EU Proposals to include Shipping in the Emissions Trading Scheme – what do we know?

On 14 July 2021, the EU Commission proposed legislation to amend the European Union Emissions Trading Scheme (“EU ETS”) to include shipping emissions (the “Proposal”). In this article, we will consider what is known about the scheme and how it is expected to function in practice.

EU Proposals to include Shipping in the Emissions Trading Scheme – what do we know?

On 14 July 2021, the EU Commission proposed legislation to amend the European Union Emissions Trading Scheme (“EU ETS”) to include shipping emissions (the “Proposal”).[1]

In this article, we will consider what is known about the scheme and how it is expected to function in practice.

Who will be responsible for compliance with the new scheme?

The most likely position is that the party responsible for compliance with other international schemes like the MRV Regulation[2] and the ISM Code[3] will also be the one responsible for compliance with the EU ETS regime.

More specifically, under the Proposal, the person or organisation which is responsible for compliance with EU ETS will be the “shipping company”[4], which is defined as “the shipowner or any other organisation or person, such as the manager or the bareboat charterer, that has assumed the responsibility for the operation of the ship from the shipowner 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 of the Council”.[5]

What about time charters?

Under time charters, the “shipping company” may not necessarily be the one who is responsible for crucial operational decisions regarding emissions. The EU Commission has anticipated that owners and charterers may wish to account for this in their charterparties, saying:

“In line with the polluter pays principle, the shipping company could, by means of a contractual arrangement, hold the entity that is directly responsible for the decisions affecting the CO2 emissions of the ship accountable for the compliance costs under this Directive. This entity would normally be the entity that is responsible for the choice of fuel, route and speed of the ship.”[6]

It remains to be seen how parties will account for this in practice – arguably both the owner and the time charterer have significant influence over the overall emissions profile of the vessel.

In the meantime, the European Community of Shipowners’ Associations (“ECSA”) has been considering the effect on the industry and how the Proposal might be amended to remove uncertainty about which party should pay. On 2 November 2021, ECSA produced a policy paper which proposed, among other things:

1. The introduction of a dedicated Maritime Climate Fund intended to stabilise the (currently volatile) carbon price and support the energy transition of maritime sector.
2. Making the “commercial operator” (in many cases, the time charterer) rather than the “shipping company” responsible for ETS compliance; or, alternatively
3. Introducing a binding public law requirement that ETS costs be “passed through” from shipping companies to commercial operators.

It remains to be seen whether these proposals will be considered by the EU, or whether there is popular support for them within the wider industry.

What about spot charters/freight rates?

It is inevitable that the costs of buying allowances will have a knock-on effect on freight rates and add volatility to an already volatile market. The European Energy Exchange (“EEX”) has identified this as an issue and has responded by creating the EEX Zero Carbon Freight Index, which is intended to give traders an idea of how the cost of carbon emissions could affect freight prices.

What will shipping companies have to do?

Monitoring, reporting and verification

Shipping companies will be required to put in place systems to monitor and report their emissions, which must be approved and then verified by an administering authority (about which, see below). As mentioned above, most shipping companies to be covered by EU ETS will already be subject to the MRV Regulation and should thus have these systems in place. The Proposal suggests that the intention is supplement the MRV Regulation obligations to ensure that all the necessary data is captured, rather than to introduce entirely new systems.[7]

Surrender of carbon allowances

At the end of a reporting period, the shipping companies will then be required surrender allowances (often colloquially known as ‘carbon credits’) in respect of their aggregated emissions for all of the applicable voyages during the period. There do not appear to be any plans to allow allocation of “free allowances” to shipping companies, so they will have to purchase all of the allowances that they need, either at auction or on the open market via exchanges like EEX or ICE.

How much will it cost?

The Commission anticipates that the new scheme will capture emissions of about 90 million tons of Co2 (or equivalent) a year.[8] At the current market price of ~EUR 75 per ton of Co2, this would require shipping companies to surrender total allowances in the order of EUR 6.75 billion per year.[9] However, the main concern for shipping companies will be carbon price uncertainty: from Oct-20 to Oct-21, for instance, the carbon price jumped between EUR 24 and EUR 62.

Ultimately, if enacted, the shipping emissions scheme will be phased in (see below), so costs will not reach these levels until reporting year 2026.

What penalties are there for non-compliance?

If shipping companies fail to comply with their obligations to monitor, report and verify emissions, and then surrender allowances, they can be fined.

In extremis, if a company fails to comply  with surrender requirements for two or more consecutive reporting periods, then the EU can issue an “expulsion order” with the result that no EU port will allow the shipping company’s vessels to enter and the vessel may even be arrested by its flag state, if that state is an EU member. [10]

What voyages does the Proposal cover?

Shipping companies will need to purchase allowances to cover:

1. 100% of emissions for intra-EU voyages; and
2. 50% of emissions for voyages beginning or ending at EU ports.[11]

Who will monitor and enforce the new ETS regime?

The EU ETS regime will be monitored and enforced by all of the EU member states, and each shipping company will be assigned an “administering authority” by which it is specifically supervised. If the shipping company is registered to an EU member state, then its administering authority will be that that member state. In most other cases the administering authority will be the member state at which the shipping company has made the most port calls in the preceding two years.[12]

From 2024, the EU Commission will publish and regularly update the list of shipping companies and their respective administering authorities.

In practical terms it is expected that administering authorities will request the assistance of the European Maritime Safety Agency “EMSA” to carry out their obligations regarding approval of monitoring plans and verification of emissions, in line with its current work in doing so for the MRV Regulation. [13]

How will the scheme be phased in?

The Commission proposes to phase in the requirement to purchase and surrender allowances over a four-year period, so that shipping companies must purchase allowances as follows:

(a) 20 % of verified emissions reported for 2023;

(b) 45 % of verified emissions reported for 2024;

(c) 70 % of verified emissions reported for 2025;

(d) 100 % of verified emissions reported for 2026 and each year thereafter.[14]

The IMO is creating similar provisions globally, like Energy Efficiency Existing Ship Index (“EEXI”) and the Carbon Intensity Indicator (“CII”). Surely this is going to doubly affect shipping companies?

The EU Commission have identified this potential problem and in response they have included a review clause aimed at considering the effect of EU ETS in combination to the global measures taken by the IMO.[15]

In the meantime, the industry will have to watch these schemes as they develop to understand if and how they interact with each other in practice.