We have observed before on this blog, shipping is subject to a ‘licence to operate’, implicitly granted by a wide group of stakeholders. There are many moving parts to this arrangement but the newest and biggest driver by far is decarbonisation.

As the experts at Danish Ship Finance observed in their most recent report, the industry is struggling to identify a clear pathway towards zero carbon. Some reasons are well understood: the size of the operators and fragmented market structure, others including the impact of zero carbon fuels on financial performance, less so.

In a market with little room for differentiation, the industry’s low return on invested capital, combined with an increased need to invest in decarbonisation has dried up the supply of equity investors and created an environment where there are more vessel sellers than buyers. Fewer new vessels are being ordered, and transaction volumes among existing vessels are currently low.

The demands to advance the climate agenda are starting to affect how businesses operate as they attempt to cut their carbon emissions, ramp up energy efficiency and adjust to new risks incurred by the introduction of new technologies. The global call to decarbonise is increasing the pressure on margins at a time when the shipping industry can scarcely handle any additional financial burden.

In the absence of clear long-term guidance from regulators that works to bridge and facilitate the energy transition, DSF foresees a bumpy outlook which is likely to reshape the industry and the way it makes money.

In the future, access to cargo, capital and ports could be at risk if owners are considered not to be doing enough to reduce their CO2 footprint. Their ability to offer a cost-competitive zero-carbon service to their customers will, at some point, be a critical element in the renewal of their licence to operate.

Mounting scrutiny from the public, the media, investors, lenders and regulators is increasing the pressure. Investors, for their part, are concerned about the effects of climate risk on valuations and access to capital. Climate-related financial disclosures are becoming more common while institutions and governments are announcing policies on CO2 and zero-carbon fuels, and some are considering implementing national or regional carbon taxes.

Ever the optimists, DSF positions the climate agenda as a business opportunity with next-generation zero-carbon-fuelled vessels emerging as an attractive asset class. It thinks shipping’s notoriously low barriers to entry could be raised – if only for a period – via the development of a zero-carbon fuel supply available to players that actively engage in sector integration.

This integration is about pooling fuel demand from various sectors in order to reach critical mass and enable prices to come down. The zero-carbon fuel choice of the future is a global challenge facing all industries and sectors of the economy, not just maritime players. The shipping industry is unlikely to be the trailblazer, but some maritime players actively engaging in the decarbonisation process would be likely to benefit from the change, it suggests.

But the fuel is not itself the issue; shifting to zero-carbon fuel will not, in isolation, create the pathway to the future and the ability to yield a return on invested capital will not improve just because the fuel mix changes. The forces at play are more fundamental and will DSF believes, begin to redesign the competitive landscape by changing value drivers and business models.

Cost savings are available for shipowners that invest to reduce fuel consumption and this is largely a question of investing in and implementing new technology, onshore and onboard the vessels. The industry has progressed in this field over the past few years, demonstrating that the potential is real.

Even so, a significant part of the fleet is owned by players that earn their money not by operating the vessels but by buying and selling them. This limits the demand for investment in solutions with long repayment periods. Many retrofit projects are focused on solutions that deliver immediate reductions in individual vessels’ fuel consumption.

Lower returns on invested capital limit the appetite of owners renew their fleets; those operating their own vessels are in a better position, but not all may have access to the competencies, technologies or capital needed to progress.

By implementing new technologies, the industry continues to improve fuel efficiency and reduce operational inefficiencies. However, if the solutions that deliver the efficiency improvements are available to all players willing to pay, it will simply drive down margins.

Ultimately, DSF concludes that the industry’s transition is not being orchestrated by the shipowners, although some are investing to be forerunners. It is charterers, ship managers, equipment manufacturers and service providers, which are working to develop and scale new efficiency-improving solutions that will allow for cost savings without risking equity in non-scalable vessels that share few standards.

Owners of existing assets in particular are exposed and the risk of stranded assets is on the rise. With freight rates low across oversupplied markets, many vessels are at risk of unexpected short-term value depreciation. DSF expects that the average small and medium-sized owner, operating a fragmented fleet, will find it increasingly difficult to deliver enough of a return on invested capital to justify the fleet renewal needed for a decarbonised shipping industry.