Hapag-Lloyd AG: Complying with IMO 2020

Abstract

A new environmental regulation known as IMO 2020 was creating what one industry analyst called “the biggest shakeup for the oil and shipping industries in decades.” According to the new regulation, all ocean-going ships would have to limit their sulfur emissions by January 1, 2020. Senior leaders at Hapag-Lloyd, one of the world’s largest shipping companies, were evaluating three ways their ships could comply with the new regulation: use low sulfur fuel, use high-sulfur fuel but install scrubbers to clean the exhaust, or convert ships to use liquid natural gas (LNG) as fuel. Each of the options had its advantages and disadvantages, and the most attractive option depended on not only the values of key parameters (e.g., future fuel prices and equipment costs), but also the strategies adopted by the owners of the other 60,000 ocean-going ships subject to the regulation. For the industry as a whole, annual compliance could cost as much as $60 billion; for Hapag-Lloyd, annual compliance might cost as much as $1 billion or more. For a company with net income of $34 million (€28 million) in the prior year, and losses in two of the past four years, getting this decision right was of the utmost importance.

Senior executives at Hapag-Lloyd had created a proposed compliance plan and were scheduled to present it to the firm’s supervisory board for approval in June 2018. Whether the team had the right plan and whether the board would approve it are the key questions in the case.

This case explores the economic impact of a major new environmental regulation. It illustrates how discounted cash flow (DCF) analysis can be used to inform a critical business decision, and how the key inputs to a financial model and the preferred compliance option depended on what competing firms choose to do. The challenge of the case is to wrestle with, but not get paralyzed by, various sources of uncertainty in a high-stakes managerial decision.

Keywords: environmental regulation, compliance cost, discounted cash flow, competitive interaction, shipping, oil & gas, greenhouse gasses, valuation, externalities, game theory, supply chain, corporate accountability, capital budgeting, decision making, pilot project, optionality

JEL Classification: G38, G31, F64, Q52