Smoke on the water
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Shortly before Easter negotiations over a greenhouse gas emission “pricing mechanism” for the global shipping industry reached a conclusion. By majority vote (63-13), members of the International Maritime Organisation (IMO) agreed to a proposal employing a dual-target global fuel intensity (GFI), a two-tier carbon price, and a trading mechanism.1
Although the talks fell short of voting through a global carbon price — deemed by many, including this author, as an essential driver of shipping decarbonisation — the proposal still represents a victory for climate policy multilateralism, in what is quite clearly a very hostile environment (see Full steam ahead, or steady as she goes?).
The GFI compels ships to gradually switch away from burning carbon intensive bunker fuel, and towards low carbon intensive alternatives. It starts with a ‘Base Target’ which is the minimum compliance carbon intensity threshold that all ships must achieve on an annual basis. The IMO have introduced a second, more ambitious GFI, known as the ‘Direct Compliance Target’ that is meant to incentivise early adopters of low carbon marine fuel technology.
The GFI targets are set against a 2008 global reference point of 93.3g of CO2e per MJ on a well-to-wake basis. Under the base target, ships must initially reduce their GFI by 4% in 2028 against the 2008 reference point. It then gradually tightens to 30% below 2008 levels by 2035. Meanwhile, the direct compliance target starts at 17% below 2008 levels by 2028, increasing every year to 43% by 2035. Under both targets the percentage reduction in the GFI required gets steeper and steeper, forcing ships to continually increase their GFI performance.2
However, even if all ships achieved the direct compliance target it would still fall far short of the IMO’s earlier emission reduction commitment. Recall that back in 2023 IMO member nations agreed to cut shipping emissions by at least 20% compared to 2008 levels by 2030 (striving for 30%), at least 70% by 2040 (striving for 80%), and to reach net zero emissions around 2050. By contrast, the adopted framework focuses on a reduction of at least 8% (base target) and 21% (direct compliance target) by 2030 respectively.
A two-tier system
Here’s how it works.
If a ship’s annual GFI falls below the direct compliance target it can earn surplus units (SU) proportional to how much it outperforms the target. The owner of the ship can choose to sell the SU to ships that are underperforming, bank the SU for up to 2 years to cover future use, or alternatively, the owner could decide to voluntarily cancel the SU as a mitigation contribution.
However, if a ship achieves partial compliance (i.e., it cuts its GFI below the base target, but not sufficiently to meet the direct compliance target), then it is deemed to be in Tier 1 compliance deficit. The owner must purchase Remedial Units (RU) equivalent to the deficit multiplied by the price of a Tier 1 RU (starting at $100 per tonne of CO2e). The funds raised from this levy go into the IMO Net Zero Fund, of which more on that later.3
Finally, if a ship fails to cut its GFI with the base target then the ship incurs both a Tier 1 and a Tier 2 compliance deficit. As before the ship owner must cover the Tier 1 compliance deficit with Tier 1 RU. There are a number of ways that the Tier 2 compliance deficit can be met including, purchasing Tier 2 RU (starting at $380 per tonne of CO2e), buying SU from ships that have achieved Tier 2 compliance, or using surplus SU it may have banked from a previous compliance period.
Narrow gap creates volatile market
Analysis by Transport & Environment finds that the pricing mechanism could generate around $10 billion per year from 2028 for the Net Zero Fund (NZF). The majority of this funding is expected to come from the sale of Tier 1 RU. At least in the short term, Tier 2 compliance costs are likely to be met through the purchase of SU from ships outperforming the direct compliance target. $10 billion is a drop in the water. It’s nowhere near enough to make a big dent in the $300 billion in investment required over the next five years to be on course to meet the IMO’s targets, or indeed to help offset the impact on those less developed countries hit hardest by the mechanism.4
However, the narrow gap between the base target and the direct compliance target (13 percentage points) could lead to volatile SU prices, NZF revenue instability, and hinder the adoption of zero/near-zero GHG emission (ZNZ) fuels such as green methanol, ammonia and hydrogen.