Decarbonisation in shipping: an introduction
Market Insight 28 December 2022 28 December 2022
UK & Europe
Decarbonisation in the Shipping Industry
Decarbonisation of the shipping industry is a high-profile current issue. We are therefore running a podcast series as well as this series of articles, addressing this seismic change.
You can listen to the podcast series here.
This series examines the various IMO and EU regulations which are due to come into force over the next few years with the aim of regulating and reducing shipping’s carbon footprint through various initiatives. We discuss the key practical and legal considerations they raise for owners, charterers, and other stakeholders.
There are two upcoming IMO measures directed at reducing greenhouse gas emissions from ships, both added to MARPOL Annex VI in 2021. The two new measures are the Energy Efficiency eXisting ship Index (EEXI), a one-off certification assessing the design, construction, and technical features of the ship; and the Carbon Intensity Indicator (CII), an ongoing measure of how environmentally friendly a ship’s operations are. The IMO’s stated goal is to reduce the carbon intensity of all ships by 40% by 2030 and 70% by 2050 (as against 2008 levels), and EEXI and CII build on existing measures to try and achieve this.
Energy Efficiency Existing Ship Index (EEXI)
EEXI is a one-off classification of the energy efficiency of a ship’s design, construction, and technical features, and seeks to impose a minimum standard on the global fleet. A wide range of ship-types are caught by the EEXI regulations (all existing ships of 400 GT and above falling under MARPOL Annex VI) and existing vessels will be required to have their EEXI technical files prepared by the time of their next International Air Pollution Prevention (IAPP) Certificate Renewal from 1 January 2023. Newbuilds will be required to do so by their initial survey before entering service. Information from various vessel documents is used to assist in preparing the EEXI technical file, including capacity plan/lightweight certificate, the trim and stability booklet, any sea trial reports, NOx technical files, the IAPP and, for newer vessels, the EEDI (Energy Efficiency Design Index) technical file.
There is not a single, universal EEXI figure for all vessels – rather, a “required EEXI” exists based on ship type, capacity, and engine and the “required EEXI” represents the minimum standard for each ship type. Each individual ship is then ascribed a calculated “attained EEXI”. The “attained EEXI” for that ship needs to be less than or equal to the required EEXI for that ship type in order to comply with the regulations.
The EEXI describes the ship’s anticipated carbon emissions, expressed per cargo ton and mile, taking into account factors like engine power, fuel oil consumption, and cargo capacity. These factors are all added into a formula which calculates the ship’s EEXI value. Improvements to the carbon intensity of the ship’s design and technical features will reduce its EEXI value.
While EEXI compliance does not necessarily require technical modifications to a ship, in practice this is likely to be required for many vessels in order to achieve the minimum required EEXI rating of “C” or above. The regulations do not prescribe any particular modifications or means of achieving compliance. The most popular choice of measures is Engine Power Limitation (EPL) and/or Shaft Power Limitation (SHAPOLI) as these are relatively cheap, quick, and straightforward to implement (though such modifications can have detrimental effects on speed and other performance metrics, with potentially adverse consequences for any warranties given to charterers, an issue which we will consider in greater detail in a future article in this series).
In 2021, BIMCO published a model EEXI transition clause for time charterparties, specifically addressing EPL/SHAPOLI modifications. Major charterers and/or shipowners also have their own bespoke clauses which we have seen being used, more than the BIMCO “standard” clause.
Other options which may enhance a ship’s EEXI classification include increasing cargo capacity, installing more efficient propellers and associated equipment, or potentially more radical (and expensive) alternatives such as switching to carbon-neutral fuel or introducing entirely green power technologies.
It is important to note that EEXI is a theoretical figure, based on a ship’s design and technical features, not an indicator of its actual carbon emissions. This aspect is covered by the CII.
The IMO intends (under MARPOL Annex VI Regulation 25.3) to review the effectiveness of the EEXI measures by 1 January 2026 to assess their effectiveness, and will possibly make amendments to them once there is real-world data available on the effectiveness of the measures and their practical consequences (such as what steps owners take to ensure vessel compliance; what, if any, consequences vessels with poor EEXIs face; and whether the measures result in a significant reduction of shipping’s contribution to global carbon emissions).
Carbon Intensity Indicator (CII)
CII is an ongoing (annual) measure of the carbon intensity of a ship’s operations – i.e., its greenhouse gas emissions relative to the amount of cargo carried and the distance travelled. CII will regularly fluctuate depending on factors such as speed, length of voyages, and nature and volume of cargo, and it is to be calculated and reported annually using a formula prescribed by the IMO. Ships are then given an energy efficiency rating, with those attaining the lowest score obliged to take steps to improve it, while – it is hoped – authorities incentivise the achievement of those with the highest ratings.
Ratings range from A to E, with A being the highest rating. Stakeholders (such as flag states and port authorities) are being included in discussions of the CII regime to provide positive incentives to ships rated as A or B, while those with the lowest ratings (D for three consecutive years, or E for any length of time) will be required to submit corrective action plans setting out the remedial steps they will take to reach the required index of C or above. No other specific consequences for low-rated ships have been set out, but one might anticipate that these would include higher port dues and other fees. The lower rated ships would also be less attractive to charterers, thereby reducing their attractiveness to the market, which would impact the rates that owners would hope to achieve.
In practice, in order to collect the necessary data for ongoing CII reporting and compliance, owners will need to monitor and record a wide range of operational data. Various proprietary software solutions are available that assist in monitoring the relevant factors.
By 31 December 2022, all ships subject to the CII rating regime will be required to have prepared a SEEMP Part III (a specific part of the Ship Energy Efficiency Management Plan developed to support CII targets). From 1 January 2024, a Statement of Compliance containing fuel consumption and CII-related data will be issued. Audits of SEEMP Part III/CII compliance will need to be carried out every six months from the issuance of the Statement of Compliance.
As CII compliance (particularly for older or less efficient ships) is likely to necessitate changes to the speed, route, or cargo capacity of a ship (or indeed all three), there are obvious potential tensions between charterers’ requirements and the need to minimise the ship’s carbon intensity. To this end, specific clauses addressing CII ratings, compliance, and monitoring (including liability for poor CII rating and charterers’ rights to access/monitor emissions data), and their interactions with other charterparty provisions, are becoming increasingly common, including the recent publication of BIMCO’s CII Operations Clause for Time Charter Parties, which envisages owner and charterer pre-agreeing a target CII value (and places responsibility for compliance predominantly with the charterer). We discuss this clause in greater detail in a separate update (link here).
The EU has set its own targets for decarbonisation in shipping, as part of “Fit for 55” (a package of proposals to revise and update EU legislation with the aim of meeting the EU’s target of climate neutrality by 2050). Its name refers to the intermediary goal of cutting emissions by at least 55% by 2030 (note that the 55% target is based on 1990 emissions levels).
Several of the 13 proposals contained in Fit for 55 have implications for the shipping industry. The Fit for 55 proposals are currently at a relatively early stage, with the EU Council having agreed its negotiating positions (general approaches) in early-mid 2022, but details remain to be fleshed out and so there may well be differences between what is currently proposed and what is actually agreed in the final legislation.
EU Emissions Trading System (EU ETS)
This proposal is expected to apply to all affected vessels operating within the EU, regardless of flag. Those whose voyages start or end outside the EU will only have to participate in the EU ETS for 50% of their emissions, but 100% for voyages between EU ports and for ships at berth in EU ports.
Changes are proposed with the intention of reducing overall CO2 emissions in applicable sectors (including maritime transport) by 61% by 2030 (as compared with 2005). This will come into force from January 2024 with a three-year phase-in period.
The EU ETS is based on a “cap and trade” principle, where a cap is set on the total amount of greenhouse gases that can be emitted by a ship, which is reduced over time. Shipping companies will purchase (and surrender) emissions allowances to cover their fleets’ carbon emissions, with fines applying for exceeding these (and a risk of being detained by port authorities or denied entry for unpaid fines or ongoing noncompliance).
The price of these allowances is intended to fluctuate based on market demand (and the availability of emissions allowances), so that as the cap reduces it becomes ever-more expensive to emit CO2, while companies who successfully reduce their emissions and have spare allowance availability can potentially benefit from selling these to their more polluting peers, ensuring that there is a positive financial benefit to investing in decarbonisation.
This is another proposal that applies to all affected vessels calling at EU ports, regardless of flag.
The intention of this measure is to encourage the use of more sustainable (either renewable or lower carbon) fuels by mitigating market barriers and technological uncertainty that presently discourage their use. It sets requirements for vessels to progressively reduce their greenhouse gas emissions from 2025 onwards, including compliance with monitoring obligations.
For passenger and container vessels there is an additional obligation: if the measures are adopted, then from 2030 they will be required to use shore power while at berth (subject to various exceptions, for example if ships are at berth for under two hours, already using zero emission technology, or if shore power is unavailable or the port call is an unscheduled one made for safety reasons).
In both instances, there are anticipated to be financial penalties for noncompliance.
The Energy Taxation Directive (ETD) and Alternative Fuels Infrastructure (AFI) also have implications for the shipping industry, although their application is somewhat narrower.
The ETD proposes to amend the excise duty rates applicable to certain marine fuels, for use on vessels trading within the EU, in order to encourage operators to move towards more sustainable fuel types.
The AFI proposes requiring certain ports to provide LNG bunkering infrastructure and shoreside power in order to facilitate compliance with both limbs of the FuelEU Maritime proposal.