IMO 2028: How Much Will 'Surplus Units' Cost?

The value of a surplus unit increases over time as the targets get tougher each year. Image Credit: Ship & Bunker

The generation of tradeable 'surplus units' for overcompliance with bunker carbon intensity targets is one of the many complicating factors in the new IMO 2028 deal.

These units can be traded to ships seeking to avoid the IMO's $380/mtCO2e charge for failing to meet its base target for carbon intensity, and initial Ship & Bunker estimates show they may be available for as little as $312/mtCO2e in 2028.

Understanding how these surplus units work, and how they might be generated, will be a key element in analysing the changes to the global bunker market the IMO's new framework begin.

How Surplus Units Work

The IMO framework sets the following carbon intensity targets for 2028-2035:

Image Credit: Ship & Bunker

For GHG emissions below the direct compliance target, surplus units are generated that can either be banked for up to two years or traded to other ships' accounts.

For emissions at the tier between the direct compliance and base targets, ships will need to pay the IMO $100/mtCO2e.

And for emissions above the base target, ships will either need to pay the IMO $380/mtCO2e or buy surplus units from others.

Calculating the Value of Surplus Units

So how much should these surplus units be worth?

The IMO's $380/mtCO2e charge for emissions above the base target provides a firm upper limit to how much surplus units might be traded for, as no-one would voluntarily pay more than the IMO charge for their compliance.

But the cost of generating surplus units should be notably lower than the IMO charge, at least in the short term.

In the immediate years after 2028, using FAME-based biofuel should be the most widespread option for generating surplus units, though bio-LNG and other alternative fuels may come to replace it in time.

On that basis, for a basic analysis, the minimum value of a surplus unit can be understood as the price premium for FAME B100 over VLSFO per megajoule of fuel, divided by the number of surplus units generated by using the biofuel.

Much will depend upon the carbon intensity of the biofuel used, as well as the price of B100 and VLSFO. A higher biofuel carbon intensity will make the surplus units generated by that biofuel more expensive, and beyond the cost of the IMO charge in some cases.

For the purposes of this analysis, we use current approximate prices of $523.50/mt for VLSFO and $1,200/mt for B100 throughout. Energy density is set at 42.7 MJ/kg for VLSFO and 37.5 MJ/kg for B100.

For a FAME B100 with carbon intensity of 14.1 gCO2.MJ - at the lowest end of what is currently available - here are the surplus units generated and their minimum value:

Image Credit: Ship & Bunker

As can be seen, the value of a surplus unit increases over time - despite underlying prices being kept flat - as the targets get tougher each year. Any increase in biofuel prices relative to VLSFO, and this would seem likely to happen in an era when multiple industries require biofuel for decarbonisation, would increase the value of the surplus unit.

And the minimum value of the surplus unit moves beyond the IMO's $380/mtCO2e charge from 2032, meaning this market would no longer be viable. But the IMO's charges are set to be revised after 2030, and would be likely to be increased to encourage further decarbonisation.

A Large Caveat

All of that said, a more complex analysis delivers almost the very opposite picture to that outlined above, with B100 surplus unit value declining over time rather than rising.

In the basic analysis outlined above, we see the shipowner essentially selling his surplus units at a price related to the full premium over VLSFO for the B100 he bought. But he keeps the value of the B100 avoiding IMO 2028 charges for the VLSFO he would otherwise have bought, despite not paying for it because he has sold the full premium.

Using B100 at 14.1 gCO2e comes with no compliance cost throughout the 2028-2035 period, as well as generating surplus units, while using VLSFO would cost $0.0018/MJ in IMO charges in 2028, moving up to $0.011/MJ by 2035. 

Taking this into account, the adjusted premium for B100 over VLSFO narrows significantly over time at flat underlying prices for both grades.

The narrowing of that premium outpaces the decline in surplus unit output over time.

This table sets out the adjusted minimum surplus unit value that effect generates:

Image Credit: Ship & Bunker

In practice, a rising B100 price relative to VLSFO over the coming years may well eliminate this effect. 

But which model is the more accurate? The second gives a more complete accounting of costs, but the first - by chance rather than by design - gives the truer picture of how surplus unit value should change over time.

I'll be spending the Easter weekend going into this subject more deeply, and thinking about its implications for biofuel bunker pricing over the coming decade.

For any comments on how we should think about this problem, please email jack@shipandbunker.com.