Studies show that about 3% of global carbon dioxide emissions can be attributed to ocean-going ships. In fact, if global shipping were a country, it would be the sixth largest producer of greenhouse gas emissions. More than 90% of global trade is carried across the world’s oceans by some 90,000 marine vessels. Still, seaborne trade is much more economical and environmentally efficient than other modes of transportation.
The International Maritime Organization (IMO), part of the United Nations, works to reduce and prevent marine and atmospheric pollution by ships. IMO has been implementing various, gradual guidelines to reduce the carbon footprint so that the industry grows in a sustainable manner and supports a greener economy.
Starting January 1, 2020, IMO will be reducing the limit for the amount of sulfur in fuel oil used onboard ships operating outside of designated emission control areas from 3.5% mass by mass (m/m) to 0.50% m/m. Both crude oil and heavy fuel oil, a type of bunker oil that is derived as a residue of crude oil distillation, contain sulfur. Following combustion in an engine, sulfur oxides are emitted. Sulfur oxide pollution can be harmful to human health; cause acid rain, which hurts crops, forests and aquatic species; and contributes to the acidification of the oceans. Knowing that this policy change could be disastrous for the industry, IMO allows ships to switch to using either compliant fuels or alternative options, as long as those options are effective in reducing sulfur content limits.
Based on this, shipping companies are likely to respond by
- using new oil blends that meet the sulfur restrictions
- switching to another fuel, such as liquefied natural gas
- continuing to purchase heavy fuel oil but install scrubbers to reduce the sulfur oxides output to meet the requirement
- using hybrid technology, such as some oil with electric or solar power.
Regardless of strategy, shipping companies will incur large costs in order to abide by the new sulfur emissions guidelines, which could jeopardize their already stressed balance sheets. Maersk Line, one of the largest companies, estimates that these new regulations will result in an increase of $200 million in fuel costs per carrier. Many businesses likely will pass on some of these costs to customers. Major carriers already have implemented a low-sulfur surcharge, which will likely increase in the years ahead.
Experts estimate that freight rates will rise 15-20% as a result of the new emissions standards. In today’s world, where margins are shrinking because of aggressive competition, this increase in freight price could majorly impact a variety of businesses. Here are three possible scenarios.
Case 1: Project-oriented companies with high-gestation deliveries
For contractors, most large-scale projects are awarded on a turnkey basis through an e-bidding system with no clause to factor in an increase in supply chain costs. For example, let’s say Company ABC bids for the construction of a 2,000-megawatt power plant on a fixed rate per unit basis. Because of aggressive competition from other service providers, Company ABC factors minor variations in logistics costs into its budgetary workings, rather than adding protective clauses to its contracts. Company ABC wins the contract but now suddenly faces increased freight costs for its equipment, which is sent via ships from around the world. In this competitive market, where companies work on minimal margins, the 10-15% logistics cost escalation could severely dent Company ABC’s net profitability from the venture.
Case 2: Logistics companies with long-term contractual obligations
Company XYZ is a door-to-door logistics service provider with a core focus on end-to-end project cargo movement. When Company ABC won the power plant bid, it contracted with Company XYZ to transport the power plant’s equipment within a span of 18 months on fixed-rate terms. Although Company XYZ was initially happy with the contract, after the equipment movement started, the new low-sulfur fuel surcharges severely impacted Company XYZ’s bottom line and made the project unviable.
Case 3: Organizations with diversified supply chains competing head-on with localized manufacturers
Global automakers such as MG Hector and Jeep are entering the very competitive Indian mid-segment car market. Assuming their strategies are to import the key components and only assemble the cars in India initially, increases in freight rates could have a negative impact on their pricing. This would make it difficult to match the offerings of local car manufacturers, such as Maruti Suzuki, and delay their market penetration because of lower sales volumes.
In conclusion, although the new IMO regulations will help to protect the environment and should be viewed as a positive step forward, there are many side effects that companies and consumers will need to grapple with. If they have not already, industries, companies and consumers should start budgeting for the inevitable shipping costs increases that are part of greener global trade.