Unintended Consequence of IMO 2020

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Long Story Short

The introduction of the IMO 2020 Convention is a necessary step towards reducing the environmental hazards that plague us today. However, proper implementation is important as this magnitude of change may cause a major disruption in global trade. Shipowners and traders are impacted in ways that may not warrant the way the IMO 2020 convention is introduced as it will definitely have unintended consequences.

More attention should be given to how to assist ship-owners to make such changes, in order to prevent shipowners from making rushed decisions or even violate the convention unwillingly. At the end of the day, it is the consumers who bear the cost.

What is the IMO 2020 Convention?

Before understanding the latest IMO 2020 convention, we need to understand the intended purpose of creating the International Maritime Organization (IMO).

 The IMO is an agency task force set up by the United Nations to ensure “the safety and security of shipping and the prevention of maritime pollution”

The conventions adopted by IMO’s 170 participating nations are crucial in ensuring safety, security and pollution are minimal. Some of the milestones are: –

Ratifying the convention to prevent the accumulation of barnacles and marine growth on shipping hulls.

The unwanted growth of algae and barnacles on the shipment hull potentially slows down the ship and therefore increases fuel consumption. Originally, ship operators use harmful chemicals in order to kill the marine growth, which affects the environment in a harmful way.

Adopted the convention of the safety of life at sea (SOLAS), which instructs the participating nations to ensure ship safety, in order to prevent losses of lives and assets at sea.

One example of adhering to the SOLAS convention is that the participating nations are required to verify and weigh cargo containers via approved means. This deters the shipper from under-declaring the weight of the cargo, which potentially could destabilize the ship or worse, damage and capsize the ship.

The IMO also erected MARPOL 73/78, the International Convention for the Prevention of Pollution from ships.

From these conventions, ship carriers are regulated by controlling the pollution of noxious liquids, sewage, garbage, and air pollution.

This is where the latest IMO 2020 regulations come in, which restricts the emission of sulphur from burning heavy fuel oil that is harmful to health. 

The regulation of sulphur emission is not a new thing, as some control has been implemented before, whereby principally the Emission Control Area or ECA has capped the sulphur emission to 0.1%. 

The IMO 2020 essentially caps the sulphur emission from 3.5% content to 0.5% content, whether it is deep-sea shipping or short sea shipping. Basically, sulphur emission from burning marine fuel is capped globally.

As you can see from the mapping below, prior regulations have assigned designated areas surrounding Northern America Sea, Caribbean Sea, North Sea and the Baltic Sea as restricted areas for harmful air pollutants. The implementation of IMO 2020 lies on the Port State Control (PSC).

What is the Port State Control?

Port State Control is not officers appointed by individual port operators, but a body with jurisdictional power under international law to practice its authority over persons, and property by the use of its municipal law. 

In simple terms, Port State Control has an international jurisdiction that may supersede municipal law or work hand in hand. This gives the port state control officers power to control foreign ships at international ports, to inspect the ships with various means, and to deter ships from sailing. 

Port State Controls are empowered by countries that signed a Memorandum of Understanding (MOU). 

For example, the Tokyo MOU has Australia, Canada, China, Fiji, Indonesia, Japan, Republic of Korea, Malaysia, New Zealand, Papua New Guinea, Philippines, Russian Federation, Singapore, Solomon Islands, Thailand, Vanuatu, Vietnam, Hong Kong (China) as participating nations. 

Should the Port State Control find any contradiction of the Convention of the IMO, they are responsible to report to the Flag State of any alleged violations. 

In other words, The Port State Control body has jurisdiction to detect violations of the Convention, but are restrictions over determining the penalty and offense imposed on the violation.

Of course, this has an unintended consequence on the effectiveness of the IMO 2020, which we will discuss further below.

Inspection

Port State Control officers are able to visit onboard a ship to inspect the certificates and documents ONLY when there are clear grounds to believe that the conditions of the said ship are subpar. There are inspection procedures that officers have to adhere to, and ultimately, it is up to the judgment of the officer to determine if there are any violations. 

Detention

Port State Control officers are able to detain a vessel at international ports upon reasonable grounds, a detention order can be issued if: – 

  1. There is a lack of documentation;
  2. Deficiencies in following the convention or regulation codes.

The bottom line is, the implementation of the IMO 2020, is undertaken by the Port State Control officers appointed by the committees in their respective MOUs.

What is Flag State?

A ship is legitimized by registering itself to a state, it could be any state, even it is land-locked. The ship signifies its flag state by flying the symbol of its registered nationality, the “Flag State”.

 By placing a ship on a registry of a flag state, the ship is bound by rules, conventions, and regulations adopted by the flag state. 

A registered ship also grants ship the freedom to sail the international seas. An important aspect if you want to transport goods internationally. The states that ships choose to register with is arguably states where the rules and regulations are in favor of the ship-owners. Therefore, you will find that the states with the most registered ships are not the economic behemoths of the world.

How Shipping Carriers are reacting to the IMO 2020?

Well, to be straight forward, shipping carriers will increase the ocean freight rates. 

Due to the fact that Very Low Sulphur Content (VLSFO) fuel costs more than the standard Low Sulphur Content fuel, the bunker cost for ships will invariably increase. 

To the recent extent, the variance between the IFO380, the staple marine fuel used, and VLSFO is more than 75%, the price of IFO380 during the writing of this blogpost is at about USD 371.50, whereas the VLSFO is priced at about USD 662.50.  

Here is the recent daily price fluctuations of VLFSO and IFO380: –

Date Price VLFSO (USD) Price IFO 380 (USD)
Dec 13 2019 613 344.50
Dec 16 2019 623 349.00
Dec 19 2019 655 331.00
Dec 23 2019 674.5 346.50
Dec 26 2019 687 354.50
Dec 30 2019 720 371.50
Jan 2 706 345.00
Jan 6 741 400.00
Jan 9 723.5 387.50
Jan 13 688.50 386.00
Jan 15 672.5 365.00
Average 682.18 361.86

Whether or not the price of VLSFO decreases or stabilizes depends on the simple demand and supply economics. The drastic increase in VLSFO price simply reflects the current market situation only. 

Ocean CarriersAdjustments
APM-MaerskNew BAF = (VLFSO – USD 50.00) x Market Factor 
*Maersk line also reserves the right to impose the Environmental Fuel Fee (EFF) where the contract validity is under 3 months.
Mediterranean Shipping Line (MSC)Bunker Recovery Charge
BRC = 3 months average LSFO 380 price x Trade Factor
CMA CGMFor short term contracts LSS IMO 2020 = (VLFSO Fuel Price per ton  – Oct 2019 Fuel Price per ton) x trade coefficient

The underlying principle is similar, where ocean liners take into account the new fuel price and multiply it by the “Trade Coefficient” or “Market Factor”, these coefficients are trade secrets and are not shared by the liners. But in essence, the trade coefficient or its equivalent is a combination of factors that overall fuel consumption.

With this in mind, any factor that contributes to an increase or decrease of fuel consumption will affect the trade coefficient, factors such as the historical weather conditions, the port facility condition, numbers of TEU capacity, etc…

Are the effects on ocean freight rates substantial?

In our opinion, in the long term, the ocean freight rate will not increase drastically. There are two points that lead us to think so. 

Firstly, in 2004, the value of the world import trade was USD 9.2 trillion and the cost of freight was USD 270 billion, this represents 3.6% of the total value of the world. 

In context, the increase of the ocean freight rate, if taken into consideration the average cost per item goods imported, will not be an amount that grinds the international trade business to a halt. 

Moreover, for most circumstances, the higher cost of freight is still less expensive than the alternative. 90% of global goods are transported via the ocean. We don’t see that the increase in ocean freight rate in the short term will change that fact the slightest even.

Secondly, the shipping industry is very competitive. The shipping industry is neither a duopoly or an oligopoly, where only a few big companies reside in the market. Rest assured that all ship-owners are looking across their collective shoulders to see what the competition is doing.

Unintended Effects of IMO 2020 Implementation?

The underlying intention for the IMO 2020 convention is pure and noble, the environment is negatively impacted by the emission of harmful toxins such as Sulphur Oxide, Nitrous Oxide, Asbestos, Particular matters, and ozone-depleting substances. The IMO showed great political will to make a concerted effort to deter pollution. 

BUT, there are a few unintended consequences which we want to bring to light. It may not be prevalent in the long term, but we like to show you the other side of the coin. 

The Regulatory Muscles Flag State or Flag of Convenience

Flag States do not have the incentive to enforce the IMO 2020 to its full extent

We briefly outline the role of port state control and flag states for an important reason in order to provide some context. 

In 2005, 48% of the ships are open registers or known as a flag of convenience.

A flag of convenience acts similarly to international or national flag registry with a difference where the company laws, tax laws and crew nationality requirements are lax and in favour of the ship-owners. 

Vessel flying its flag state’s flag, Source: piqsels (www.piqsels.com)

It is similar to registering a company offshore, with an intended purpose of avoiding company tax, which is not illegal by the way. 

Apart from the tax advantages for shipowners to opt for registering with a flag of convenience, it is easy to reason that these states have a limited capacity to govern the seaworthiness of the vessel. 

International Laws adopted by the IMO usually takes time for individual states to ratify. Moreover, the extent of the ratification of new international laws also varies depending on the state.

Almost 50% of the vessels registered with a flag of convenience, there exist loopholes which are favourable to the shipowners, making global governance difficult. 

We have yet to see the extent to which states will ratify and exercise the most recent IMO 2020 convention limiting the sulphur emission percentage. Empirically speaking, there are many cases which supports the statement that vessels registered under the flag of convenience are exploiting these regulatory loopholes.

Effectiveness of Air Scrubbers

Shifting from one form of pollution to another

Another point of concern is the use of open-loop air scrubbers, it is installed on vessels in order to filter sulfur and other harmful chemicals from the marine fuel burning. 

Open-loop scrubbers are preferred over the closed-loop scrubbers solely because it is significantly cheaper for shipowners to install.

the filtered sulfur is dumped into the ocean in an open-loop air scrubber system, there are many debates among experts whether this is actually an act of pollution with the same magnitude of negative impact. 

Nevertheless, many countries such as the UK, USA, Norway, Sweden, Singapore and China and more recently Malaysia are imposing a ban on the use of open-loop air scrubber. This shows that there are actually detrimental effects on the environment in which countries are making efforts to steer away from. 

The issue is that not all countries impose this ban, and also the majority of vessels are installed with open-loop air scrubbers. It stands to reason that this IMO convention 2020 maybe just shifting a form of pollution to another form

Shipbreaking Boom

Making another form of pollution lucrative

Not all vessels are able to comply with the regulations because of the air scrubbers are not compatible with older models of vessels.

Average age (years) of the world’s merchant fleet in 2011, Source: UNCTAD

The oldest vessels on average are general cargo vessels and oil tankers.

Granted that there are many factors that contribute to the decision to break a ship, the technological obsolesce of a ship is a major factor.

The shipowner could decide that the ship is no more profitable to operate, for example, by the introduction of a new IMO Convention, requiring millions of dollars to comply.

Hence, there will logically be an increase in shipbreaking activities. In addition, the immediacy of the convention also speeds the urgency to dispose of obsolete vessels, regardless of whether shipowners profit from it or not.

Shipbreaking prevalent in Bangladesh, India, Pakistan, Source: https://www.atlasobscura.com/articles/inside-the-shady-dangerous-business-of-shipbreaking

Shipbreaking is a notoriously dangerous endeavor that also causes marine pollution and health concerns. That is why only nations such as Bangladesh, India, and Pakistan are willing to undertake the shipbreaking business.

Shipbreaking Yard, Source: commons.wiki

Conclusion

We do not advocate that IMO Convention 2020 is bad, we merely think that more care should be placed on all stakeholders and we should study the ripple effect of such perceived immediate change in the standard.

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