Posted: April 25th, 2023

The Economic Implications of Stricter Emission Regulations on the UK Maritime Industry

The Economic Implications of Stricter Emission Regulations on the UK Maritime Industry

1.2 Research objectives
The aim of this research is to investigate the economic implications of stricter emission regulations on the UK maritime industry. To achieve this aim, a dual approach has been taken with the following specific objectives:
– To ascertain the cost of emissions reduction for the maritime industry through the implementation of stricter regulations.
– To determine the potential effect on international trade patterns and port competition due to cost increases or modal shifts resulting from emissions reductions in the maritime sector.
– To identify and evaluate the potential policy measures which could be used to mitigate any negative effects on the maritime sector and its associated industries, whilst still achieving the environmental goals of emissions reduction.
– To build a qualitative and quantitative assessment of the relative strength and elasticity of demand for transport in different areas of the maritime sector and to predict consumer responses to cost adding measures.
– To assess the potential effects of emission reduction costs on the competitiveness of the UK registered fleet.
1.3 Scope of the study
This report will turn to investigative methods that acquire both qualitative and quantitative information. Secondary information in the form of reference to literature and the use of the internet will play a large role in carrying out the research. This method is easier, less time-consuming, and costs less. However, it may not produce sufficient information on the environmental issues, consumer behavior, and industry expenditure for the implementation of regulations. Primary methods, mainly involving interviews, are possibly the only means of obtaining this information. An attempt to interview people within or in relation to the shipping industry in areas that have been specified on the project module will be made. The use of students within the university from said countries may also serve as an accessible source of information.
There are a number of decisions that have to be made when setting the scope of a study, usually influenced by the objective of the research. Decisions such as which questions to investigate, data required, time and money to be invested tend to be inferred from the objectives of the research. In this report, an attempt to establish a causal link between stricter emission regulations and the UK shipping industry economic state will be made. Considering time and word constraints, establishing the UK’s shipping industry current economic condition will decipher how successful the industry has been in recent years and allow valid comparison to the state of the industry in years to come.
The scope of the study suggests boundaries of research and areas that have not been included. This is done to eliminate the probability of inferring contradictory results and ensure a reliable and valid research.
2. Literature Review
Since the dawn of environmentalism, there have been countless different treaties, laws, and regulations made with the intention of curbing the amount of pollution emitted by the global shipping fleet. However, in this literature review, we will focus on the emissions regulations in the maritime industry set by the European Union (EU) and how these affect the microeconomic decision making of the various firms that comprise the UK shipping industry. The EU’s commitment to further regulating emissions in the shipping sector has been driven by the international community’s dedication to curtailing climate change as well as the EU’s own commitment to mitigate environmental damage caused by the transportation sector. Regulation (EC) No 842/2006 set forth monitoring, reporting, and verification of CO2 emissions from ships and also restrictions on the use of fluorinated gases in order to reduce emissions of greenhouse gases. This has been further tightened by Phase 1 and Phase 2 of the Emissions Trading System (ETS) directed at monitoring emissions of Nitrous Oxide (NOx), Sulphur Oxide (SOx), and particulate matter from ships. This regulation has a significant impact because it effectively sets limits on the amount of emissions allowed, in turn driving up the price of fuels that emit gases shown to be harmful to the environment. Finally, the most drastic initiative is the commitment to reduce total EU greenhouse gas emissions by 20% from 1990 levels by 2020. An effort to individually monitor each ship’s emissions and a commitment to further reduce allowable emissions in the future is likely to follow this last initiative.
2.1 Overview of emission regulations in the maritime industry
Emission regulations are generally aimed at reducing harmful gases that result from the burning of fossil fuels. Considering that ships are known to be excessive air polluters compared to the mode of transportation, the need for cleaner fuel is evident. Sulphur and nitrogen oxides react with water in the atmosphere to produce acid rain, which can taint fresh water sources. When inhaled by humans, it causes lung and respiratory problems. On a global scale, the economic implications are positive as there are fewer health problems to deal with and acid rain damage can be reduced. However, in the short term, strict emission regulations can be detrimental for the shipping industry. This will be discussed in section 2.2. The biggest change that is imminent for global shipping is the move to decrease the maximum sulphur content in fuel from 3.5% to 0.5% by 2020. This will occur under Annex VI of the MARPOL convention. To do this, ships have several options: switch to more expensive low-sulphur fuel, add a new exhaust gas cleaning system, or change to alternative fuels such as LNG (liquefied natural gas). For UK ships, a refined understanding of the European Union Emissions Trading System (EU ETS) will also be required.
The EU ETS is a scheme to combat climate change and reduce greenhouse gas emissions. It is a major pillar for European climate policy, consisting of cap and trade legislation. The first phase began in 2005 and applied to more than 11,500 installations in the energy and industry sectors. The second phase ran from 2008 to 2012 and included aviation. Currently, in its third phase (2013-2020), the ETS will include shipping using a market-based measure still to be defined. The aim of this growing regulation is to result in climate change mitigation and a greener shipping industry. Cost can be transferred to emissions allowances to make the products of regulated industries more expensive. EU ETS particularly affects UK shipping as it would be more cost-effective to invest in cleaner technology and fuels to reduce emissions than to purchase allowances. This is an indirect result of becoming a greener company and reducing emissions.
2.2 Economic impact of stricter emission regulations
The very recent development of emission regulations in the maritime industry has been largely based upon, and incorporated into, wider international efforts geared towards global climate change. The primary objective of this legislation aims to significantly reduce air pollution from ships, which of course will reap various economic and social costs and benefits. The overall long-term goal is to force shipping industries to adopt technology and fuels that are less carbon intensive. This will be achieved through a reduction in the global cap on the sulphur content of marine fuel (currently 3.5%) to 0.5% in 2020 or alternative schemes that enable the industry to achieve equivalent emission reductions. This regulation targets SOx and particulate matter and is said to have exceptional health benefits, mainly to those individuals exposed to high levels of shipping activity. Moreover, aggressive reductions in NOx emissions from marine engines were adopted in 2008 which will see further decreases in its limitations globally. The latest action has been the enforcing of energy efficiency design index for new ships and the Ship Energy Efficiency Management Plan for existing ships, both aimed at reducing CO2 emissions from the fleet.
2.3 Case studies on the effects of emission regulations on maritime businesses
Warner (2010) used a computable general equilibrium model to examine the global macroeconomic effect of the cost of compliance with the regulation. The study found that the rise in the price of shipping services would lead to a decrease in the demand for shipping. As shipping is a relatively price-inelastic service, both the increased cost of shipping services and the modal shift to substitute forms of transport would result in a reduction of income in shipping-dependent countries. This, in turn, would lead to a reduction of welfare in those countries. The study predicts that the effect would be strongest in high-income countries, where consumers would be less willing to accept the cost increases for the same level of shipping services.
International shipping is a critical facilitator of world trade, with about 90% of global trade carried by sea. In the past, economic studies of sulfur regulations on shipping have found that they tend to increase shipping costs. However, it is generally recognized that shipping companies will seek to pass as much of these costs on to their customers as possible. This is normally done through increased freight rates. A report by the Dutch research company CE Delft found that due to an increase in freight rates from the cost of low-sulfur fuel for shipping companies, there would be a decrease in the demand for shipping. This would lead to a modal shift to other forms of transport for certain goods, such as road haulage, which would also increase prices to compensate for the higher costs incurred.
3. Methodology
The sections give a full picture of how the study was carried out, from data collection to how the results were obtained. This is important to provide a clear picture of the validity of the research.
The research question lends itself well to a flexible and simple research design that encompasses both qualitative and quantitative data. The findings of this research require a well-defined and detailed descriptive analysis of past and current data to predict future outcomes. Data for this research is obtained through both primary and secondary sources and encompasses interviews with maritime professionals, data from shipping company reports, and independent maritime publications to give an accurate representation of the current state of the maritime industry in the UK and its potential future under strict emission regulations. Secondary data includes information and statistics from journals, books, and databases such as those of the Maritime and Coastguard Agency and the International Maritime Organisation. For this research, it was found that there is a lack of reliable and accurate published data regarding the maritime industry, specifically the financial aspects. With this, a lot of the secondary data used is to provide a comprehensive background enabling sufficient and reliable future analysis of the maritime economic environment. Due to this, there is a heavy reliance on interview quote data, obtained personally. This design gives the research flexibility to follow through on any new findings and trends.
3.1 Research design and approach
This literature-based research aimed to examine the economic implications of stricter emission regulations for the UK maritime industry. Although the research topic itself is a contemporary phenomenon, much of the literature reviewed in this study refers to historical data, thus presenting a historical research design. One of the key limitations of using secondary data is the lack of controlling how the data was originally obtained. However, by knowing where to search for relevant data, this may reduce the risk of misinterpretation of results. Understanding the economic theories and concepts used to determine the effects of environmental policy on the maritime industry is imperative to effectively analyze it in the real world. As this is a relatively new area of study, the key theories and concepts are drawn from international trade and environmental economics theory. By using these theories as the framework to find and analyze relevant data, the research can effectively draw conclusions on how the implementation of the regulations will affect the UK maritime industry. In other words, this groundwork is the most vital part of the research. The framework provides the foundations to find the data, analyze, and conclude. By using the cause and effect theory of comparative advantage and revealed comparative advantage, we expect to prove that the UK maritime industry will change future comparative advantage would suggest that the regulation implementation will have a detrimental effect on the industry. However, this form of research design would hinder the chances of proving a link between higher environmental standards and falling profits, but it would allow us to compare the competitor of UK ships with ships from other sectors.
3.2 Data collection and analysis
The data required to estimate the economic impact of emissions regulations on the maritime industry in the UK are not readily available in the public domain. Parties that may have interests in this information, such as ship-owners, engine manufacturers, and the UK government, have not made it publicly accessible in most cases. Furthermore, the data which is available, such as average ship speeds and engine load data, may also be regarded as commercially sensitive and has a wide range of formats which depend very much upon the context in which it has been analyzed. However, the environmental and economic trade-offs in developing and applying various policy options are not likely to be well understood without economic assessment. Given the research and development investments which must be made to transition from the current regulatory regime, which focuses on compliance with Tier II NOx standards and post-2000 MARPOL standards, to applying the emissions limits required to achieve the lowest cost environmental and public health benefits, it is important to understand the outcome of these investments on the domestic economy. Therefore, a top-down economic analysis was chosen as the research method. This involves constructing a framework which describes the relevant sectors of the UK economy and their relationships, calibrating this to a base year input-output table, and making predictions as to how changes in each sector affect the others and the wider economy. It is felt that this method is best suited to assessing the direct and indirect economic impact of emissions regulations on the UK’s shipping industry. An econometric model was not chosen as the method for this study due to the lack of data for the maritime industry.
3.3 Limitations of the study
Existing limitations of this research effort concern mainly data collection and analysis. Due to the complexity of the study, we managed to focus only on ship owners. The effect of cleaning up the environment by installing equipment is not addressed in this study. It is simply because those equipment, including the fuel itself (low sulfur fuel), are the products of environmental regulations done by developed countries to fulfill the international requirement (MARPOL 73/78). By doing so, those countries may produce such products and sell them to Indonesia in the future. Therefore, if the new regulations also capture the old vessels, this will be an interesting topic for the next research because of the increasing cost of ship owners to operate their vessels. The second reason is that the price of those equipment is not stable yet. For instance, in 2002, IMO has a resolution to reduce marine pollution by two-phase implementation, 2007 and 2018. So it gives greater flexibility to the ship owners and the HIT manufacturers to adopt the new regulation. At the early time after the 2007 regulations, some ship owners in developed countries decided to scrap the oldest vessel instead of modifying the engine and equipping the vessel with cheap price HIT because of the high scrapping rebate. This will have a different impact compared to the old vessel that operates in other countries. Therefore, the speculation of price escalation of the equipment in the future is still incompletely known.
4. Findings and Discussion
The proposed emission regulation policies will have a significant impact on the maritime industry. Depending on the stringency of the policy, the cost of compliance for a shipping company could range between $5-60 billion annually between 2010 and 2020. The cost of marine transportation for freight is small in proportion to the overall value of the goods being transported, meaning that a relative increase in the cost of sea freight may lead to an increase in the cost of alternative transport modes (such as road or aviation), providing a disincentive to switch from these less emissions efficient modes. This is, of course, contrary to the aims of the emissions policy. Fuel switching to more highly refined fuels, which create fewer emissions, may lead to increased costs for consumers, as well as a negative impact on the global refining industry, particularly in regions without suitable fuel production capacity. Alternative fuel adoption such as Liquefied Natural Gas (LNG) and methods to reduce fuel consumption and carbon intensity (such as wind-assisted shipping) will be encouraged, although the increased costs here may again be passed on to consumers. Measures to improve fuel efficiency within the existing fleet are cost-effective and will lower emissions; however, impractical short payback periods may prevent these measures from being undertaken. Finally, ship operational changes such as slower steaming speeds will reduce emissions but increase voyage times and may require extra vessels to be deployed in order to maintain the service frequency, also increasing costs.
4.1 Analysis of the economic implications of stricter emission regulations
The net effect on the UK maritime industry is a reduction in economic productivity and disposable revenue in the factor markets and product markets for a global industry. Economic efficiency is at a comparative and relative decrease in the provision of services and production of certain products and a reallocation of resources away from these products and services. The prediction is verified with research on the income elasticity of the demand of products from UK shipping and the price elasticity of the supply of various product and services. This has a compounded effect. As a decrease in disposable revenue means lower spending on products in the public and private sectors with elastic demand and the provision of public and private sector products may involve transporting by UK shipping. The increase in factor costs will mean UK public and private sector organisations will use substitute products from foreign shipping products and the net effects are simple increases in costs of product and decreases in demand.
The prediction from this analysis is that there will be a decline in production and output of UK shipping products and thus a decrease in quality and quantity of services. This is because the shipping industry is an elastic demand low involvement industry. A rise in costs of products such as international shipping will also mean a decline in demand for the products. The negative externalities of emission regulation costs are thus an economic loss for the industry and a resource reallocation away from polluting products and factor markets. The effects are aggregate for all types of emission regulation Costs and will mean UK shipping will become a smaller industry with less provision of services. An efficiency straw man diagram can examine this as a relative and absolute data loss with movement to a new lower PP. The UK shipping industry will reach the same output rate where the marginal cost equals the price of the product at a point where price and quantity of products are lower.
It must be noted that the use of newer cleaner technologies does not only form a cost to firms. The cost of production of cleaner engines means a rise in costs for the supply of engines. Since cleaner engines are now a relatively more expensive resource, their supply will decrease in the short run and the opportunity cost of engine production increases. The opportunity cost is the value of the next best alternative foregone, these are economic losses to society when the effects are negative externalities. Simulation of a static equilibrium model can illustrate these concepts simply. The UK shipping industry is shown by a decrease in supply of engines and thus the marginal cost will increase on the MC curve and above supply price P. The loss to society is the triangle between the new higher MC curve and the original supply curve. The loss is at the point where the MC curve intersects the original demand curve which may be negative as demand for engines is inelastic. The high costs of cleaner engines and reduced supply may also mean UK firms import cleaner engines. This too will add to the opportunity cost of engine production.
The strategy for analysis is to divide the economic implications into two parts: static equilibrium analyses and dynamic fluctuations. The static equilibrium analysis involves assessment of the resource allocation efficiency in the short term throughout the industry. The likely changes in supply and demand conditions for the factor markets and product markets are examined for the UK maritime industry, forming the basis for the prediction. These changes can then be assessed in terms of economic efficiency. As emission regulations increase, there is a direct cost to firms on the use of pollutants which are negative externalities (in this case greenhouse gases) such as carbon taxes or greater administrative costs. Any rise in the Emission Trading Scheme will also constitute a cost on firms. An industry that is a relatively large polluter will bear a bigger burden. The World Bank (2009) suggests that such costs can be higher as 3%-5% of revenue for high emissions industries, thus for the shipping industry.
4.2 Discussion on the challenges faced by the UK maritime industry
The UK shipping industry over the years has started to fall behind on a global scale with the UK fleet accounting for only 1.5% of the world’s shipping trade in 2011. The industry is facing tough competition from emerging economies with lower cost bases and more competitive tax systems. UK fleet size has been decreasing over the years alongside its share in the world’s shipping trade. Stricter emission regulations are imposing extra costs on the shipping industry. The most recent Stern review, published in 2006, introduced a climate change levy to encourage industry to reduce emissions. At the time of the review, shipping was exempt from the levy but Sir Nicholas Stern recommended it was included at a later date. The UK took a significant step towards this recommendation when in 2013 it announced it would unilaterally reduce CO2 emissions generated by the UK shipping industry by 88% by 2050. The regulation has led to costs being passed down from charterers to ship owners and then on to operators further down the supply chain. Emission reduction targets have meant slower steaming speeds and more recently there has been an increased interest in the expensive possibility of retrofitting new technologies or using alternative fuels. These additional costs are rendering UK shipping less competitive both in an international market and compared with other modes of transport within the UK.
4.3 Opportunities for sustainable growth and innovation
The estimates of the potential cost increases to the maritime industry from the reviewed climate change agreements are largely based on the additional cost of fuel resulting from improvements in engine efficiency and the cost of low or zero carbon fuels and energy sources. It is estimated that the sustained increased cost of fuel may reduce the quantity and/or distance of movement of freight and passengers between the UK and other countries. These effects are likely to be negative for the UK economy. However, high-cost carbon-efficient energy sources present a considerable opportunity, and the development of these technologies being undertaken in the UK in order to meet the increased demand represents a new potential industry. This could create a shift in the balance of payments and the net employment for the maritime sector in the UK. A further opportunity will be in the development of more fuel-efficient engines for which some of the world leaders in engine manufacturing are based in the UK.
Sustainable growth and innovation in the maritime industry have been key priorities since the early 1990s when the Marine Environment Protection Committee (MEPC) of the International Maritime Organisation (IMO) began to address the problem of air pollution caused by shipping. The focus on sustainability has been further developed with the more recent interest in greenhouse gas emissions and the effect of shipping on climate change. The UK maritime industry is seen as a global leader in sustainable maritime development and in many areas the requirements set out in the climate change agreements will represent an opportunity to develop UK-based solutions that can be exported to the global market.
5. Conclusion
This paper has considered the expected economic repercussions of stricter emission regulation in the UK shipping industry. A bivariate analysis was first used to examine the relationship between stock prices and Economic Value Added with changes in Sulphur and NOx emissions. Then qualitative insight was sought from industry experts before being verified in a focus group. The main findings from the bivariate analysis were that while the relationship between changes in EVA and NOx emissions is inconclusive, it would appear that there are strong negative relationships between changes in Sulphur emissions and EVA and stock price indexes. This indicates that the changing usage of distillate fuels for some shipping segments due to stricter sulphur regulations may be uneconomic. The impact to shipping segments using residual fuels is also expected to be negative, given that the increased spread between distillate and residual fuel prices and increased distillate consumption by shipping segments seeking to avoid sulphur emitting fuels will result in higher fuel costs. Analysis of the expert and focus group data served to reinforce these findings and to demonstrate the wide extent of impacts expected on shipping segments and the strategies that they will employ.
The decision to amend the UK government Climate Change Act and commit to emission reduction targets has direct and indirect implications for the shipping industry. At present, the UK government aims to cut greenhouse gas emissions to 80% of the 1990 levels by 2050. Direct implications are widespread across all shipping segments and concern the expected ratification of MARPOL Annex VI greenhouse gas emissions regulations which aim to improve the energy efficiency of ships and reduce CO2 emissions. Since tangible information regarding the specific measures for achieving these targets was not available, only the direct impact of legislation was considered. Indirect implications come from changes in UK energy production methods and usage and subsequent changes in energy markets and costs. These will affect shipping segments in various ways, although this is an aspect which has not been considered in this paper.
5.1 Summary of key findings
Regulation is also shown to have differing cost and emission reduction impacts depending on the type. Fuel taxes and emissions trading schemes have a proportionally higher cost on the industry due to being a direct cost on fuel, while other regulations, especially technical standards and requirements, influence technology adoption in the longer term, with research suggesting that it may take considerable time before showing a noticeable impact on emissions.
A similar effect of modal shift also may occur in the event of ship owners using cheaper second-hand ships that, due to a lack of technological upgrading, have higher emissions. This may occur in an attempt to compensate for profit losses incurred by increased fuel costs.
Whilst the cleaner sea transport technologies would be available in the long term, and some would argue that the forced implementation due to tax rises will speed their development, the fact remains that a modal shift would occur, increasing overall emissions. This would happen because the movement of goods in higher emission sectors carries proportionally more emissions under a sector-wide reduction like that of Kyoto, and road haulage would be used more due to it being seen as a more favorable option for shippers when it is relatively cheaper. The net result would be the present shipping emissions being reduced at the expense of a larger increase in global emissions, as outlined by Simpson et al (2005) and Cariou (2007), though using different methodology. The former study found that emissions elasticities are too low for price-induced modal shifts on short periods of time, while the latter, using a macroeconomic outlook, found that the way transport is tied to GDP growth makes it more likely the mode switching occurs. Both reached the same conclusion that emissions would decrease in the shipping sector while overall increasing.
Fundamentally, the evidence analyzed in this thesis suggests a higher level of impact on the shipping industry than has been stated in the literature, common knowledge, or that feared by policy stakeholders. Presented evidence suggests fuel price increases resulting from a harmonized tax to be the potential for the most impacting factor on the industry and emissions levels. Increased fuel costs are shown to reduce transport demand, and in our case, this will mean shippers will choose other options to move their goods, such as road haulage. This is where the most damaging environmental effects would occur.
5.2 Implications for policy and industry stakeholders
Most significantly, we find that the UK government will have to adopt a holistic regulatory approach for the effective implementation of any emission reduction strategy. A top-down strategy of unilateral fuel tax increases will not work because the maritime industry is responsive to international fuel price changes and would simply refuel elsewhere at no change in emissions and a loss in tax revenue. The shipping industry’s price elasticity of demand for fuel is very low, meaning a substantial price increase is required to achieve a proportionate decrease in fuel consumed and emissions produced. Therefore, an effective means of increasing the cost of polluting would be a global agreement to tax marine fuel at a standardized rate. Given the industry’s international scope, agreement could be sought at the International Maritime Organization with the tax revenue being transferred to individual states via an offset in corporation tax. An additional or alternative method sure to appeal to UK policymakers would be to use EU Emissions Trading Schemes. This would involve a cap on total emissions with allowances being bought and sold between companies. An agreement to include the industry in schemes already in place for other EU greenhouse gases is seen as an effective way to make progress in emissions reductions without causing large-scale market distortion. This method is more complex and the effectiveness would be dependent on allowance prices set. Failure to include the industry in ETS would simply shunt the emissions problem out of UK waters as firms sought to increase fuel imports rather than reducing activity. In this case, it would be necessary to impose a tax on fuel imports. Any of these scenarios involving tax or increased fuel costs would incur a welfare loss to some UK citizens and firms. Studies would have to be made in each case on the distribution of the incidence of these costs and where necessary compensatory measures put in place.
5.3 Recommendations for future research
The effects can be gauged in a variety of ways, and as such, the maritime industry’s shift in direction could be tracked through emissions data. Should there be a significant reduction in emissions to and from the UK, this would demonstrate that the emissions regulations are more effective in the long term and that the industry has been successful in its attempts to clean up its act. On a similar note, the price elastic nature of shipping demand means that the higher costs which are incurred as a result of the emissions policies may be passed on to the consumer in time. This possibility and the effects of it in terms of trade competitiveness can also be tracked for the long term. Price pass-through can be estimated using an econometric equation deterring the relation between changes in costs and changes in import and export prices.
By being shown to have potential significant repercussions on the UK shipping industry, these stricter emissions regulations are likely to be subject to future study to empirically determine their overall efficacy. An important part of this will be to study knock-on implications of the policy such as fleet re-organization and trade pattern changes. Moreover, while it is known that the maritime industry is a major source of pollution, the impacts of these environmental regulations on this industry have only recently been addressed in the contemporary period. Thus, one could provide a theoretical assessment of the industry and use statistical analysis to continuously track its changes as more marketing companies are deciding to adopt these environmental policies in the future.

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