Decarbonization of the shipping industry

Dominique Barker: Welcome to The Sustainability Agenda, a podcast series focusing on the evolving complexities of the sustainability landscape with a view on addressing current issues in a concise format to help you navigate and take action. I’m your host, Dominique Barker. Please join me as we explore today’s most pressing matters with special guests that will give you some new perspective and help you make sense of what really matters.

James Mitchell: This is just about the only way we think to sort of build an approach that is really robust enough to stand the test of time. And it’s something that can kind of be the linchpin to what is frankly a meaningful commitment because of size of signatories. If we’ve learned anything, I think it’s that, you know, these things take time. They have to be robust methodologically.

Dominique Barker: In partnership with The Centre for Climate Aligned Finance, we’re pleased to welcome you to the second episode of our little miniseries. On today’s episode, we’re going to focus on the shipping industry and the framework used for integrating climate considerations into lending decisions to promote shipping decarbonization, which is known as the Poseidon Principles. I’m speaking this morning with James Mitchell. He’s a principal of RMI and Director of the Centre. James also led the development of the Poseidon Principles, and he serves as an advisor to the Poseidon Principles Association today. And don’t worry if you don’t know what Poseidon Principles is. That’s the whole point of this episode. Welcome to The Sustainability Agenda, James.

James Mitchell: Thank you, Dominique. It’s really great to be here.

Dominique Barker: So let’s start with an overview of the shipping industry, and I have to admit I personally do not know much about the shipping industry. Can you just give a little brief overview of the emissions that they contribute today?

James Mitchell: Sure. So I think the first thing to mention about the shipping industry is that they really do sort of connect the economies of the world. So it’d be very difficult to imagine an economy without a maritime shipping industry. In terms of what the industry is made of, we have over 50 thousand vessels moving around the water, moving all of our goods to service our economy. Those vessels contribute between 2 and 3% of global GHG emissions. It is a very significant contributor to the climate. To put this in context, it’s around the same level of emissions as the nation of Germany, so quite, quite a lot. That being said, it is also quite an efficient industry in terms of moving goods around the world. The emissions per ton are quite low, so it’s a good way of getting things around the world.

Dominique Barker: And that’s mostly, and I take it the emissions is really based, probably on the fuel, the heavy bunker fuel and the fuel that goes into the ships. Is that correct?

James Mitchell: That’s right. So the fuel that ships burn is largely bunker fuel, which is residual fuel oil, and most industries run on that today, a bit of LNG as well.

Dominique Barker: Great. So this was the first industry that the Centre for Climate Aligned Finance looked at. Why was it the first industry? How did that get targeted first?

James Mitchell: So RMI and latterly The Centre for Climate Aligned Finance decided to sort of create a, what we would call on the NGO side, a theory of change or more a market solution when we’re working with our partners in the shipping industry for a number of reasons. One is RMI had a long history of work in the shipping industry, deep ties with shipping companies, ship finance. So we had some good connections there. But also the shipping industry has something that many or most other sectors don’t. That’s something called the International Maritime Organization or the IMO. So the IMO is the UN body that governs shipping and so shipping, unlike other industries, as one regulator that can say, this is the target for this industry. So right now, the absolute emissions target is 50% absolute emission reductions by 2050. Once the IMO said that this is our absolute emissions reduction target, we were able then to go and kind of, I guess in a way, make a very good example of shipping. We have this target. All we had to do is kind of fill in the details around that target. Now there are some other things about shipping that make it very difficult. So I mentioned that there’s these 50 thousand vessels that sort of move around the world servicing our global economy. They’re not actually owned by just a few large companies, actually owned by thousands of smaller companies. And then there’s a few very big ones, in particular in the container sector. The challenge this creates is very practical challenges around how do you get data from thousands of ship owners? How do you sort of communicate that something important is happening to that many different companies based in every corner of the world? That’s something that the Poseidon Principles had to be kind of designed to overcome in their creation as well as their implementation.

Dominique Barker: Can you describe the process? Maybe, first of all, just describe what the Poseidon Principles are. And then maybe you can describe the process of how you went through designing them because I think we can use those and I think that’s the whole idea is that we can use that as something to copy in other industries. So what is the Poseidon Principles and describe your process?

James Mitchell: Sure. The Poseidon Principles are a collective commitment by lessors, lenders and guarantors to the maritime shipping industry to do a few very specific things. It’s what we called a climate aligned finance agreement. And so signatories to this agreement commit to measure and disclose the, what we call climate alignment of their financial portfolios. So what the Poseidon Principles do is they create a common benchmark to measure against a methodology to measure against that benchmark, which I can talk about more later, but is very tailored to how shipping actually functions. It also creates a data solution to make sure that we can actually implement that methodology by creating a data source directly from shipowners to banks mostly. That’s what they are. I think they’re also a bit of a movement, I think, as well. So I think prior to the creation of the Poseidon Principles, it wasn’t really a voice of shipping financiers. That is very much changed. So what we’ve seen is through the creation of this side and principles, this kind of collective commitment to basically help the industry achieve its climate targets. We’ve seen that not only ship finance kind of step up in it in a very sort of common way. We’ve also seen this approach become adopted by other parts of the shipping industry. So in addition to the Poseidon Principles, we now have something called the Sea Cargo Charter, which uses almost the exact same methodology, the same benchmark to commit chartering decisions. So you can imagine sort of trading houses like Cargill. They’ve also committed to those same trajectories. So what that does, it creates a business incentive for ship owners to build the ships that can actually remain climate aligned, which is luckily the same thing that the banks of the ship owners are also asking for. We’ve seen the Sea Cargo Charter come to fruition. We’ve also seen and we’re expecting in the next month or so a set of insurance principles. They should be coming out as well, also leveraging the Poseidon methodology. So it really has kind of started a sea change, I suppose to use a phrase, in the shipping sector.

Dominique Barker: Nice pun. And so that’s interesting that it’s the banks and the lenders that are providing the disclosure as opposed to the companies. So that’s an interesting distinction to make versus other sustainability type of disclosure. So how did the Poseidon Principles help banks engage with their clients?

James Mitchell: Yeah. So prior to the Poseidon Principles, you know, the conversation, I think, had largely been about energy efficiency, which was a great conversation. But as we, I think the world really focused around achieving net zero by 2050 or at least really focusing on decarbonization, I would say this really happened in the shipping industry over the last 10 years, and it became clear there was a need for common benchmarks and became clear there was a need for really kind of just the basics, the nuts and bolts of where are we today versus where we need to be? So what the Poseidon Principles do is they solve these very practical barriers, but they also create a very clear, forward looking expectation. This in itself is very useful for client engagement conversations, and we heard that those have very much, I think, ramped up since the development and implementation of the Poseidon Principles. They’ve also helped in a number of other ways. So we’ve seen, firstly, the creation of a two point two billion dollar sustainability linked finance market leveraging the Poseidon methodology, that’s great. We’ve seen the expansion of bank financed retrofits largely by signatories in the development of advisory solutions as well, largely by banks that want to help their clients to meet these climate targets. We’ve also seen something happen outside of banks, which is the development of really an ecosystem of service providers to help estimate forward looking alignment, both in terms of emissions, as well as what needs to happen to ships or companies to actually stay aligned into the future. So it really has kind of initiated this ecosystem of efforts to really help decarbonize the shipping industry.

Dominique Barker: Great. What is the required disclosure and reporting for the signatories? And do they require outside auditing, for example?

James Mitchell: That’s a great question. So the disclosure requirements for signatories, so again, this would be lenders, lessors, guarantors, are actually quite, quite simple. Signatories are required to disclose their portfolio alignment score on an annual basis. They are required to disclose that one in their relevant sustainability reports and two to the Poseidon Principles Association, which is the governing entity of the Poseidon Principles, and they publish that in a report every year. There’s one additional level of disclosure, which is really kind of designed to make sure that this agreement remains robust and that signatories trust that disclosures are accurate. This is a disclosure of metadata to the Secretariat just around how exactly these calculations were done, which service providers were used to support calculations, and some other details. In terms of auditing, it’s a very good question or assurance. So what the Poseidon Principles do is they sort of piggyback onto a pre-existing regulatory initiative called the IMO so International Maritime Organization Data Collection System so IMODCS. So this system was created only a few years ago to basically require that every ship owner in the world report their greenhouse gas emissions to the IMO so that we have a better understanding of shipping emissions. What the Poseidon Principles do is they create a very clear covenant clause that gives banks access to that data once it has gone from the ship owner through verification and then comes back to the ship owner. So basically, what signatories ask for is please give me that information and please give me the document, the statement of compliance that you’ve received post verification. So that data comes in and it has been verified. There are no assurance requirements on the disclosures of signatories as of yet.

Dominique Barker: Ok, well, maybe they’ll come depending on, I guess, how material it becomes. Where do the Poseidon Principles stand at the moment and maybe what’s next for the shipping industry and shipping finance, I should say?

James Mitchell: Yeah. Good. Good question. So the Poseidon Principles sit at around twenty seven signatories, representing 45% approximately of senior shipping debt. What’s happening is that signatories to this agreement are continuing to recruit each other. And so I think there’s clearly progress to be made to really make this an international standard. We’re very hopeful that progress continues in Asia.

Dominique Barker: Do you have a sense of how big that could be, how many possible lenders there is to the shipping industry?

James Mitchell: We do have a list, yes. And I think, I guess the last frontier really is Asia. I think with the addition of, I would say, the largest both leasing houses as well as lenders in the Asian market, we could see the addition of 20 signatories covering the great majority of the rest of finance in the industry.

Dominique Barker: Great. And then so what’s next for shipping finance? So just I guess adding the signatories, anything else?

James Mitchell: So I think the next challenge, and I think this expands to banking as well is what transition finance commitments mean, really kind of from an implementation perspective. And I think this comes down to what needs to happen to decarbonize hard to abate sectors like shipping. So in shipping, it’s a question not only of the infrastructure on the water with the assets on the water, it’s also a question of shoreside infrastructure for fueling as well as R&D. So the question, I think, really comes down here to what is a good deployment of transition finance commitments and what is that going to require in terms of partnerships with kind of other parts of the investment chain in particular towards the public side? I think that is going to be sort of the next frontier. Obviously, we’ve seen and we’re very supportive of the implementation of the Poseidon Principles. I think the next place we see, I guess, sustainability strategies going is not only disclosing that alignment but also saying, and here’s what we’re doing, here’s our sector strategy. Here’s what we’re thinking about in terms of not only how we’re engaging with clients, but how we’re deploying the other commitments we’ve made to really make sure that we can achieve our climate commitments.

Dominique Barker: And what lessons has the Centre learned from the Poseidon Principles? Because I can certainly see this expansion into other sectors, and I know that that’s what the Centre is working on and we’ll be hearing about those in further episodes, what are some of the lessons? Maybe you can give us a little taste of what’s to come?

James Mitchell: Sure. So I think the lessons are that this is not as simple as writing methodology, which we could have done at the beginning. It’s a process of firstly education, but it’s a process of, I guess, collective decision making. So we are very careful in how we design our working groups to make sure that there is a manageable size. But we have a much larger group, which we call review group of banks typically, we sort of bring along in that effort to make sure that this isn’t just a group of a few in a smoky room making decisions. This is a process that is carefully informed by other banks, by industry, as well as by experts, including other NGOs and advocates. This is just about the only way we think to sort of build an approach that is really robust enough to stand the test of time. And it’s something that can kind of be the linchpin to what is frankly a meaningful commitment because of size of signatories. If we’ve learned anything, I think it’s that, you know, these things take time. They have to be robust methodologically, but they really are about managing stakeholders while listening to a diversity of viewpoints and ultimately settling on something that achieves as much as possible.

Dominique Barker: Thank you very much, James. And one thing we heard in episode one of the series was from Brian O’Hanlon, who talked about how the banks and governments are like air and water. And so if we think about that, banks and financial institutions, we have a really important role to play in terms of helping to decarbonize the economy. And I think the Poseidon Principles is a way that shows one way in which financial institutions can play a role. James, thank you very much today for explaining all of this to us and thank you for participating and thank you to our listeners for listening in.

James Mitchell: Thanks for having me.

Dominique Barker: Thank you. Please join us next time as we tackle some of sustainability’s biggest questions providing different perspectives to help you move forward. I’m your host, Dominique Barker, and this is The Sustainability Agenda.

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