Headwinds hinder the Poseidon principles

In July 2023, the International Maritime Organization’s Maritime Environment Protection Committee (MEPC) will consider revising the UN agency’s strategy on greenhouse gas emissions from ships. Starting from a current target of reducing CO2 emissions from ships by at least 50% by 2050, based on 2008 levels, influential governments are striving to accelerate to net-zero or even zero by 2050.

The change would also apply to the “decarbonization path” adhered to by the Poseidon Principles – launched in 2019 as a framework for financial institutions to assess the alignment of their shipping portfolios with IMO greenhouse gas emissions targets.
By the end of 2022, 30 shipping banks with around $200 billion in available ship financing (two-thirds of the market) had subscribed to the Poseidon Principles. Signatories include a standardized credit agreement clause in each new financing agreement, requiring shipowners to provide specific data to their financiers. In order to measure and manage progress, lenders and lessors will apply the “climate adaptation” principle to all credit products where one or more ships fall within the purview of the IMO. They also commit to sharing “climate adaptation” results annually.

Banks are already actively assessing owners’ environmental credentials before investing in newbuilds and retrofitting older ships. Société General’s global head of maritime industries, Paul Taylor, said at the Marine Money Ship Finance Forum in London in January that each shipping client is evaluated for its commitment to net zero and the quality of reporting on sustainability issues.

As the IMO rules themselves evolve, alignment also requires the ability to adapt. The Poseidon Principles were updated in September 2022 to anticipate a shift in the MEPC towards a net zero target for ships by 2050. However, headwind is expected at the forthcoming MEPC for a proposed switch from ‘tank-to-wake’ accountability for greenhouse gas emissions from ships to a broader ‘well-to-wake’ assessment that considers the entire fuel value chain – a change , already anticipated by another revision of the Poseidon Principles last year.

“The Poseidon Principles were updated in September 2022 to anticipate a shift in the MEPC towards a net zero target for ships by 2050. However, headwind is expected at the forthcoming MEPC for a proposed shift from tank-to-wake accountability for greenhouse gas emissions from ships to a broader well-to-wake assessment that considers the entire fuel value chain.”
James Clayton, Director, Campbell Johnston Clark.claim and responsibility

While the true ambition of shipping’s environmental aspirations post-MEPC may again make headlines, the way climate adaptation is assessed will continue to test a set of principles consistent with IMO-specified data types, sources, service providers and technical guidelines are bound.

Classification societies and other recognized organizations are required to derive unbiased carbon intensity performance for participants in the Poseidon Principles to enable signatories to assess and report climate alignment. In practice, portfolios are assessed for carbon intensity, based on the IMO’s approach of establishing a carbon intensity indicator for each ship to measure the efficiency in transporting goods/passengers in grams of CO2 emitted per cargo capacity and nautical mile.
The IMO’s CII became mandatory from 1 January 2023 under MARPOL Annex VI and rates existing vessels on an AE scale reflecting CO2 emissions versus haul miles.

In theory, the IMO approach would reward owners on the preferred “decarbonization path” with a better CII rating, with lower-carbon vessels outperforming other vessels of their type/size and proving attractive to charterers. Similarly, a Poseidon funded portfolio would be characterized by a high volume of aligned ships, high loan values ​​associated with aligned ships, or a combination of these factors.

Effects on the real world

Indeed, the programme’s own scoring mechanism has revealed how shipping’s aspirations towards sustainability can be quickly thwarted by real-world events. For example, the recently released Poseidon Principles Annual Disclosure Report for 2021 showed that only seven of the 28 signatory institutions achieved their alignment targets, with an average score of 9.7% over target, an increase from the 7 % achieved in 2021.

The poor alignment scores are said to have been heavily driven by the impact of Covid-19 on the cruise industry. During the lockdown, many cruise lines have warmed up their ships and run them on conventional carbon-based fuels. Inevitably, with haul miles limited or sometimes zero during a shutdown, carbon intensity performance deteriorated even though cruise ships produced far fewer emissions in absolute terms.

When cruise ships were reported separately for 2021, they were on average 46% over alignment, while cargo ship portfolios, which were reported separately, were almost aligned at just 0.8% over target.

Waiting for answers

Although the CII is now in effect, owners across various industry segments continue to highlight perceived shortcomings. A leading bulk carrier owner has pointed out that since ships burn more fuel than ballast, a ship continuously sailing unladen could achieve A-band performance where the same ship sailing fewer days laden would produce equivalent emissions , but would achieve a C rating. The scenario, which was clearly not foreseen in reality, nevertheless underlines the vulnerability of the system to manipulation: a ship waiting to be loaded and having a tender to enter port could take the opportunity to accumulate miles in ballast, to improve its CII rating.

Again, as a calendar-based system, a ship’s CII rating may be penalized arbitrarily based on days in port within the confines of a given year, when a rolling format could account for a standard deviation.

The methodology underlying the CII will be reviewed, even though the instrument is now in force. Over the past year, relevant committee work limited a review of the way carbon emissions were estimated on ro-ro ships. However, it was also announced that correction factors for severe weather and waiting times would be reviewed in 2025.

The MEPC Intersessional Working Group on Greenhouse Gases already had comment from the World Shipping Council (WSC) on the IMO Data Acquisition System (DCS) used to derive the CII. One passage suggests “breaking down the reporting of cruising and idle fuel consumption for different fuel consumers (main propulsion engines, auxiliary engines and boilers) and indexing the emissions of the cargo carried versus the rated capacity”. In another, she advocates “recognising that when quantifying the cargo carried, it is important to recognize the fundamental differences between ship types and thus the critical importance of using appropriate cargo units for each ship type”.

It is expected that the technical guidance on the Poseidon Principles will evolve as the IMO creates new guidance or as the Poseidon Principles Association decides to interpret the IMO’s original strategy differently.

fuel discussion

However, other questions also play a role that call into question the decision-making basis of the IMO and thus also the Poseidon principles. Some wonder whether CO2 emissions can really be taken as the only indicator of the environmental impact of shipping.

While it plays an important role in removing SOx and 85% of NOx from ship exhaust, claims of the extent to which LNG used as ship fuel reduces total greenhouse gases are hotly contested. When burned, LNG is said to produce 20 to 25% less CO2 emissions than, for example, fuel oil, but the Transport & Environment campaign group cites IMO’s own figures to state that – depending on the ship’s engine installed – between 0.2% to over 3% of the LNG is not burned at all.
Because LNG is 90% methane, unburned fuel flowing through the engine is mostly a gas that traps 86 times more heat in the atmosphere than the same amount of CO2 over a 20-year period. T&E claims that around 80% of the LNG burned by marine engines today results in worse overall greenhouse gas emissions than conventional engines that run on fuel oil.

The same study also suggests that to meet the Paris Agreement’s goal of limiting global temperature rise to 1.5°C by 2100, recently ordered LNG-capable ships will need to be upgraded to use scalable zero-emission solutions, or before their end of life have to be scrapped. According to a recent study by the UCL Energy Institute, the value at risk of the LNG-enabled fleet could be around US$850 billion by 2030.

Separately, the UCL study highlights how pushing environmental regulations carries its own risk of creating stranded assets. Ship scrapping and new building, for example, also have environmental impacts and it can sometimes be less harmful to extend the life of an older ship than to replace it. The Chair of the Poseidon Principles, Michael Parker, has already indicated that the entry into force of the long-awaited IMO Ship Recycling Convention would logically result in additional action points for signatories*.

There is hope…

There is no doubt that the Poseidon Principles were an overwhelmingly positive initiative, but reservations remain about focusing on carbon emissions as the sole measure of progress. Expanding the scope of the Principles and accelerating their adoption by other banks, alternative financiers and lessors will be critical next steps towards the desired transformative change in global shipping finance.

About the author
James Clayton is a Director in Campbell Johnston Clark’s London office, Head of Commercial and Treasury and also leads the firm’s Marshall Islands advisory team.

*On Thursday 23rd February Campbell Johnston Clark (CJC) and SPNL – Shipping Professional Network London hosted a panel discussion on ‘Latest Trends in Green Ship Recycling’. Speakers will include James Clayton, CJC, Darren Lepper, Clarksons, Philip Arcoumanis, Maritime Asset Partners and Ehud Bar-Lev, Lloyd’s Register.

(embed)https://www.youtube.com/watch?v=hRa5DxDJ3F4(/embed)