Shipping's carbon bubble: Banks need to climate-proof $400 billion shipping debt

Navigating the ship that brings you the iPhone in your pocket or the trainers on your feet is an exercise in planning and risk mitigation. In a true example of diligence and professionalism, captains ensure the safety of crew and vessel by taking account of possible routes, weather and tides when plotting a course to the destination.

So, for an industry that prides itself in carrying 90 percent of global trade, it seems reasonable to expect the same level of diligence from all of those at the rudder of the global shipping industry as we approach the onset of climate regulations, be they regional or global in their initial form. But, this is not what we see.

As 18 months of research from Carbon War Room and UMAS reveals with its concluding report this week, top banks holding up to $400 billion of shipping debt are steaming ahead without an understanding of these climate transition risks or lending programs in place to keep assets competitive. 

"Navigating Decarbonisation" demonstrates for the first time that the financial impacts of decarbonization are indeed material and will require management. It also suggests that pragmatic enhancements of due diligence by financiers, shipowners and shareholders can help ensure that the first step of decarbonization is profitable and successful.

It may be tempting to dismiss the urgency of managing these risks in the face of truly challenging, unprecedented market conditions in much of the shipping industry. This thinking should be questioned vociferously; a new-build vessel financed today will very likely will be competing under some form of a carbon price before its first dry-dock — a period of scheduled maintenance when efficiency modifications also can be made. Risks need to be assessed and managed today.  

Amid the findings of this work, three key points stand out:

1. Under carbon pricing, ships may have to operate at slower speeds or undergo expensive retrofits to remain competitive.
2. Ships with high operating costs as a result of anticipated climate regulations could be vulnerable to asset devaluation or even illiquidity.
3. There is little evidence that most financiers are assessing vessel efficiency, working to anticipate climate transition risks, or considering lending programs to keep assets competitive.

Let's be clear, we are talking about regulations that could affect over 50,000 vessels in the coming decade.

While our conclusions don't support a future as negative as that suggested in the first carbon bubble analysis by Carbon Tracker in 2011, there are similarities.

Like the fossil fuel sector, shipping is suffering from a glut in supply, which is driving consolidation and inhibiting new investments. Last month South Korea's government announced a $5.6 billion rescue package for the nation's shipping industry. That wasn't enough to stop Hanjin Shipping — which once accounted for 8 percent of U.S. maritime trade — from declaring bankruptcy.

In addition to this, the industry is putting plans in place to comply with the hugely capital-intensive ballast water management convention this year and a global sulfur cap in 2020. Research by KfW IPEX bank suggests the combined effect of market conditions and the need for capital expenditure may lead to the scrapping of 13 percent of the merchant fleet.

It is no wonder that many industry voices have said that now is not the time to add to their burden, but even those voices have begun to wane. International shipping accounts for 2.4 percent of global emissions and future regulation is certain. 

In October, at the U.N.'s International Maritime Organization (IMO) in London, over 170 countries agreed to deliver a draft climate plan by 2018, ahead of a global strategy by 2023. As political discussions stand today, shipping may enter into the European Union's ETS by 2023 if the IMO is unable to deliver.

The Carbon War Room wants to see the first step of decarbonization be a success. If financiers, shipowners and shareholders act now to ensure that due diligence practices look beyond the current crisis, decarbonization can be more than successful. It can be an opportunity for innovation and prosperity.