EU Parliament votes to extend the Emissions Trading System to include shipping
Market Insight 26 April 2023 26 April 2023
UK & Europe
Decarbonisation in the Shipping Industry
On 18 April 2023, the European Parliament voted strongly in favour of including shipping in the European Union’s Emissions Trading System (ETS). The European Parliament announced that 500 MEPs voted in favour of including shipping in the ETS, with only 131 MEPs voting against and 11 abstaining. This vote will have a significant impact on the shipping sector in Europe. Shipowners, charterers, and managers trading in this part of the world are encouraged to familiarise themselves with the new measures.
The EU ETS is a carbon market introduced by the EU in 2005 to combat climate change by reducing greenhouse gas emissions. It is the world's first major carbon market and remains the largest.
Although the shipping industry did not initially fall within the scope of the EU ETS, this changed on 29 November 2022 with the provisional agreement made between the European Parliament, the European Commission, and the EU member states.
The inclusion of shipping within the EU ETS is designed to become part of the “Fit for 55” package, the EU’s plan to reduce greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels, in line with the European Climate Law.
The EU ETS works on the “cap and trade” principle, meaning that a cap is set on the maximum amount of certain greenhouse gases (GHG) that are allowed to be emitted by the GHG-discharging installations covered by the system. Such cap is reduced over time.
Within the cap, GHG-discharging installations may buy or receive emissions allowances, which they can trade with one another as needed. If stakeholders have not acquired the necessary allowances for their emissions, they are fined.
On 18 April 2023, MEPs adopted the reform of the EU’s Emissions Trading System which, in the case of the shipping industry, will see the ETS phased in gradually over a three-year period, with the first compliance year starting on 1st January 2024.
The ETS will apply (i) to vessels of 5,000 gross tonnes and above and (ii) to all intra-EU voyages and to voyages between the EU and non-member states.
In 2024, stakeholders will be required to buy and surrender allowances for 40% of their verified emissions for intra-EU voyages and 20% of their emissions for voyages into or out of the EU.
In 2025, this increases to 70% of emissions for intra-EU voyages.
In 2026, the figure will reach 100% of emissions for intra-EU voyages and 50% for voyages into or out of the EU.
The deadline for surrendering emissions allowances will fall on 30 September of the following year. So, for example, 2024 allowances for reported verified emissions will need to be surrendered by 30 September 2025 at the latest.
Initially, the scheme will cover CO2 emissions but by 2026 this will be expanded to also include methane and nitrous oxide gases.
Where stakeholders require additional allowances, they should be able to purchase these on the secondary market or from authorised auction platforms.
Stakeholders include owners, charterers and managers carrying cargo or passengers for profit, and from 2026, offshore vessels above 5,000 gross tonnes. Although owners and managers will be primarily responsible for surrendering allowances, they will no doubt look to charterers for recouping part or all of those costs.
At the time of writing, the final text of the amendments aimed at including shipping in the ETS scheme has not yet been approved, although it is expected to be shortly. A provisional legislative draft was, however, published on 8 February 2023 (Proposal for a Directive amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union and Decision (EU) 2015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme).
In terms of next steps, once the European Council formally endorses the legislation, it will be published in the EU Official Journal and will enter into force 20 days later.
The cost of the ETS to the shipping industry is anticipated to range between EUR 6 and 7 billion per annum, once all emissions are included in the scheme from 2026 onwards.
Who is most likely to bear the cost for the ETS allowances? The “polluter-pays principle” has been adopted in the proposed Directive. Article 3gaa1 of the proposed Directive referred to above requires that the Member States take the necessary measures to ensure the costs of the EU ETS pass-through to the party that bears the ultimate “responsibility for the purchase of the fuel and/or the operation of the ship” (if different from the shipping company).
The Directive further provides that the shipping company is entitled to reimbursement from that entity for the costs arising from the surrender of EU ETS allowances.
In practice this means that those costs will be passed down through the contractual chain from the shipowner to the charterers and sub-charterers. Ultimately, it is quite possible that the end-user (i.e., the public at large) ends up absorbing those costs through higher prices, as companies seek to ensure that they are not “out-of-pocket”.
This has, therefore, already become, and will become even more of a crucial negotiating point between shipowners and charterers, and charterers and sub-charterers, as each party seeks to try to pass on the cost to the other party.
The inclusion of the shipping industry in the EU ETS comes together with a provision in the recitals of the proposed Directive (recital 31c)2 according to which revenues from the emissions trading scheme will be ringfenced: at least 20 million ETS allowances (corresponding to EUR 1,5 billion under the current ETS allowance price) are to be allocated to specific shipping projects via the Innovation Fund and the Climate Investment Fund. These projects will aim to invest in the shipping industry’s green transition.
The European Parliament’s adoption of the ETS reform represents a huge step towards the shipping sector’s decarbonisation. However, it should be noted that there is a possibility the ETS may be amended to accommodate the International Maritime Organisation’s own initiatives, should it decide to implement specific international market-based measures to incentivise the global transition to zero emissions in shipping.