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  • Writer's pictureRyan Lynch

Alternative Fuels, Increased Complexity

In this, our last weekly analysis of 2021, we highlight the discussion around LNG and other alternative fuel sources for usage in the maritime segment. In this presentation, we are not making qualitative judgments about the environmental effect of each fuel (leave that to the scientists), nor are we assessing the long term efficiency of engines or design characteristics (leave that to the engineers); rather we look uniquely at the marginal and fixed cost viability. This being said, we do assess the carbon emission prices but only as they affect the economic viability of capex fixed versus marginal cost functions.

The analysis is based on project financing for a newbuilding, where we use Aframax/LR2 as a large/ high utility segment, which has an equivalent in nearly every other maritime segment. We simulate a Co2 levy based on European trading alone (due to enforcement effect), and look at what the bid/ask spread on time-charter is today after accounting for carbon benefit of LNG or alternatives versus the fixed and marginal cost structure of the fuels.

There is much in the way of ambiguity still in this analysis which has prevented significant uptake by "tramping fleets" on switching. First commoditized tramp fleets have (generally) a less secure employment function, that is a more robust spot market. While spot market becomes accretive (at times) to managers with volatility effect; when there is increased capex servicing loan underwriters may prevent the projects from being accomplished without revenue visibility. This revenue visibility is long term time-charter rate appreciation from end users for the carbon abatement strategy/technology; be that corporate ESG, relative price effect or other strategy. In a market like today where gas prices (and all their derivatives) are high and volatile, this may prevent the marginal buyer from switching to alternative fuel as lack of underwriting capacity for fixed costs and economic viability for marginal costs become preventative.

There are other considerations which make the story complex such as cost of debt servicing (interest margin/risk), residual risk and operations. The interest rate risk is a considerable problem, with LTV on the order of ~70% for a new building tanker/bulker, the fixed "improvement" costs are on the order of 10-20m depending on the ship size on which basis normal commercial assumptions is about 350-500k in marginal interest expenditure. There are transactions which do qualify for Green Bonds, such as a recent methanol project, however these are seemingly only available to the best of maritime debtors. Additional uncertainty as to covenants and LNG emission calculations are also material concerns.

Residual risk interpretation presents a problem, such as how rapidly do you amortize the engine, and is it just the engine you are accelerating, or are you attempting to double decline the whole ship over the life of the charter? For a tramp fleet that might be closer to 50% or maybe even 25% of the economic life of the ship, at ~70% LTV, that becomes quite substantial. Of course there may be some benefit from a tax standpoint, as traditionally offshore tax jurisdictions are now possibly under a global minimum tax, it is still a headwind. Operational concerns are principally due to the fixed equipment, meaning do we have hoses, pumps, piping, barges and all the needful in place at strategic bunker nodes? The answer is not generally yet, although with the right investment this concern can quickly be mitigated and is being done in the US, Singapore and EU regions. With the right financing (Ex-Im, Dev. Banks) this can likely accelerate and become a tailwind, however an agency needs to make steps. Finally who is responsible for the voyage emissions, the shipowner or the end user? Lack of regulatory guidance can make this a market variable (like ECA), at least on voyage economics, who has the upper hand in the negotiation will determine the carrier of the burden.

All told, even leaving the regulatory, environmental, and engineering problems to the experts, the economic concerns are problematic to say the least. It's difficult to see how these projects can be accomplished without long-term lease rate protection, and with the price of alternative increasingly inflationary (compared to oil), the picture only becomes murkier.

As always don't hesitate with any question or issues.

MOIC 20 Dec
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