Op-Ed: Energy transition and the race to secure new fuels

Credit: Shutterstock

By Aarnoud van Weelderen and Peter Taylor, Macquarie Group

Shipping companies working to reduce greenhouse gas emissions face several complex decisions in transitioning to lower-carbon energy sources. Vessel owners must sort through and understand new regulations, weigh the pros and cons of various alternative fuels in line with customer requirements, make decisions about engine upgrades and vessel orders, and plan for how they will secure consistent fuel supply. Pressure to decarbonize is coming not only from regulators and cargo owners, but also from investors, capital providers and non-governmental organizations.

There’s much to weigh and consider, all with long-term implications. Shipping is far from the first industry to navigate the shift. In the last 20 years, the electricity sector has been gradually transitioning from coal to solar, wind and natural gas. As a lower-emissions alternative, natural gas has several advantages over coal. It can leverage existing pipeline infrastructure, and natural gas-fired power stations are quicker and less complex to build than, for example, nuclear power stations.   

Similar decisions are and will continue to affect the shipping industry as it transitions away from traditional marine fuel oil and gasoil. While efficiency measures such as wind-assisted propulsion, new hull coatings, slow steaming and route optimization can help, lower-carbon fuels will be a critical part of the equation. The challenge for vessel owners is to identify and incorporate a portfolio of lower-emissions fuels that will allow them to meet their climate commitments and regulatory obligations, while continuing to provide competitive rates to clients.

Risk-mitigated plans must weigh and consider carbon intensity reductions, technical and commercial readiness of the fuels, new vessel delivery timing and safety, and key infrastructure across the supply chain. Shipping companies seeking to secure lower-carbon supply will need to consider leveraging spot and long-term contracts as well as multi-year fuel commitments to achieve attractive prices and stay competitive.

Fuel considerations

For more than a century, vessel owners have relied on relatively cheap fuel oil supported by a global network of oil production, refining, delivery, storage and bunkering infrastructure. Given that the average lifetime of a ship can be more than 25 years, most vessels ordered today will be sailing in 2050, when the Paris Agreement calls for global emissions to reach net zero. Legacy vessels currently in operation will be able to comply with existing regulation until 2030, but they will have a problem thereafter if they do not reduce their emissions. In certain jurisdictions such as Europe, the penalties will increase significantly every five years through 2050.

Transitioning to a new set of fuels will require considerable capital investment and internal resourcing commitments. With some exceptions, notably drop-in biofuels and e-fuels, vessels need new systems and engines that can run fuels such as lower-carbon methanol, liquefied natural gas (LNG), liquefied petroleum gas (LPG) and ammonia. Gone are the days when the most complex fuel decision was what quantity to bunker and what sulfur content to choose.

The array of new fuels potentially available to shipping is broad, including traditional fuel lookalike generated from electricity, biofuels generated by crops or waste, lower-carbon methanol, LNG, ammonia and even nuclear. While methanol and LNG have reached a degree of technological maturity, others such as ammonia are still in development. Handling cryogenic fuels such as LNG and ammonia requires more complex systems, and some concerns remain about the toxicity of several of these marine alternatives, but progress is being made.

Ships with fixed routes that visit ports with infrastructure for specialized fuels will find it easier to transition. Vessels without fixed routes, on the other hand, must be able to utilize whatever fuels are available in the ports—a key consideration when retrofitting engines or ordering new vessels. However, because cleaner fuels can be produced in many more areas globally than petroleum-based fuels, they have the potential to be more available and accessible, and dual-fuel or multi-fuel engines provide optionality to buy the cheapest fuel when and where it’s needed.

From all these options, low carbon methanol, which allows for significant reductions in carbon intensity, has become a real alternative for the industry in the near-term. Methanol engines have been developed and are readily available. According to the Methanol Institute, there are currently 251 methanol newbuild vessels on the water or in the order book globally, including large container ships, chemical tankers, ferries, car carriers and bulkers. The number of vessels on order – with a lag time of two to three years from purchase to delivery – essentially assures that low-carbon methanol will be a key fuel in the future ecosystem.

Unlike LNG, ammonia and hydrogen, methanol does not require pressurization or cryogenic handling facilities. With an established track record in the maritime propulsion space, it can often be stored and transported using the same tank ships, barges and trucks used for liquid hydrocarbons. Methanol also has flexibility in the logistics chain, making it suitable for the retrofit and tramping market. This flexibility is important in the current fragmented global regulatory environment, where different regions have different rules.

Certainty of supply

The evolution of lower-carbon fuels will usher in new and expanded commodities markets. Shipping companies will play a pivotal role in providing the anchor demand that can catalyze and shape those markets to ensure consistent long-term supply and mitigate price volatility.

Unlike traditional marine fuel, which is generally purchased and hedged with the help of one or two suppliers, locking in future supplies of alternative fuels means partnering with a range of producers, suppliers and fuel logistics specialists. For emerging fuels, relying on standard term purchase agreements may not sufficiently mitigate supply risk. Some market participants are diversifying their fuel portfolios by investing in low-carbon fuel production facilities or partnering with a supplier that has done so. Being close to the source of production in carefully selected, politically stable jurisdictions can provide vessel owners with the potential to achieve reliable supply, consistent pricing and first-mover advantage to acquire their fuels of choice.

Renewable and low-carbon methanol production capacities are set to increase to 37.5 mt by 2030, compared with current capacity of 1 mt, according to research conducted by GENA Solutions and the Methanol Institute. New production projects are well underway, including Pacifico Mexinol at the Port of Topolobampo, Mexico, announced at COP28 in 2023. Once operational, Pacifico Mexinol aims to contribute over 2 million metric tons of green and blue methanol per year. Another project is BIA Energy’s facility at the Port of Caddo-Bossier in Louisiana, which aims to produce 550,000 metric tons of blue and bio-methanol per year once operational. Macquarie Group is responsible for marketing the production from these facilities.

Despite some progress on lower-carbon methanol production, continued regulatory uncertainty is holding back investment in some jurisdictions. A number of projects have been materially delayed or cancelled in 2024 throughout Europe and the U.S., with many U.S.-based project developers citing slower-than-expected clarification of the implementation rules of the U.S. Inflation Reduction Act (IRA) and the EU’s Renewable Energy Directive III (RED III). Part of these regulatory delays can be tied to a lack of harmonization between regions on the definition of a biofuel and its fungibility between regions.

This is a complex issue for regulators to solve, but is key to providing international transport companies, such as shippers and airlines, confidence to invest. As regulations get tighter, fuel choices will have to change. Traditional fossil fuels will continue to be phased out; after 2034, even LNG will likely need to be blended with bio and e-fuels such as bio-methanol or renewable natural gas (RNG) to reduce the carbon intensity.

Another nearer-term concern is the implementation of the Union Database (UDB) and the associated gas grid mass balancing in Europe. Whilst providing traceability and ensuring lack of double counting, there are issues around the qualification of fuel traveling through transmission networks outside of the EU. For instance, RNG transferred by mass balance on a foreign grid where it is blended with other gases may not be accepted as a biogas if imported into the EU as LNG. That said, regulation and the industry have progressed materially, and companies are proactively managing their fuel strategies, increasingly taking into account cross-commodity interdependencies as well as supply chain requirements.

Evolving policies and regulatory frameworks will impact pricing for alternative fuels, but so will other factors such as the agricultural, natural gas and electricity markets, availability of carbon sequestration, and ongoing advancement in alternative fuel production processes. Fuel buyers will need to manage price decisions not from just one commodity, but from across the competing forces and risks affecting multiple commodities.

Gain a foothold or wait?

The energy transition requires a reengineering of the modern economy, and the pressure on shipping companies to make it happen quickly is significant. Just as the electricity generation industry has been phasing out coal by utilizing natural gas and renewables, the shipping industry is also making progress investing in near- and longer-term solutions. LNG, biofuels and lower-carbon intensity methanol are acting as important energy transition fuels that serve a key purpose as vessel owners progress to cleaner options. It is likely that for specific higher frequency routes, shipping will coalesce around a single fuel choice given economies of scale.

Shipping companies need to set their forward fuel-adoption strategies while dealing with many changing parameters, including national and international regulations that often have inconsistent timelines and criteria. For some jurisdictions, the near- to medium-term penalties associated with non-conformance are not material and are likely to be easily passed through to consumers with little impact. It is therefore not surprising that vessel owners are already committing to ordering dual-fuelled vessels but are still hesitating to commit to long-term supply of transition fuels. However, the industry needs to be mindful that without commercial commitments, lower-carbon fuel production projects will struggle.

While doing nothing seems like an easier and lower-risk option in the short term, it becomes a very high-risk option when you consider the multitude of considerations such as the lifespan of new multi-fuel vessels, the fuel supply needs for those vessels, changes needed in transport and port infrastructure, and impending competition for key commodities. Even when owners make a decision, the lead time on construction and fuel supply chain development will take many years to implement.

While the route to decarbonization is not a straightforward one, the maritime industry is and will continue this energy transition. As we respond to a rapidly evolving regulatory landscape, choosing the right fuels for different applications and stages and ensuring supply will be critical in meeting customer demands and investor expectations.

About the Authors

Aarnoud van Weelderen is Senior Managing Director and Peter Taylor is Managing Director in Macquarie Group’s Commodities & Global Markets business, which provides broad commodities services including access to fuel supply, logistics management, hedging, working capital, offtake services and bespoke solutions.