Contributed by Austin Pierce, John Michael, and Kelly Rondinelli of Vinson & Elkins
Shipping keeps the world moving; but what moves the ships? As part of the increasing global push to achieve net-zero greenhouse gas emissions by 2050, significant attention has been paid to the energy and power sectors. However, pressure is also mounting to address emissions from various “hard-to-decarbonize” sectors, such as shipping. This pressure comes from a variety of sources. For example, in 2018, the International Maritime Organization (“IMO”) adopted a goal of reducing greenhouse gas (“GHG”) emissions 50% below 2008 levels by 2050. Commensurate with the IMO’s goal, several financial institutions launched the Poseidon Principles, committing to reduce the emissions from their shipping finance portfolios.
Hydrogen as a clean fuel source poses an enticing, and increasingly compelling, option for shipping companies to meet these goals, particularly as multiple countries incorporate hydrogen into their sustainable economy plans. The remainder of this article discusses how these trends intersect to help shipping companies that are considering riding the “hydrogen wave.”
Hydrogen in Shipping
There is increasing support for the feasibility of hydrogen to fuel vessels. A March 2020 report by the International Council on Clean Transportation found that 99% of voyages on a particular China–United States shipping route could be done by vessels powered by hydrogen. It can be used in fuel cells or combusted in engines, similar to the use of heavy oil today (though with certain modifications). And hydrogen can even be compartmentalized in modular containers, as some companies have recently proposed.
Such uses of hydrogen come with many benefits. Hydrogen is energy-dense (on a unit mass basis) and produces virtually no direct GHG emissions when used for energy. This is particularly important given the IMO’s GHG emissions reduction targets. And, unlike electric-powered alternatives, hydrogen has a relatively quick refueling time on the scale needed for global voyages. Additionally, in applications where the use of pure hydrogen would be impossible or infeasible, hydrogen can be chemically stored or converted into other fuels such as methanol or ammonia.
However, there are still several challenges that hydrogen must surpass, though they are not necessarily unique to shipping applications. Despite a high gravimetric energy density, hydrogen has a low physical density. So it must be stored in either larger spaces, carrier chemicals (e.g. methanol or ammonia), or under very high pressure/low temperature. If hydrogen is meant to be burnt, the temperatures required also encourage the formation of certain air pollutants, particularly nitrous oxides. And, despite hydrogen’s potential to lower direct GHG emissions, hydrogen is currently produced primarily from natural gas in a process that produces substantial emissions (for more information on the various types of hydrogen, see our colleagues’ prior post here).
Nevertheless, hydrogen is still seen as a major tool to reduce direct GHG emissions from the shipping sector. Affected shipping companies may be able to combine these trends with the current financial and political climate to support their own sustainability targets and energy transition strategy.
Role of the Poseidon Principles
The Poseidon Principles (the “Principles”) are a voluntary framework for financial institutions to align financed emissions from their shipping portfolios with the IMO’s goal of a 50% reduction in GHG emissions from shipping below 2008 levels by 2050. The Principles do not dictate what assets a shipping portfolio may include; instead, it sets a standard for assessment and disclosure of the emissions associated with that portfolio in comparison with the targets required to keep on progress with the IMO’s goal.
Signatories of the Principles must annually assess the carbon intensity of the vessels in their loan portfolios and compare these against the required decarbonization value for that year. These vessel-level assessments are then aggregated via a weighted average, using the debt outstanding for a vessel to determine the weight of a vessel’s carbon intensity, to determine the portfolio’s overall climate alignment.
These signatories include several major shipping lenders, such as BNP Paribas, Citibank, and Credit Suisse. These banks will likely need to examine and adjust their lending portfolios over time to meet their commitment under the Principles. Shipping companies should therefore be able to take advantage of a bank’s need to reduce the emissions intensity of its portfolio to help fund the construction or conversion of vessels with lower emissions.
Hydrogen-powered vessels have two significant advantages in attracting a lender’s interest. First, because use of hydrogen in transport emits no direct emissions, it produces zero carbon emissions for the purposes of the IMO calculations Though hydrogen is not currently included in the IMO’s emissions factor charts, the emissions factors for fuels listed therein appear to only account for emissions from consumption (i.e. combustion) and not production, transport, etc. Additionally, because hydrogen-power is a new technology for vessels, its application requires either the construction of new vessels or the conversion of existing vessels to use hydrogen-fueled equipment. Both of these are capital intensive and likely would require larger loans. Taken together, these two features mean that loans for hydrogen-powered vessels would allow signatories of the Principles to reduce their shipping portfolio’s carbon intensity more rapidly than by certain other means. Shipping companies that appropriately consider these goals in their own transition plans may therefore be able to attract loan capital for a hydrogen fleet on more competitive terms than otherwise anticipated.
Government Strategies on Hydrogen
In addition to financial institutions, governments are also playing a key role in shaping the incentives for hydrogen in shipping. Several countries—including, e.g., Chile, Germany, Japan, and Norway—have adopted national plans to foster the development of hydrogen production and use. Certain of these plans specifically contemplate hydrogen as fuel in the shipping industry.
While these plans contain varying amounts of detail, they generally emphasize two major roles for government: (1) providing financial support and (2) establishing clear regulatory frameworks. Government funding can often be important in helping to test ideas and refine them towards the point of commercial viability. As a result, several countries, have provided funds for feasibility studies and pilot programs. However, the funds are not necessarily limited to research and development. For example, Japan recently provided for a temporary waiver of port fees for ships using hydrogen fuel cells. Similarly, Norway’s Hydrogen Strategy highlights how the Norwegian government has used its procurement power to contract for a ferry that will be majority-powered by hydrogen.
However, as we’ve previously discussed, governments serve an equally vital role in fostering new technological trends by building out the regulatory structure to accommodate them. Norway’s strategy connects these two roles by using collaboration between agencies and private parties to establish best practices that can inform future regulation. Similarly, Japan’s Basic Hydrogen Strategy announced a plan to develop safety guidelines and establish a roadmap for the use of hydrogen fuel cells in vessels. Though they are still being fleshed out, these strategies signal that governments are keen to work with the shipping industry in making hydrogen-powered vessels a reality.
Part of tackling current climate issues entails addressing emissions from the shipping industry. While multiple alternatives may be under consideration, hydrogen is quickly emerging as a favored contender for hard-to-decarbonize sectors such as shipping. This is the result both of various government initiatives and of increasing emissions reduction commitments by financial institutions. Taken together, such alignment of regulatory and financial support could mean significant opportunity for shipping companies to incorporate hydrogen-powered vessels as they consider their transition strategy.
About the authors:
Austin Pierce, the first associate appointed to Vinson & Elkins’ ESG Taskforce, helps clients to navigate ESG matters both individually and in how they intersect with each other and related topics, such as the burgeoning hydrogen economy.
John Michael, Houston-based partner and head of Vinson & Elkins’ Maritime & Offshore practice, represents clients in corporate, finance, and commercial matters relating to the marine industry, and regularly advises clients on clean and renewable energy projects in the maritime industry.
Kelly Rondinelli is an associate in Vinson & Elkins’ Washington, D.C. office, where she advises clients on environmental and natural resources matters, such as permitting and regulatory compliance, transactional support, renewable energy projects, and other aspects of the energy transition.
The opinions expressed are those of the authors and do not necessarily reflect the views of the firm or its clients. This article is for general information purposes and is not intended to be and should not be taken as legal advice.