Navigating the impending EU ETS Regulations in Shipping

Navigating the impending EU ETS Regulations in Shipping

Published on November 22, 2023

A rapidly evolving regulatory environment

Greenhouse Gas (GHG) Emissions from the shipping sector accounted for approximately 2.9% of anthropogenic GHG emissions globally in 2020*, and are projected to increase significantly between now and 2050 on the current trajectory.

In July 2023, the International Maritime Organisation (IMO) unveiled the “2023 IMO Strategy on Reduction of GHG Emissions from Ships”. The 2023 IMO GHG Strategy outlines an ambition to put the shipping sector on a path to net zero by 2050, to encourage the uptake of alternative fuels and to reduce the carbon intensity of vessels through improvements in energy efficiency.

At a European Union level, the regulation of emissions from shipping is now in place. The EU Emissions Trading System (EU ETS) will be enlarged to include maritime transport sector emissions from 1st January 2024.

Shipowners and operators who arrive or depart from EU ports will be directly impacted by these changes and will need to comply with the rules of the EU Emissions Trading System (EU ETS). Failure to do so will result in punitive penalties and significant fines.

In conjunction with the EU ETS expansion, the separate FuelEU Maritime regulation has also been finalised and will enter into force on 12th October 2023. This regulation aims to ensure the adoption of renewable and low-carbon fuels through increasingly stringent limits on the carbon intensity of the energy used by vessels. The FuelEU Maritime regulation relates to the full lifecycle emissions from a specific fuel, the so called “well to wake” emissions. For the purposes of this article, we focus on the EU ETS expansion and the regulation of “tank to wake” emissions.

What is changing?
On 1st January 2024 the European Union Emissions Trading System (EU ETS) is expanding to include the maritime transport sector. Vessels over 5,000 gross tonnage, who load or unload cargo or passengers at ports within the European Economic Area (EEA), will have to purchase and surrender European Union Allowances (EUAs) to cover the verified emissions from their voyages within any given calendar year.

Since 2018, in preparation for this change, shipping companies arriving or leaving EU ports have been required to monitor, report and have verified their emissions of CO2. From the data available, we know that over 12,000 vessels have been impacted by the requirement, reporting over 125Mt CO2 emitted in 2021.

The obligation to purchase and surrender EUAs relates to:
• 100% of verified emissions for voyages between EU ports and while at EU ports,
• 50% of verified emissions for voyages starting or ending at EU ports.
While the current monitoring and reporting requirement covers only emissions of CO2, from 1st January 2024 the requirement will also extend to include methane (CH4) and Nitrous Oxide (N2O).

What will be the cost?
The cost for shipping companies to comply with the EU ETS will be significant. At the current DEC23 EUA price of €83/Mt, the cost of purchasing EUAs to cover the associated emissions of consuming one tonne of bunker fuel, on an intra EU voyage, could be approximately €260. This represents a roughly 50% increase in fuel costs at current prices..

Static installations under the existing EU ETS, with the exception of power plants, received a number of EUAs for free each year. This had frequently meant, due to sometimes generous free allocation, that many installations had not actually needed to buy EUAs at all. In many cases, companies had excess allowances to sell on the market, sometimes generating very significant windfall profits.

There will be no free allocation of EUAs to the maritime sector. This means that from 1st January 2024, all vessel operators, entering or leaving EU ports, should be aware of the market price of EUAs and the material impact it may have on their operations.

There is, however, some initial relief for shipping companies. The introduction of the compliance obligation will be gradually phased in. Shipping companies will be required to buy EUAs to cover the following proportions of their emissions:
• 2024 compliance year: 40% of their verified emissions,
• 2025 compliance year: 70% of their verified emissions,
• 2026 compliance year onwards: 100% of their verified emissions.

The financial penalties for non-compliance will be severe. Companies that fail to surrender enough EUAs to cover their verified emissions, will have to pay a penalty of €100/Mt. They will also still be required to purchase and surrender the appropriate number of EUAs. At current prices, this equates to a penalty of approximately €183/Mt of CO2, or roughly €575 for every tonne of fuel consumed on an intra EU voyage. This is potentially more than the cost of the fuel itself.

Where a shipping company fails to surrender EUAs for two or more compliance periods, then vessels under the responsibility of that shipping company may be refused entry into EU Member State ports. This would apply to all vessels under the responsibility of that shipping company, not just the non-compliant vessel in question. Furthermore, it would apply to all EU Member State ports, not just the relevant Member State, until the compliance obligation has been satisfied

Who will have to pay?
Unlike static installations covered by the existing EU ETS, the contractual nature of the compliance liability in the maritime transport sector is far more complex. Who ultimately bears the cost of compliance will depend on the specific contractual arrangements between parties.

The legislation refers to the “Shipping Company” as being the obligated party, defined as “the shipowner or any other organisation or person, such as the manager or bareboat charterer, that has assumed the responsibility for the operation of the ship from the ship owner and that, on assuming such responsibility, has agreed to take over all the duties and responsibilities imposed by the International Management Code for the Safe Operation of Ships and for Pollution Prevention, set out in Annex I to Regulation (EC) No 336/2006 of the European Parliament and Council.”

It is clear, therefore, that shipowners and operators must ensure that this liability is reflected in all contractual arrangements to ensure the significant cost is appropriately managed.

How can Energex Help?
Those shipping companies impacted by the EU ETS, should start taking measures now to prepare for the first compliance year, commencing 1st January 2024.

From an operational perspective, companies will need to open a “Maritime Operator Holding Account“ in the Union Registry. This can be a complex and time-consuming process, requiring an application to the registry operator of an individual EU member state. Applicants will need to comply with the specific requirements of each Member State administering body, and this can vary considerably.

It is important to recognise that an EUA is a widely traded commodity, with a very liquid secondary market and many sophisticated market participants. Aside from the “compliance buyers” and natural “short” positions in the market, there are many hedge funds, commodity traders and banks operating in spot, forward and derivative markets. The price of EUAs is volatile, and the cost for a shipping company can rapidly change.

Affected companies, therefore, should develop a strategy to procure and trade allowances ahead of the compliance deadline. Shipping companies will need robust risk management strategies in place to manage their exposure and to ensure they are not left facing the very significant penalties mentioned above.

At Energex, we have extensive experience in the EU ETS. Our advisors have been directly active in this market since the initial pilot phase of the EU ETS commenced in 2005 and have first hand, practitioner experience of trading the market and managing a compliance position.

We work with clients in the shipping sector who will be impacted by this imminent expansion of the EU ETS to help them develop and implement a risk management strategy, to manage their compliance obligations effectively and to develop an operating model that aligns with that strategy.

We also help clients understand the options available to them to reduce their compliance obligation, through for example the use of biofuels and alternative fuels.

If you would like to like to discuss the EU ETS and it’s expansion to the maritime sector, please contact Michael Fulton at Energex Partners on mfulton@energex.partners.

*International Maritime Organisation (IMO) Fourth Greenhouse Gas Study 2020