Destination zero: An action plan for shipping CEOs

(11 pages)

Decarbonization has risen rapidly up the agenda of shipping CEOs. The shipping industry—one of the most costly and challenging sectors to decarbonize—faces growing calls by shareholders, regulators, customers, and other stakeholders to decarbonize at a pace commensurate to the needs of a warming planet. The EU, International Maritime Organization (IMO), and individual countries are tightening carbon regulations, while customers and clients want decarbonized shipping to meet their own Scope 3 decarbonization targets.¹ The same goes for lenders trying to decarbonize their lending portfolios,² and environmental groups and civil-society organizations are campaigning for decarbonization more vigorously than ever.

On top of this, as shipping CEOs work to steer their organizations through a multidecade transition to net zero, they are simultaneously having to juggle near-term market disruptions, geopolitical tensions, crewing challenges, and burgeoning digitalization.

What is a shipping CEO to do?

On the one hand, inaction is a default choice. Some shipping companies have taken a posture of “strategic patience.” Choosing from a sea of emerging sustainability technologies and alternative fuels can feel more like a gamble than a savvy investment. A wrong choice could have ramifications lasting as long as a ship’s life span, which is often more than two decades. Currently, the production and bunkering infrastructure for alternative fuels does not exist at any meaningful scale. Moving too early may saddle the business with an uncompetitive cost structure. The regulatory environment remains murky and uncertain. In this context, “wait and see” seems more prudent.

On the other hand, “green leaders” have chosen to act purposefully to try to cut through the uncertainty. They seek to capture the emerging “green premium” for decarbonized shipping services from customers and get ahead of the coming regulations such as the Carbon Intensity Indicator (CII), Energy Efficiency Existing Ship Index (EEXI), EU Emissions Trading System (EU ETS), and potentially IMO-mandated carbon pricing. They anticipate a “green fuels” shortage in coming years and want to lock in supply now, turning this into a significant competitive advantage. They look over the horizon and aim to avoid stranded-asset risk in the coming decades. These companies are following the maxim of the great ice hockey player Wayne Gretzky, “I skate to where the puck is going to be, not where it is.”

Both postures are built on fiercely held beliefs about the future, and there are no simple answers to the questions surrounding decarbonization. It is no exaggeration to say that how one chooses to decarbonize—at what pace, with which technologies, and to what degree of integration with the company’s asset strategy and commercial posture—is one of the biggest strategic choices facing shipping CEOs right now.

What a decarbonization action plan looks like

For companies embarking on a decarbonization transformation, an action plan helps to incorporate both bottom-up and top-down tactical actions at the level of each individual vessel, which, in aggregate, meet a fleetwide target trajectory for decarbonization and optimize for cost and capital expenses. Some companies approach this purely at the level of individual vessels (“What efficiency technologies are net-present-value-positive and should we install them?”); others make overly sweeping generalizations about future fuels (“We will move our entire fleet to ammonia”). In our experience, the cost-optimal decarbonization pathway is more nuanced than either approach.

In collaboration with the Mærsk Mc-Kinney Møller Center for Zero Carbon Shipping, for which McKinsey acts as a knowledge partner, we’ve created the Fleet Decarbonization Optimizer tool. The tool harnesses the proprietary bottom-up cost modeling of the Center’s NavigaTE model and optimization algorithms to rapidly identify the specific actions across fleet and fuel that will meet a given decarbonization objective.

Given the level of uncertainty, actions vary by scenario. Even within a single scenario, a shipping fleet may adopt multiple fuel pathways. And each vessel will have its own unique adoption of energy-saving devices, based on the specific operating characteristics, age, and starting efficiency of a vessel (Exhibits A and B).

Use of LNG, biodiesel, e-ammonia, and bio-/e-methanol differs substantially depending on assumptions about the future.

Various efficiency technologies are adopted (or not adopted) depending on total-cost-of-ownership economics.

What would be imprudent is not to have a plan at all, and not to stress-test that plan against a range of scenarios. Given the significant uncertainties around future costs of technologies and fuels, policy, customer demand, the financing landscape, and other factors, CEOs need clarity on what decarbonization moves are “good for all seasons” and which ones should be made only under certain conditions. The plan needs to be robust and practical at the level of each individual vessel (for example, which retrofits to do at the next dry dock and which propulsion and fuel pathway to choose for each new build) while also satisfying a portfolio-level decarbonization pathway and financial-return profile (see sidebar “What a decarbonization action plan looks like”).

A decarbonization action plan checklist

A decarbonization action plan is an indicative, comprehensive decarbonization trajectory to provide orientation for fleet planning, fuel sourcing, and commercialization over the next ten years and longer. Here’s a checklist of questions for companies to answer as they plan.

Fleet:

Which energy-savings devices and other efficiency measures should we adopt?
Should we retrofit our existing vessels for new fuels?
What propulsion and fuel configuration should our new builds adopt?

Fuel:

Where can we find alternative fuel, and how much will be available—by when and at what cost?
What mix of fuel pathways best balance decarbonization, cost, resilience, and other considerations?
What agreements should we strike to secure supply at an attractive price?
How can we best manage a portfolio of diverse suppliers?
How can our fleet deployment/network change to adopt new fuels?

Commercialization:

What are our customers targeting in their Scope 3 emissions?
What green shipping services can we offer to meet our customers’ needs?
What is the right price point for our green shipping services?
What enablers are required to unlock “green demand” (for example, carbon accounting and transparency)?

This article presents three levers that decision makers can activate to accelerate the industry’s transition toward zero carbon and capture value in the process (see sidebar “A decarbonization action plan checklist”). Each lever—fleet, fuel, and commercialization—represents a critical aspect that shipping companies could address now. As we’ll explain, these levers share deep interdependencies that, when pulled, can activate the much-needed velocity to reach the industry’s sustainability goals. We’ll show how creating a decarbonization action plan across all three levers can be a methodical approach to achieving just that.

Fleet: Making ships more sustainable

As ship owners and operators look at their fleet for opportunities to boost decarbonization, they could consider three actions: hardware efficiency, analytics-driven sailing optimization, and slow steaming. A McKinsey study conducted in 2020 found that around 70 percent of the world’s tankers and container fleets would fail in 2018 to meet the 2028 CII requirements. The IMO introduced these carbon-intensity indicators as part of a data-collection system to track and reduce vessel emissions.

However, as the CII trajectory beyond 2027 hasn’t been formally agreed on and enforcement of the regulations isn’t clear, some ship owners and operators may be putting off the necessary efficiency upgrades. While this may defer short-term costs, these companies are also forfeiting the cost savings generated. Typically, onboard adjustments have very short payback periods of less than two years, so the earlier they are made the greater the returns.

Hardware improvements are the most straightforward way to boost efficiency. These include technical modifications that are both exterior—propeller improvement devices, bulbous bows, and high-performance paints, for example—and interior, including boilers, auxiliary-demand reductions, and auxiliary-supply efficiencies. As an example, a leading container line that made over 400 modifications to more than 150 vessels in its fleet was able to reduce its fuel consumption by 8 percent. The benefits were so encouraging that the company has started next-level conversations with their suppliers and yard partners.

When new ships need to be added to existing fleets, ship owners and operators could adopt a design-to-value (DTV) approach and improve existing procurement processes. DTV optimizes the vessel’s lifetime value by removing unnecessary features (which may include shaft generators) and adding enhancements that make a clear positive business and environmental impact, such as energy-monitoring devices and premium paints. It also ensures that the size and specs of the main and auxiliary engines are appropriate for the vessel’s function. This would reduce cost while fulfilling the specifications that are directly relevant to the operator.³Buyers can also implement a rigorous procurement process to bring down the purchase price of new ships. For instance, procurement decision makers can follow technical normalization to compare offers like for like, analyze their product’s cost structure to optimize design, expand their supplier portfolio, and conduct transparent multiround negotiations that encourage competitive bids. A container line that implemented such an approach managed to save $15 million in capital expenses and $5 million in operational expenses for one vessel.

Analytics-driven sailing optimization is an increasingly important lever for decarbonizing in the short term. A number of variables need to be managed to achieve optimal fuel burn and carbon emissions, including weather and currents, port berth availability, fuel price forecasts at upcoming ports, and customer needs; optimization algorithms are increasingly up to this task. The question here is one of “build versus buy”: Does a company gain a competitive advantage in developing its own algorithms or benefit from the wider data pool addressed by off-the-shelf solutions? For example, a leading cruise line built its own voyage-optimization algorithms in-house, and then realized the value it held for others and sold the solution to a major shipping supplier. Meanwhile, digital “natives” such as ZeroNorth and NAPA are proliferating, with solutions that learn from ever-growing datasets.

Lastly, slow steaming may be another way for ships to lower their carbon impact by sailing at significantly slower speeds, which reduces fuel consumption. Reducing speeds by a knot could reduce fuel consumption by between 10 and 15 percent. This could be a meaningful strategy for older container ships, which can remain in operation without biofuels for an extra three to five years and meet target CII scores. However, slow steaming may be less relevant for bulk carriers, which are already moving at very slow speeds.

Sometimes contracts with customers will need to be rewritten to enable slow steaming: in the pure car carrier (PCC) segment, automotive OEMs historically demand fast sailing for inventory management reasons but now have the opportunity to reduce their Scope 3 supply chain emissions by allowing their shipping partners to sail more slowly.

Moreover, if maintaining transport capacity is a top priority, ship owners and operators should also be aware that more vessels may be required to compensate for the low speeds. This may potentially result in higher shipping costs. In such cases, slow steaming may not be a feasible strategy. There’s no straightforward, “always right” answer to whether companies should deploy this strategy.

Fuel: Designing a diversified supplier portfolio

The type of fuel used by ships has a direct impact on the industry’s carbon footprint. There are numerous classes of clean (or cleaner) energy sources, including biofuels and electrofuels that are at different stages of maturity (see sidebar “The challenging choice of future fuels”). Shipping companies can actively plan for a diversified sourcing funnel to support their future clean-fuel needs. Decision makers could move from seeing fuel procurement as purely commodity purchasing to actively managing a multisource, multiproduct, and multipartner supply landscape.

The challenging choice of future fuels

There are a number of alternative fuels in focus for the shipping industry. Our work in shipping, across segments, indicates there is no one-size-fits-all answer, and we expect to see many, if not all, of these options adopted over the next 30 years:

Liquefied natural gas (LNG). An alternative fuel in shipping for decades, LNG reduces CO₂ emissions on a “tank to wake” basis by approximately 20 percent. However, methane-slip issues onboard the vessel and during production (“well to wake”) are factors that can increase LNG’s emissions, potentially beyond the levels associated with traditional fuel oil.
Bio-methane/bio-LNG. Derived from bio-feedstocks and leveraging existing LNG infrastructure (for example, storage, bunkering, and ships), it can be used to displace fossil LNG but can also face methane-slip issues and has an unpromising cost-down potential because the production processes are relatively mature.
E-methane. Derived from green hydrogen and captured CO₂ and leveraging existing LNG infrastructure, e-methane is more expensive than either e-methanol or e-ammonia but may also face methane-slip issues during the combustion process, especially in medium-speed four-stroke engines. CO₂ is still emitted during combustion, but if sourced from biogenic CO₂ or direct air capture (DAC), it is generally considered “carbon neutral” on a life cycle basis.
Biodiesel (HVO). A “drop in” fuel that burns in existing internal-combustion engines (ICEs), biodiesel can provide up to 50 to 90 percent decarbonization (depending on the feedstock and production process), faces potential bio-feedstock constraints (which are also in demand for fuels in other sectors like aviation), and has limited cost-down potential (because the production processes are relatively mature).
Bio-methanol. Derived from bio-feedstocks, bio-methanol can be a carbon-neutral fuel (on a life cycle basis). There are marine engines today that can burn methanol, and it is liquid at room temperature, so it can be easily handled and stored (helping to counteract the cargo capacity loss from its volumetric energy density, which is lower than fuel oil). However, it has a limited cost-down potential due to relatively mature production processes.
E-methanol. Derived from green hydrogen and captured CO₂, e-methanol is more expensive than bio-methanol today but will become cheaper in the long run. It will always be more expensive than e-ammonia, as the latter is manufactured from nitrogen, which is abundantly available in the air, but it has an attractive cost-down trajectory (as the costs of green hydrogen come down). CO₂ is still emitted during combustion, but if sourced from captured biogenic CO₂ or DAC, it is generally considered carbon neutral on a life cycle basis.
E-ammonia. Derived from green hydrogen and nitrogen pulled from the atmosphere, e-ammonia is a truly zero-carbon fuel and has the most attractive costs of any of the “e-fuels” (plus an attractive cost-down trajectory as the costs of green hydrogen come down). However, ammonia is toxic, so leaks and safety are a major concern, and an ammonia engine won’t be on the market for another two to three years. Ammonia needs to be stored in refrigerated tanks which take away some cargo capacity. Combusting it can create nitrous oxide (N₂O), which is a very potent greenhouse gas that can be addressed with scrubbers.
Green/blue hydrogen. Given its disadvantaged volumetric energy density, pure hydrogen—either compressed or liquefied—will probably only find a market in short-sea segments such as tugs, ferries, offshore supply vessels, and potentially cruise ships, possibly through the use of fuel cells (which have yet to be stress-tested in a marine environment).
Nuclear. The closest thing to zero-carbon shipping on the water today (in navies and the Russian ice-breaking fleet), nuclear still has to overcome environmental, regulatory, economic, and societal acceptance issues for it to be adopted at scale in commercial shipping.

Designing a supplier portfolio of different clean and traditional fuels is the most effective way of managing this added complexity. In the past, shipping companies would rely on one or just a few providers able to supply the fuel needed across their fleets in major ports. Price was the determining factor; companies were mostly concerned about optimizing price by betting or hedging long-term contracts against spot purchases.

Making the transition to alternative fuels, however, requires a different tack. Many suppliers operate locally and lack the vast supply networks of legacy providers. They also don’t have long-established track records and need strong supportive partners (for instance, offtake agreements to make their projects “bankable”). This means that shipping companies will need to invest in and partner with energy providers without guaranteed success. To spread the risk, speed and diversification are key: shipping companies will need to be prudent to ensure that they have a wide array of alternative-fuel suppliers and lock in supplies while they can.

Executives can make efforts to ensure that their supplier portfolio is balanced across six dimensions: technology readiness, CO₂ abatement cost, potential to build partnerships, regional distribution, first-mover foothold, and supplier maturity (Exhibit 1).

Shipping companies may need to seek new features in fuel suppliers.

Right now, most companies still source their energy needs from a handful of mostly fossil-fuel suppliers. Diversifying supplier portfolios with more clean-fuel providers opens up more options. While alternative fuels may lag behind in maturity, technology readiness, and cost, suppliers tend to be more willing to partner with their customers to pilot new innovations. This could open the way for shipping customers to seize a first-mover foothold and secure supply or even better fuel prices than their competitors over the longer term. Clean fuels can be manufactured in many more areas globally compared with mature carbon-based fuels, improving availability. Finally, as costs come down, clean fuels can, in time, offer CO₂ abatement costs that are lower than paying any future carbon taxes.

Making the transition toward a more diversified supplier portfolio may require shipping companies to acquire several new capabilities. First, they need more transparency on the supply and demand of sustainable fuels. Trackers that monitor global data—including announced commitments, published sourcing deals, and new production projects—may need to be built (or bought) so shipping companies are constantly up to date with the latest developments. Shipping companies could also set up a “technology radar” to keep abreast of the most recent cutting-edge innovations that affect the supply or usage of sustainable fuels, including by collaborating on research projects with universities and partnering with VC accelerator networks to screen potential solutions in the start-up space.

Shipping companies may also need to train up their optimization and sourcing muscles. For procurement decisions, a data-driven cost model is useful for calculating the appropriate cost the company should be paying for each fuel type, based on feedstock sources, production pathways, scale advantages, fuel hedging, and supplier margins. Live data for tracking demand and supply should also factor into the calculations. Meanwhile, a logistics calculator—which takes into account the specific costs of blending and distribution at the production site, as well as the costs of bunkering and uplifting at the fueling location—could help to optimize the cost of transporting the fuel from source to tank.

Commercialization: How companies can make a green margin

The third decarbonization lever is about making the economics of sustainable shipping work. As customers look to decarbonize their Scope 3 supply chain emissions, they will increasingly differentiate among shipping partners based on their emissions. An attendant green premium, depending on its level, could also make such green offerings value-accretive. Yet, while more than 85 percent of shippers say that sustainability will significantly affect their choice of logistics partners in the next five years, their preferred choice of green products and their willingness to pay differ.⁴

Shipping companies, therefore, can consider how to tap into their understanding of their customers to develop and offer relevant sustainable services at an appropriate price. To do this they can break down their customer base into strategic segments. The starting point is to examine their customers’ Scope 3 decarbonization targets, and then to understand the marginal abatement cost curves (MACCs) of their customers’ Scope 3 emissions: How important is shipping to their decarbonization ambitions, at what cost relative to other sources of Scope 3 emissions, and in what time frame? Analysis of these segments could then inform the creation of differentiated green offerings that address customer-specific decarbonization needs.

The portfolio of green offerings could comprise a number of features, which are dependent on the shipping company’s existing fleet and fuel choices. There are three main categories: direct reduction (when goods are physically shipped on dedicated lower-carbon vessels); physical decoupling (whereby a customer pays for fuels that improve a fleet’s carbon footprint, even if their goods are not moved onboard the vessels in which those fuels are consumed, underpinned by “book and claim” certificates); and carbon-neutral voyages (when carbon offsets are used that support sustainability projects but are not directly linked to the transport value chain). Other features could include forward sourcing for future cost reductions—for example, by making advanced market commitments for green shipping services.

Shipping companies may be able to promote the uptake of sustainable shipping modes by positioning greener shipping as a value generator for shippers (Exhibit 2). Not only may shippers be able to avoid potential carbon taxes, but they may also attract new, sustainability-focused customers. If shippers market and price their green products astutely, they may not only be able recoup the increased costs of decarbonized shipping but should also be able to enjoy a green margin. Emerging product-level carbon accounting and labeling will be important enablers in this respect.

Green products offer substantial value creation potential if not priced as cost-plus.

Creating a decarbonization action plan

The three areas set out in this article do not operate independently from one another and so require a systematic approach to spark a virtuous cycle in which positive outcomes are mutually reinforcing. For example, companies need to ensure that they can secure a sufficient amount of sustainable fuel to deliver the green products they’re offering to their clients. A decarbonization action plan—an indicative, comprehensive decarbonization trajectory that provides orientation for fleet planning, fuel sourcing, and commercialization decisions over at least the next decade—serves as a critical tool for shipping companies in this respect.

The decarbonization action plan consists of three main components: ambition setting and baselining, action planning, and execution and learning.

Ambition setting and baselining. The company defines its decarbonization trajectory, deciding whether it will meet the minimal regulatory compliance requirements or pursue more ambitious targets. The baseline of each vessel’s emission performance is taken, and calculations are made to determine the emissions thresholds to reach the target. Different combinations of the fleet, fuel, and commercialization tasks are modeled and evaluated based on cost, complexity, and risks.
Action planning. An integrated set of actions across fleet, fuels, and commercialization is then defined to meet the decarbonization ambition. On fleet, hardware upgrades are planned for upcoming drydocks; new builds are planned to adopt expected clean fuels; analytics solutions are adopted; and contracts are reviewed and amended to enable slow steaming (where relevant). On fuels, clean-fuel needs are compared with expected supply developments; partnerships with producers and bunkering providers are formed; and network strategies for vessels consuming clean fuels are updated. On commercialization, customers’ Scope 3 targets and MACCs are analyzed and green products are defined and A/B tested.

Crucially, action planning needs to be tested against a range of scenarios, underlying the inherent uncertainty in expected future technology and fuel costs, policies and regulation, and customers’ demands for green shipping. It needs to be clear which actions are considered no-regret moves across all scenarios and what the company should do only under certain scenarios.
Execution and learning. As the tasks are executed, the company will learn more about how the market is developing, how stakeholders’ needs are evolving, and what works and doesn’t work. It’s important that the company has a central “single source of truth” for their decarbonization initiatives—usually a decarbonization transformation office or nerve center—so the company can rapidly adopt learnings across the business.

Customers, regulators, shareholders, and other stakeholders are stepping up the pressure for shipping companies to decarbonize at a much faster pace. Opportunities abound for companies that take decisive action now. By making smart fleet upgrades, savvy fuel-supplier choices, and commercially beneficial arrangements, shipping companies should not only be able to offset the risks involved and propel the industry toward greater sustainability, they could very likely also reap significant returns in the process.