Diverse times | Info spectrum: Climate, Covid and raw materials are the “new three Cs” of maritime risk

With a view to 2022 and beyond, Infospectrum emphasizes the “Three Cs” of creditworthiness (character, capacity and capital) in a context and highlights the collective and increasing relevance of the “New Three Cs”, namely climate, Covid and raw materials for the maritime Risk:

The uncertainty and volatility associated with these “new three Cs” are likely to play an increasingly important role in assessing counterparty risk in the near future.

Climate compliance: countdown to January 1, 2023

The International Maritime Organization (IMO) has passed two major emission reduction laws that will come into effect on January 1, 2023. These technical design and annual operating performance parameters for ships are better known under the abbreviations EEXI (Energy Efficiency Existing Ship Index) and CII (Carbon Intensity Indicator). While regulatory compliance with these upcoming standards will be the bare minimum requirement for a ship to operate, the level of willingness or even awareness appears to vary significantly among shipowners / operators, with many understandably still waiting for clearer guidance before committing require substantial, long-term investments where the costs of going the “wrong way” as a first-time user can be substantial.

Beyond the regulations, everyone involved, including increasingly discerning charterers, is rigorously re-evaluating supply chains to minimize the associated carbon footprint. We’re already seeing charter pricing rewards for greener ships, and ships equipped with Energy Saving Devices (ESDs) are likely to have a competitive advantage by avoiding slow steaming, which is otherwise required for emissions compliance compared to similar ships with no ESD installed could be . Alternative fuel systems still appear to be on the verge of technical-commercial feasibility for widespread adoption, but progress is being made. In addition to promising ESD retrofits, digital offers (including travel optimization) are helping to pave the way for shipping to decarbonise.

More regulation and activism are expected. Whether these involve a CO2 tax, emissions trading systems or options for CO2 compensation, the administrative and financial costs for ship owners / operators will increase. Regional regulations to reduce emissions, such as the inclusion of maritime transport by the European Commission (from July 2021) into the EU emissions trading system or government obligations such as the Clydebank Declaration for Green Shipping Corridors, which was agreed at the most recent UN climate conference COP26 in Glasgow, could possibly provide blueprints for global scaling or, conversely, divide markets into multiple trading zones. Compliance with climate regulation requires a redesign of the processes through measures such as the introduction of emission reduction clauses in charter contracts and possibly the shortening of charter chains. Building appropriate support infrastructure (especially in ports) will be crucial. Additionally, green references for financial assistance can make the link between an asset’s issuance profile and access to liquidity more direct.

Infospectrum in September 2021 White paper provided a preparatory framework for assessing “Emission Reduction and Mitigation in Shipping” and took into account the many aspects of the maritime industry’s transition to “net zero carbon”. We are now closely monitoring the rapidly evolving standards, pursuing best practices and identifying potential weaknesses in compliance with climate regulations. Ultimately, the ability of a counterparty to meet stakeholder expectations and legal compliance while handling the increased administrative, operational and financial burden depends on the sustainability of their business model in the age of decarbonization.

Covid-19: final chapter?

The recent emergence of the Omicron variant underscores the uncertainty surrounding how the Covid-19 pandemic will evolve, government responses to it, and the wider economic impact. To deal with the economic fallout, governments around the world have launched fiscal stimulus programs that have sparked a resurgence in demand for raw materials and consumer goods. The most visible impact has been seen in the container shipping industry, where freight volumes between Asia and North America are reported to have increased by 27% in the first seven months of 2021, from pre-pandemic levels. Existing supply-side vulnerabilities from pre-Covid-19, such as the productivity gaps in port infrastructure from east to west, have exacerbated and new ones have emerged, including crew quarantines, local port closures and labor shortages. After the boom in container ocean freight rates, wealthy owners – perhaps unsurprisingly given historical cyclical precedents – have moved into the New home market. The resulting debt / investment risks of some operators require close monitoring, especially as the cycle moves in the direction of its inevitable correction.

Apart from the container operators, the demand impulse coupled with disruptions on the supply side has increased inflationary pressures. Uncertainty about the economic recovery has led central banks to allow for looser monetary policy. This can change. After years of near zero interest rates, the pressures of debt servicing in a rising interest rate environment will require close monitoring.

The pandemic has reignited discussions about nearshoring, diversification of production facilities and the transition from a “just-in-time” to a “just-in-case” business model. The importance of these discussions is determined by the practical difficulties companies face in reversing decades of business strategies and capital allocations and the importance attached to supply chain risk mitigation in light of recent events.

Raw materials: Choppy Waters

Regarding commodity markets, The Economist notes: “The 2000s were about supercycles. The 2020s is about super chaos. ”Although not without volatility, the super cycle phase mainly focused on Chinese commodity demand during urbanization and industrialization. With the transition of the global economy to a more climate-friendly standard with newer technologies in development, it can be assumed that the shifts in the composition of the raw material mix will continue to gain momentum. In addition, the latest protectionist tendencies, nearshoring trends and climate-related market segmentation could be subject to an adjustment phase in addition to the tonnage mile profile.

While the demand for oil is unlikely to peak for another decade (maybe longer) and the COP26 participants have agreed to a “phase-down” (instead of an “exit”) of coal, a shift in global demand is expected in the long term from hydrocarbons to electrification. The intergovernmental organization International Energy Agency (IEA) predicts that the supply of minerals such as copper, lithium, nickel, cobalt and rare earth elements must be increased significantly. In an IEA report from May 2021 it says: “Today the income from coal mining is ten times higher than that from minerals from the energy transition. In a climate-driven scenario, however, there is a quick reversal of fate, as the combined revenues from minerals of the energy transition overtake that from coal well before 2040. “

As countries strive to secure mineral supplies, it is important to consider the broader environmental, social, and governance (ESG) risk factors. For example, more than 70% of the world’s cobalt is mined in the Democratic Republic of the Congo, a country facing certain operational and ESG challenges. China has already established its mineral supply chains and is estimated to process 72% of the world’s cobalt and 61% of its lithium. China’s unofficial 2020 ban on Australian imports in retaliation for Australia calling for an investigation into the origins of the Covid-19 pandemic shows that trade policy can be used politically. More recently, the US, Australia, Canada and the European Commission have all announced independent measures to secure natural resources.

Meanwhile, climate change has immediate and short-term effects. According to reports, unusual or extreme weather events are increasingly causing supply disruptions. In 2021 alone there were droughts in Argentina, floods and droughts in Brazil, floods in China and India and extreme heat in California (USA). Weather events in Brazil, Indonesia and Vietnam are said to have led to a significant rise in coffee prices worldwide in 2021, while floods in Asia adversely affected coal mining and supplies. The weather can of course also have an impact on logistics; the low draft conditions in south-central South America caused by the drought-ridden Paraná led to global supply bottlenecks in the iron ore trade by reducing the cargo capacity of the barges of the mining giant Vale. In some cases, supply disruptions are attributed to climate compliance, such as the 20 Chinese communities that ordered local coal-fired power plants to be closed to reduce emissions and improve air quality.

In addition, governments have intervened in the markets to influence pricing. In late October 2021, China’s National Development and Reform Commission (NDRC) imposed price caps on domestic coal at mines and terminals, a move that halted the price rally and affected a number of speculative coal traders. Since June 2021, China has also released aluminum, copper and zinc (several times) from its strategic reserves in order to dampen prices. The quantities released remain small, but signal the government’s attitude. For example, a group of countries led by the US and along with China, Japan, South Korea and India have approved a minimal release of crude oil from strategic reserves as a policy tool to put OPEC + producer cartels on the table.

Given changing demand dynamics, supply-side disruptions, and increasing government intervention, the extractive sector will experience increasing volatility. The maritime industry must closely monitor the impact of the resulting risk on freight owner customers while adapting to the operational impact of a changing commodity and tonnage mile mix.

Challenging Change: 2022 and Beyond

The maritime sector is facing a change of unprecedented proportions that poses significant (but unknown) regulatory, technical and financial challenges. The “New Three Cs” will test the limits of a previously reactive maritime industry. Infospectrum’s Risk Assessment Framework is ready for the challenge.

Photo credit: Infospectrum
Published: December 17, 2021

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