How LNG marine propulsion will impact the global gas market [Gas in Transition]

As world LNG prices spike to painful levels the shipping industry must be looking nervously over its shoulder. Nearly half of this year’s new ship orders will be equipped with LNG-powered engines. Is this the high-water mark for LNG ship propulsion? And how will marine LNG propulsion affect the global gas market?

LNG is not a new fuel in marine propulsion – LNG carriers have been using boil-off gas as a fuel source for a generation – but it is very new for the rest of the shipping industry.

From the end of coal/steam propulsion in the 1950s until now large-scale shipping has used cheap fuels from the bottom of the oil barrel for propulsion.

IMO changes the ballpark

That changed in 1997, when the International Maritime Organisation (IMO) adopted a protocol to limit emissions of sulphur and nitrogen oxides produced by combusting that dirty barrel-end (SOx and NOx). It took eight years for the protocol to come into force, and another five years before Emission Control Areas and limits were designated, in 2010, and its regulations began to bite. Even then its effects were staged, as the protocol set a gradually falling level of permitted sulphur content in marine fuels.

Faced with a choice between buying low-sulphur fuel (twice the price of their traditional fuels), installing expensive sulphur scrubbers, or completely changing their approach to fuel emissions, shipowners began allocating a significant percentage of new-build orders to LNG propulsion. LNG emits effectively no sulphur (so no SOx) and emits almost no NOx. As a bonus, if measured from tank to wake, LNG also emits about one third less CO2 per mile steamed than fuel oils.

Shipowners reacted by commissioning LNG propulsion

Today the global population of LNG-powered ships larger than 1,000 metric tons numbers some 940, out of a world total of some 54,000 vessels. That’s still a small drop in the fuel ocean. Numbers are flattered by the fact that they include 540 LNG carriers, which have been LNG-fuelled for a generation or longer. Leaving out LNG carriers, today’s LNG-powered fleet contains just 460 ships using LNG, less than 1% of shipping.

The great majority of the LNG-powered fleet, and effectively all of its larger ships, have been given dual-fuel capability, allowing them to swap from LNG to fuel oil at will. Dual-fuel increases build costs by about 20%, and cuts cargo-carrying capacity by a few per-cent as well, but the wins in terms of operating and cost flexibility are substantial, so at present shipowners are adopting dual-fuel LNG capability fast. Clarksons estimate that 39% of current new orders (by tonnage, but a much smaller percentage by number) are dual-fuelled.

China has been quietly leading the way

One quarter of the >1,000-mt fleet is owned and operated in China. Beijing mandated the build (or conversion) of a test fleet of inland and coastal ships to prove the concept of LNG marine operations in advance of the IMO’s regulatory uplift, to serve a core Beijing agenda of improving China’s poor urban air quality. In consequence China operates a hundred LNG powered ships ranging in size from 1,000 DWT to 6,000 DWT – a fifth of the world’s LNG fleet – mostly on inland and coastal routes.

This move is part of a wider strategy in Beijing to clean up urban air. By a combination of subsidy and decree China has adopted LNG-powered goods vehicles at great speed. From zero ten years ago, LNG goods vehicle numbers passed 500,000 in 2020 and are now fast approaching a million. That’s double the total number of HGVs in the UK. If that pace of change is a precedent then we can expect to see an LNG revolution in China’s inland and coastal fleet over the next few years.

Forecasting shipping demand into global LNG demand is hard

But how will this possible revolution affect the wider global market for LNG? Forecasting LNG demand for ship propulsion is extremely complex because of the number and uncertainty of the inputs needed, but we can make a useful approximation.

The current LNG fleet (including China’s fleet of smaller vessels) burns somewhere in the region of 21bn m3 of gas/year. At present the great majority of that is consumed by LNG carriers – numerous, large and comparatively fast, and making up 1% of global shipping by hull numbers.

A useful starting point for a forecast is a possible end-point: what would the situation be if the entire global merchant fleet swapped to dual-fuel LNG?

A hundred times as many ships burning LNG would not consume 100 times as much LNG as those LNG carriers. First, the average size of a merchant ship in the global fleet is well below the average size of an LNG carrier. Next, average speeds are lower than average LNG carrier speeds (at sea, fuel consumption rises exponentially with speed). Finally, some proportion of energy input would still come from traditional liquid fuels, in areas governed by less stringent emissions rules or less well-policed.

A fully-fitted global fleet would need 1 trillion m3/yr of LNG

Taking those differentials into consideration it is reasonable to estimate that a global merchant fleet completely fitted with LNG propulsion might consume fifty times as much as the fleet of LNG carriers.

That conclusion (arguable, of course) would create a new global demand of around 1,000bn m3/year. Current global LNG production capacity sits around 600bn m3/yr. Those two numbers present a strategic obstacle of some size to wholesale adoption of LNG propulsion.

If an average ship hull life is, say, 25 years, my conclusion would imply that 100% LNG adoption would add 40bn m3/yr to global LNG demand.

Fuel choice is complex and fraught with unknowns

Shipowners planning their new-build strategy have a complex decision matrix that is not based just on build costs or environmental impact. Apart from the core question of how their LNG demand would compete with demands for gas-to-power, gas-to-heating, gas-to-products and land-based transportation (those Chinese HGVs) there are many other variables, all with deeply uncertain outcomes. These include:

• The future size of Emission Control Areas
• The future emissions levels permitted in those areas
• The future costs of installing LNG storage and handling equipment versus fuel oil equipment
• Uncertainty over whether LNG propulsion will be measured against the well-to-wake methane cycle or the more flattering tank-to-wake cycle
• Future prices of both LNG and fuel oil
• Future supply constraints in the global LNG market
• Political uncertainties flowing from the small number of major LNG exporters, including risk of sanctions and embargoes
• Uncertainty over residual values of LNG-powered vessels
• The trade-off between cargo space and LNG equipment space
• The visibility and impact of methane slippage
• The impact of a many other factors on vessel efficiency (for example, sail assistance, slow steaming, hull paint, utilisation rates, and a dozen other factors)
• The impact of competition between spot and contract markets for gas sales
• Uncertainties of how the gas-to-power sector specifically will grow in competition with wind, solar, fission, fusion, coal, hydro and geothermal sources

Even the availability of bunkers is a question…

At a practical everyday level an additional decision variable is the availability of LNG bunkering around the ports of the world. At present some 250 ports have LNG bunkering facilities of some sort, but generally not large enough to guarantee that a large vessel can refill quickly and at a time of its choosing. For example the port of Long Beach only made its first LNG refuel last month, and that was a small one (of the 2,500 TEU MV George III). If an owner can’t refuel reliably when you need to then vessel utilisation will suffer along with returns on capital.

…and the possibility of LNG price turbulence in a political world

As if that decision matrix was not already complex enough a powerful new factor has emerged recently. European Commission sanctions against Russia have effectively removed a key supply of cheap gas to Europe, causing a global scramble for LNG supplies to meet gas-to-power and gas-to-heat demands in competition with the EU. In consequence LNG costs have become highly volatile, and have spiked to unheard-of levels. A product that has traditionally sold for $8/mn Btu ($0.30/m3) has been seeing spot prices from $40 to $70 over 2022 ($1.50-2.50/m3).

LNG at $50 ($1.80/m3) doubles the cost per ship/mile over fuel oil at $800/mt. For a large merchant ship that adds $60,000/day to costs – a significant sum in the context of ship charter costs ($20,000-30,000/day for an Ultramax at today’s rates).

Shipping is a price-taker for LNG, not a price-maker

So, shipowners making procurement decisions now have to operate in a market which has proved itself to be volatile, uncertain and expensive. There is no law of nature that caps LNG prices. Since most LNG ends up in the gas-to-power market, and since power is absolutely essential to the minute-to-minute existence of a modern economy, economies will pay almost any price to ensure supplies (and they currently are). Ship propulsion forms such a small part of the global LNG market (a fraction of 1% if we exclude ships using boil-off gas) that shipowners have no influence on total demand or on fuel prices.

Compare that position with the balance of power between shipowners and fuel-oil producers. Most fuel-oil is bought by the shipping industry (the only serious alternative demand, oil-to-power, is a small and shrinking market), while some 50 economies are net exporters of oil. That balance of power – few buyers, many sellers, few competitors – gives shipowners collectively a level of bargaining power which they do not have in the LNG market, and would not have until a third or a half of the global fleet was LNG powered.

And even the emissions case has structural weaknesses

Even the reasons for fitting LNG propulsion are under attack. LNG propulsion cures the SOx problem completely, and 90% of the NOx problem, but the GHG emission “cure” depends on how emissions are measured.

Shipowners focus on the GHG effect of LNG propulsion measured from the ship’s LNG tank to her wake. On this measure LNG is a winner, by about 25%.

Emissions activists, on the other hand, take GHG measurement back to the well-head. Adding in the (small) escapes of methane between the well-head and the ship, plus the CO2 emitted to generate the energy required for liquefaction, and finally adding in methane slippage inside the ship engine itself gives a total GHG effect per ship mile that is some 25% higher than the equivalent cycle for fuel oils.

How much higher is also affected by the time horizon of the calculation. Much of the well-to-wake problem flows from the fact that Methane has some 80 times more global warming effect than CO2. Methane is reacted out of the atmosphere over a long time-cycle. If methane’s GHG effect is measured over a 20-year time scale it has two or three times the global warming effect compared with measurement over an 80-year cycle.

A recent analysis by the International Council on Clean Transportation claimed that LNG-powered ships have 70-80% more GHG impact than fuel oils over the shorter time-frame, partly because they slip an average 3.7% of input methane into the atmosphere. Slippage is affected by engine type. Low Pressure Dual Fuel 4-stroke engines slip five grammes per kwh, double the amount slipped by Low Pressure 2-stroke engines. 75% of existing dual fuel ships have the slippy 4-stroke engines.

LNG propulsion is not an easy or automatic choice

Under pressure from regulators to reduce SOx and NOx emissions, and from global warming activists to reduce GHG emissions, shipowners will not automatically opt for LNG propulsion. To make the problem even more complex methanol is now emerging as a viable propulsion option, with Ammonia coming up behind. Stena has ordered half a dozen 50,000-dwt bulkers with methanol dual-fuel capability, and Maersk eight 16,000-teu methanol-powered containerships.

Owners are most likely to hedge their bets

In a market with so many influential uncertainties perhaps the best strategy is to accept that one must pay a known risk premium to hedge one’s bets. The risk premium is contained in the cost difference between installing a plain fuel-oil based propulsion system and a dual-fuel system – about 20% of build cost, and a few per cent of lost cargo space.

With a dual-fuel system installed the shipowner can play fuel-oil and LNG markets off against each other over a long time scale, both in compliance terms (switching fuels to match the emissions control regime covering the vessel’s location) and in market terms, switching fuels to move demand pressure to the most accommodating source. Flexibility has value, probably as much value as its installation cost.

Shipping’s impact on global LNG demand may be surprisingly small

It is possible, indeed likely, that a merchant fleet widely fitted with LNG dual-fuel equipment will in fact use very little LNG in practice. If that happens then shipping would make up only a marginal part of global LNG demand (probably less than 5%) for at least a decade, and probably two.