Incentivizing low-emissions fuels: policy options and trade-offs

Decarbonizing international shipping calls for a shift towards low- and zero-emissions fuels, but these fuels are currently significantly pricier than fossil alternatives. This price gap exists because the true environmental cost of fossil fuels isn't reflected in their market price. Financial aid can help bridge this divide, but the design of such aid plays a crucial role in determining whether it leads to immediate but limited emissions reductions or the establishment of a long-term low-emissions fuel system.

The discussion around subsidy programs for low-emissions fuels centers on a policy debate: how to motivate the use of "zero or near-zero" (ZNZ) fuels within the framework of the International Maritime Organization’s (IMO) Net-Zero Framework (NZF). If adopted, this upcoming global regulation for shipping could set ambitious climate targets for the industry.

At the heart of any ZNZ incentive scheme is a fundamental decision: should subsidies be used to reduce the cost of reducing emissions with fuels that are already nearing competitiveness, or to speed up the adoption of more expensive yet scalable next-generation fuels? Using a single, undifferentiated tool for both goals often results in suboptimal outcomes.

To address this, we break down a ZNZ reward program into five interconnected variables: eligibility, abatement benchmark, multipliers, differentiation, and reward instruments. In this analysis, we explore the options within each variable, examining the trade-offs between incentive strength, fiscal sustainability, and environmental effectiveness. Ultimately, we advocate for a specific approach that emerges as the preferred option.

To set the stage, we first need to understand why incentives are necessary. The next section introduces the NZF and outlines the methodology for calculating ZNZ rewards. Then, we delve into a comprehensive analysis of each of the five variables, leading to a consolidated decision table in the conclusion. For those interested in the technical aspects, two appendices cover the multiplier mechanism and additional differentiation criteria.