Frequently Asked Questions on Net Zero Framework (NZF) - Deep dive on Zero and Near Zero (ZNZ) incentivisation
Summary of key findings:
There are a range of different Zero-or-Near-Zero (ZNZ) fuel types - to foster innovation, minimise costs for reaching net zero emissions and maximise affordability and availability, most need to be incentivised. But different ZNZ fuels have different characteristics leading to different drivers of premium (capex / opex), and different reliance on new shore-side/infrastructure.
Differentiation in the incentive level between ZNZ fuel types is critical whichever incentive option is chosen – without differentiation the incentive is not technology agnostic as only the current-least-cost ZNZ fuel is incentivised. This can further amplify all the downside risks (environmental integrity, SU market stability and fund liability risks) associated with specific ZNZ fuels. . Energy transition consequences for single-level incentivisation can be worse than for scenarios with no ZNZ incentives.
Incentive level(s) need calibrating to the other policy specifications - if in finalising the NZF, adjustments are made to the GFI levels or third compliance (e.g. Residual Unit price) levels change, the SU market price can be expected to change. This then means the reward rate or multiplier level needed to ensure take-up will need adjusting.
Both types of multiplier result in increased emissions (relative to a reward mechanism or no incentive, because GFI compliance can be achieved with less actual GHG emission reduction) - which needs compensation by increasing the GFI trajectories used, especially in initial periods. Multipliers can also result in oversupply of SU’s significantly reducing SU prices and delay incentivisation of direct compliance, so will need sunset clauses or equivalent guardrails.
ZNZ incentives must be sufficient to close the remaining cost gap with conventional fuels to ensure uptake - in many scenarios modelled, incentive levels proposed by both China and Norway for their respective multipliers (for example) would not enable take-up of ZNZ’s, particularly e-fuels.
JET faces several different risks depending on which incentives are used - these risks can be mitigated if the incentive is designed to be cost-effective (through the use of differentiation or sunset clauses).JET can also be positively enhanced if JET-eligibility is used as an additional criterion for incentives (could work for both multipliers and rewards).
Predictability for investors in ZNZ is traded off with cost-effectiveness - for all multipliers and IMO-defined reward rates. A reverse auction mechanism can be cost-effective and provide predictability in reward rate to maximise confidence in longevity of offtake, but it is not clear how other options can create equivalent predictability.
The Chinese GFI multiplier could work well for shore-power, wind-assistance and drop-in biofuel ZNZ - these are all ZNZs that have a business case that can work for a modest (e.g. 25% or less) share of a ship’s total annual energy use, a level of ZNZ use that the GFI multiplier produces maximum support for. But as a result will not work as well for batteries, e-fuels and nuclear (which favour incentivisation for high ZNZ shares of a ship’s annual energy ).
The Norwegian SU multiplier can also work for e-fuels and nuclear - but looks more likely to need early guardrail intervention e.g. through differentiation and sunset clauses, particularly for its incentivisation of drop-in biofuels, wind-assistance and possibly also electrification where SU oversupply risks are high.
Incentives have to work over a number of different phases of ZNZ transition - (emergence, scale-up), during which the respective pros and cons of the mechanisms differ. Multipliers have higher reliability after the SU market is more established and predictable, but before there is too much ZNZ use and the sunset clauses risk being invoked. IMO-defined reward rates are most predictable early in the transition, but lose reliability as clauses that manage their liability risks to the fund (e.g. discount rates / carry-forwards) become invoked.
Another form of differentiation could be to use different incentives in combination - the Chinese GFI multiplier could be used to incentivise solutions that are always partial shares of a ship’s annual energy use/emissions reductions (drop-in biofuel, wind, CCS, shore power), and a targeted reward (for e-fuels, nuclear, battery ships) could help incentivise the options the ZNZ types not incentivised by a GFI multiplier.
