance/tonne CO2
30
20
10
des.05 des.06 des.07
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56
Impacts
Impact on cashflow
The impacts on costs and profits ultimately feed through to cash and managing this 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. Phasing of a levy Under the current levy proposal, the levy should overall track the price trends of a major carbon market. Within a levy phase, there is no price volatility as the price is 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 expectations, there may be a substantial revision required in the levy when moving into the next phase. For example, if the price set during Phase I was too low to purchase the requisite number of project credits, this may need to be compensated for in Phase II 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.
Banking & borrowing 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 substantially more. Conversely, borrowing allowances from the next phase allows companies to meet current obligations. The level of banking and borrowing between phases may therefore also affect how shipping companies manage their compliance strategy. Shipping companies may choose to hedge against future carbon price increases by purchasing credits today and banking them, especially if they have adequate free cash flow. Conversely, during periods of tight cash flows, a shipping company may choose to borrow from the next phase to meet existing obligations.
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 contribution
Phase I levy too low so higher in Phase II
Phase II lower as external carbon price dropped
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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.
Seaborne trade volumes will decline compared to business as usual
There are additional impacts resulting from the increased freight rates and these are discussed in the following section.
Regional road transport increases
Modal shift is a particularly relevant scenario for the short-sea freight 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 trans-siberian railway. Road transport will increase as a consequence of increased freight rates for 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 impacted. The dynamics are complex and depends upon the ratio of freight costs to the cost of the goods, as well as the elasticity of demand and capacity of domestic producers.
Global seaborne trade volumes declines
PwC
58
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 regional transports, road and rail transports are competing against shipping. Potential for modal shift has been analyzed in a number of studies on the impact of low-sulfur regulations concerning Europe. These studies are highly specific about routes and transport corridor options and impacts vary greatly depending upon local factors. Some general principles may be transferable to other regions around the world. These are indicated in the figure below. It is also important to note that if it does happen it is likely to be from the impact of rising fuel cost due to sulfur regulations rather than carbon cost. The latter has a smaller impact on the total cost increase as have been shown above in this study.
Trade volumes could remain broadly unchanged, but the sources of goods may vary. Locally produced goods may become more competitive vis-a-vis faraway producers, but so will goods from neighboring countries. Technically these still count as trade, so it is more about a shift from faraway producers to closer sources (not just local). Currently shipping is the most carbon efficient mode of transport, and a shift towards road transport may increase the carbon footprint of the products and undermines the environmental impact of a carbon regulation. However, over the longer run, this depends on the relative improvements in carbon efficiency of land vs. sea transport as there are substantial incentives by many countries to promote low carbon land vehicles.
Modal shift is likely to happen, mostly stemming form the increase in fuel cost
Figure 3.35: General findings regarding modal shift
Specific findings from Europe
Fuel cost increase would transfer through freight rates Rate increases would decrease competitiveness of sea transport In some instances, sea transport would become uncompetitive and new patterns of transport would emerge
Impacts at low fuel price scenario at $500 per metric ton could give average volume loss of 15 percent Volume loss at fuel cost of $1300 per metric ton may reach 22 percent Severe impacts for particular routes (i.e english channel) 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
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59
Impacts
Future trade routes will shift eastwards

Rise of the emerging economies The patterns of global trade have shifted noticeably over the last twenty years. In 1990 the developed economies dominated the trade map. Europe was responsible for over half of the worlds exports, but these were mostly intra-European flows. The last twenty years saw global manufacturing shift swiftly to lower cost countries, which boasted cheap labour and good trade links with which to provide Western markets with cheap consumer goods. By 2009 the emerging economies, and developing Asia in particular, had gained significant share of worlds exports. Imports into developing countries are also growing. Robust industrial growth has boosted the demand for raw materials, and the emergence of middle classes has led to increased demand for finished products and consumer goods, and more diversified and sophisticated food items. Expected future growth of trade and shipping The global economic recovery from 2010 will be dominated by growth in the emerging economies, in particular from fast-growing Asian countries like China, India and Indonesia. PwC report on the Future of world trade: Top 25 sea and air freight routes in 2030 finds that the divergence in economic growth prospects between emerging and developed economies is expected to be mirrored in future trade patterns. Trade routes between emerging economies and developed economies and between emerging economies and other emerging economies are expected to become more significant over the next twenty years. 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 emerging economies

Figure 3.36: Top 25 sea and air freight bilateral trade pairs in 2009
2030 is expected to see increased trade between China and developed countries
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 +
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PwC
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 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 carbon pricing represents a relatively small increase in total shipping transport costs. Increased shipping cost raise the cost of carrying out trade, which may have an impact on the levels and distribution of trade. The overall level of trade Trade in some products is particularly affected by changes in maritime transport costs, where transport costs as a proportion of the total cost is relatively high. Figure 3.38: The impact of maritime transport costs on the cost of production
Product Agriculture Raw materials Crude oil Manufactures Ad valorem (%) 10.89 24.16 4.03 5.11 MTC ($/tonne) 80.64 32.59 18.09 173.94
The distribution of trade Export-orientated economies or countries dependent on imports are likely to be most affected when the cost of trade increases. The market shares of different producers may therefore vary as a result of increase in shipping costs. Studies have found that Developing and least developed countries whose trade in price-sensitive goods often comprises a significant component of their export potential might suffer disproportionately from an increase in trading costs (WTO, 2003). The OECD identified several countries, mostly remote nations with very small markets, face such high transport costs that they affect most exports significantly. Average ad valorem maritime transport costs of exports for Guam (48%), Nauru (40%), Christmas Islands (34%), Togo (29%), Guinea (25%), Tonga (22%), Sierra Leone (21 %) and Pitcairn (17%) were found to be substantially higher than the average for developing countries of 7 % (OECD, 2008). Directional imbalance in trade between countries implies that many carriers are forced to haul empty containers on their return trips, resulting in cost imbalance in one-directional and return shipping (Fuchsluger, 2000) . For example, exports from the USA to selected Asia ports were found to be only onethird of the volume of those on the return trip, with correspondingly lower shipping rates to Asia (ibid). As carbon cost rise, the impact on freight rates may not be linear across different shipping routes, with some routes experiencing a disproportionate increase in their shipping costs.
Source: Maritime Transport Costs Database, WIT, Korinek & Sourdin (2009)
Trade levels in raw materials and agricultural products are therefore most likely to be affected by an increase in transport costs. A doubling in the cost of shipping for agricultural goods is found to be associated with a 42% drop in trade on average (OECD, 2008).
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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 selected products and product markets. Looking at iron ore market in China, the study finds that a 10% rise in the cost of bunker fuels is found to increase the average freight rate to China by around $3 per tonne of metal (2.7% increase in the cost per tonne of metal) . Iron ore exporters into China will suffer a fall in market shares and margins, while domestic producers stand to gain. Larger and closer producers (e.g. Australia) appear to be less affected while producers further away (e.g. Brazil) and smaller producers (e.g. India) tend to be affected more. Figure 3.39: The change in market shares and profitability of iron ore exporters to China as result of a 10% increase in the cost of bunker fuel
Producer Australia India Brazil South Africa Iran Rest of world Domestic producers Original market share in China 29.4% 11.2% 8.3% 1.6% 0.4% 2.7% 46.0% Change in market share -0.90% -6.50% -2.40% -0.90% -0.40% -2.70% +13.6% Change in margin ($ per tonne of metal) -0.9 -1.4 -4.1 -2.7 -2.8 -4.1 +1.6
Our analysis finds that the cost of a market-based measure, with the assumed 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 those outlined in Figure 3.38. This translates in to an increase in the imported price of iron of 0.71%, or $0.79 per tonne of iron, with an approximately similar decrease in the quantity of iron imported. Figure 3.40: The impact of carbon costs on Chinese price of imported iron
Average added cost for Cost pass-through for sea Change in price of sea importers ($ per tonne importers (%) imported iron (per tonne) of metal) 1.53 51.7 0.79 Change in price of imported iron (%) 0.71
Source: Vivid Economics (2009), PwC analysis. Assumes similar proportionate demand reaction between a 5% and 10% increase in fuel price.
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%.
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Forbruket ker og henger nrt sammen med kt Annex vekst og velstand
PwC
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): Capesize Bulker (148,000 dwt) Handysize Bulker (30,000 dwt) Handysize Product Tanker (43,500 dwt) 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 Emissions / Abatement Cost impact (USD) Different allocation scenarios Linkage with CER Market Cost impact relative to other costs Profit impact An integrated overview of the model is presented overleaf.
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Industry-level analysis
Cost of compliance
Cost of compliance
Ship-level analysis
Top-down
Bottom-up
Top-down
Bottom-up
64
Annex: Methodology
Model overview
BAU Emissions
Core policy decisions
Size of emissions target or cap
ETS or levy
Linkage to another carbon market Mechanism design policy options
Global price for CERs Levy ETS
Allocation method
Abatement Costs Cost of carbon Capex Outcomes Opex Profit impact on industry Fuel Costs
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Cost to industry
Industry freight rates

Key
Core policy decisions Key inputs Design options Outcomes
Annex: Methodology
Overview
The model overview shows that the modelling process is split into three interacting modules, running across the industry-level and ship-level components of the model. Core policy options Mechanism design policy options Outcomes
Mechanism design options Allocation method : The allocation method (free allowances versus auctioned allowances) does not affect the market price of carbon, since demand and supply 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 both 100% free allocation and 100% auctioned alllowances as the two extreme cases, as well as one intermediate scenario (where the auction percentage was 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 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) ETS or levy : Throughout the main document, results for a levy are presented, 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. Linkage to another carbon market : We assumed: i. That under a levy, the funds raised will be used to purchase CER allowances.
Cost to industry
Industry freight rates Profit impact on industry
Outcomes We have considered in our quantitative analysis two primary impacts of the proposed carbon pricing regulations on the shipping industry : 1) Cost base. The application of a carbon levy or introduction of a carbon ETS raises costs. These costs largely raise proportionately with fuel consumption. Our analysis considers the likely financial cost impact of regulatory scenarios on both the whole industry, and individual market segments. 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.
ii. That under an ETS there is linkage with the CDM market, so shipping companies can and will purchase CDM credits to meet their compliance obligations.
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Annex: Methodology
Cost Modelling Assumptions

This section provides details on our data sources and parameter choices. Emissions BAU Emissions Emissions were modelled as a fixed by-product of fuel consumption, using a carbon intensity of 3.13 tC per tonne of fuel (the actual coefficient is between 3.093.17 varying with fuel quality). Fuel consumption grew from the baselines outlined in IMO 2009, following the growth assumptions outlined in Figure A.1. Abatement The difference between BAU Emissions and the emissions cap is the abatement. Our model has assumed that market-based measures would only bring about outof-sector abatement. This implies that abatement costs are always higher than permit prices from other global ETSs (see discussion on slide 18). This contrasts with the IMO Expert group (2010) assumptions, which included a small degree of in-sector abatement. We have also included analysis of a scenario with an abatement impact, but only at industry level given differing ship abatement potentials. Costs Costs are of four types: capital costs, operating costs, fuel costs and carbon costs. 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 Economic Growth Seaborne Transport Growth Emissions growth Fuel efficiency improvements Value 3.6% pa 3.3% pa 2.65% pa 1.25% pa Source IPCC A1B scenario IMO (2009) base case IMO (2009) base case IMO (2009) base case + impact of EEDI (Our assumed basecase is equal to the sum of the two) 2010 Period Average
67
Operating costs 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 maintenance, insurance, administration, and drydocking costs. Capital costs Capital costs (capex) estimates are taken from CE Delft (2010) which estimates 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. Fuel Cost We have assumed that following the onset of low-sulfur regulations (MARPOL VI annex), there will be a gradual phasing in of the low-sulfur fuels starting at 20 percent in 2010, reaching 80 percent in 2020, and 96 percent in 2030. The forecast for future fuel prices are based upon the US Department of Energy Review (2010). The price of low-sulfur fuel is 60 percent more expensive than bunker fuel (from AEO forecast), and 80 per cent more by 2030. The increase 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 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 is however very probable. Our forecast is illustrated in Figure A.3 overleaf.
Comments
26% improvement from 2010 to 2030 implies annual rate
Exchange Rate EUR : USD

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Figure A1: Parameters used in the PwC GHG Shipping Model
Annex: Methodology
Further Assumptions
Carbon prices Given the international nature of shipping, and the proposed role of the CDM market in meeting the shipping industrys 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) ETS (15%auction) ETS (0% auction) Levy Figure A.2
$152 $87
Forecast $ per ton fuel (2010$) 1320

600
Forecast $ per CER (2010$) 44

20 0 2010 2020 2030
$66 $66
2010 2020 2030 0
Figure A.3
Figure A.4
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Annex: Methodology
Profit modelling
To establish the impact of increased costs on segment profitability we have used data on pass pass-through ability, and make assumptions on freight rates. Figure A.5 below provides in detail the calculation process and assumptions made, given a 25% mark-up of freight rates on the cost base. The elas up elasticities of freight rates with respect to fuel costs are drawn from Vivid Economics (2010).
Figure A.5: Daily profitability impact in 2030 on different ship types (assuming 25% mark mark-up)
Ship Type Daily cost of fuel, US$ Capex and opex, US$ Total cost base, US$ Fuel price, forecast US$ Daily fuel consumption, tonnes Cost of carbon (per tonne of fuel), US$ Daily cost of carbon, US$ Elasticity of freight rates relative to fuel cost Estimated daily freight rate, (implied by mark-up) Change in freight rates due to impact of carbon cost, based on elasticity estimates Change in profits per day US$ New mark-up after pass-through of costs
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 markup)). This is a gross simplification of how the sectors freight rates and profits are determined, and is intended to illustrate potential impacts only.
Capesize Bulker 59,365 25,163 84,528 1,321 45 66 2,947 0.98 105,660 5141 2,193 27%
Handysize Bulker 21,767 13,490 35,257 1,321 16 66 1,081 0.26 44,071 569 -512 512 23%
Handysize Product Tanker 31,661 20,502 52,163 1,321 24 66 1,572 0.30 65,204 971 -601 23%
VLCC 89,047 42,280 131,327 1,321 67 66 4,421 0.30 164,159 2445 -1,976 23%
Container Main Liner 133,571 22,417 155,988 1,321 101 66 6,631 0.20 194,985 1936 -4,695 21%
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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)
Ship Type Daily cost of fuel, US$ Capex and opex, US$ Total cost base, US$ Fuel price, forecast US$ Daily fuel consumption, tonnes Cost of carbon (per tonne of fuel), US$ Daily cost of carbon, US$ Elasticity of freight rates relative to fuel cost Estimated daily freight rate, (implied by mark-up) Change in freight rates due to impact of carbon cost, based on elasticity estimates Change in profits per day US$ New mark-up after pass-through of costs
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 markup)). This is a gross simplification of how the sectors freight rates and profits are determined, and is intended to illustrate potential impacts only.
Capesize Bulker
Handysize Bulker
Handysize Product Tanker
VLCC
Container Main Liner
59,365 25,163 84,528 1,321 45 66 2,947 0.98 92,981 4524 1,577 11%
21,767 13,490 35,257 1,321 16 66 1,081 0.26 38,782 501 -580 580 8%
31,661 20,502 52,163 1,321 24 66 1,572 0.30 57,380 855 -717 8%
89,047 42,280 131,327 1,321 67 66 4,421 0.30 144,460 2152 -2,269 8%
133,571 22,417 155,988 1,321 101 66 6,631 0.20 171,587 1704 -4,927 7%
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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
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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 IETAs 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.
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Annex
Glossary
BAU Business as usual. BAU abatement The growth rate for seaborne transport minus expected growth rate of emissions, assuming efficiency gains. See also reference case emissions. Capital expenditures The cost of purchasing and financing a ship (in this study). CDM and CER The UN Clean Development Mechanism which issues emissions allowances (Certified Emission Reductions) to certified abatement projects. Compliance cost See cost to industry. Contributions to global climate fund Contributions to an international fund, which may be established to provide financing for carbon abatement or impact adaptation purposes. 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 any other sources of revenue such as ETS auction revenues and contributions to a global climate fund. These are the direct costs from compliance, i.e. paying the levy or procuring the emissions certificate, and do not include any additional administrative burden. Costs per ton of carbon abated The total compliance cost divided by the MBM abatement. EEDI Energy Efficiency Design Index. EEDI abatement The emissions reductions stemming from the implementation 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 implementation of EEDI. 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). EU ETS and EUA The European Emissions Trading Scheme, on which European Union Allowances are traded. 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. Fuel price The weighted average forecast price of bunker and distillate fuel (see methodology section). In-sector abatement Carbon reductions that take place within the shipping sector. MBM Market-based measures MBM abatement. This refers to the carbon reductions resulting from implementation of the market-based measures (levy or an ETS) Abatement may occur out-of-sector or in-sector. Net emissions This is used to describe emissions generated by international shipping minus those emissions offset through carbon reduction projects undertaken outside of the international maritime sector. Operating costs The recurring expenses related to the operation of a ship (see methodology section). Out-of sector abatement Carbon reductions take place outside of the shipping sector, funded from the proceeds of a shipping carbon scheme. Reference case emissions The scale of carbon emissions in the absence of regulations or any efficiency measures. Target emissions/Cap The objective for net emissions from the shipping sector. The target is expected to be set by an appropriate international body such as the UNFCCC or IMO.
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Shipping GHG PWC Final

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A game changer for the shipping industry industry?

Contact: Team lead Ivar Strand: ivar.strand@no.pwc.com

Scope and objective

Summary of key findings

Considerable fuel cost increase as fleet shifts to low-sulfur fuels

Fuel cost increase would drive efficiency gains

Dramatic reduction of fuel use and emissions since 2008

Metric tons CO 2 (million) 2000

USD per metric ton fuel ($2010) 1320

gram fuel/ton mile 11

Fuel consumption (International fleet)

Index 1,0 0,9

1500 1000 500 0

0,8 0,7 0,6

7 0 1990 2010 2030 2008 2009 2010

Summary of key findings

Certificate owners (shipoperators/ owners) can trade certificates in market

Central authority engages in market to purchase offsets

Ships to pay levy on fuel

Summary of key findings

Impacts on the shipping industry

Metric tons C02 (million) 2000

Abated through efficiency gains

Abated through market-based measures

41 billion to global fund

41 billion to global fund

2,6 billion to global fund

Summary of key findings

Impacts on the shipping industry

Seaborne trade volumes would decline

Container Main Liner Capesize Bulker

9,0 % 7,5 % 7,3 % 6,7 % 6,6 %

VLCC Handysize Product Tanker Handysize Bulker

Sulfur regs impact

Carbon high case impact

New fuel price

Three key issues will be addressed

1 Context 2 Options 3 Impact

Most emissions are from cargo transport

Global shipping; 3,3 % Aviation; 1,9 %

Source: IMO 2009

Shipping is the most carbon efficient mode of transport

Shipping is the most carbon efficient mode of transport

Larger vessels are more carbon efficient

Average load Max load

Source: IMO 2009: * 747-F

Massive efficiency gains required to reduce emissions

100% more emissions if unconstrained growth alongside growth in seaborne trade

Target for reductions at 783 million tonnes

0 1990 2000 2010 2020 2030

Potential to reduce emissions is substantial through existing proposals

Figure 1.6: Abatement potential

The impact in 2030

592 Abated through marketbased measures

783 Remaining emissions

0 2010 2015 2020 2025 2030

Sources: IMO 2009, 2010; PwC GHG Shipping model

Figure 1.7 Global fuel reduction estimate 2008-2011

Speed reductions across the fleet 2008-2011

Fuel consumption reduced by 30-40 percent 40

Index 1,1 1,0 0,9 0,8