The EU Emissions Trading System – Shipping

Posted: 16/12/2021

On 14 July 2021, the EU published proposed legislation to extend the European Union Emissions Trading System (EU ETS) to the shipping sector. This article considers how the scheme is likely to work in practice, and how to navigate the challenges it will bring to the shipping sector.

Shipping emissions in the EU ETS

Following a vote by the European Parliament in September 2020, on 14 July 2021 the EU Commission published draft legislation for the phased inclusion of carbon dioxide emissions from the shipping sector into the EU ETS from 2023.

The proposed framework suggests amendments to the EU Monitoring, Reporting and Verification Regulation[1] (EU MRV Regulation) and the EU Emissions Trading System Directive[2] (EU ETS Directive).

When will it be in force?

It is proposed that there will be a phased extension of the EU ETS to shipping emissions as follows:

• 20% of verified emissions reported for 2023;
• 45% of verified emissions reported for 2024;
• 70% of verified emissions reported for 2025; and
• 100% of verified emissions reported for 2026 and each year thereafter.

Which vessels and what voyages will be within the EU ETS?

The proposed framework will apply to ships over 5,000 gross tonnes performing voyages for the purpose of transporting passengers or cargo for commercial purposes, and arriving at, within, or departing from ports under the jurisdiction of an EU member state.

It is proposed that where the whole of a voyage takes place within the EU, credits will need to be purchased for 100% of emissions. For voyages that enter or depart from the EU, but where the port of origin or destination is outside the EU, credits will be required for 50% of the emissions.

Who is responsible for compliance?

The person responsible for compliance is the ‘shipping company’, the definition of which is set out in the amended EU ETS Directive:

‘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.’              

It is thought that this is likely to mean that the party responsible for the ISM code will also be responsible for compliance with the EU ETS scheme.

Recital 20 of the amended EU ETS Directive anticipates that parties may wish to alter the responsibility for EU ETS compliance by way of contractual agreement, on the basis that the party responsible for the pollution should bear the cost:

‘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.’

Without express contractual agreement however, the responsibility for EU ETS compliance will remain with the ‘shipping company.’

The cost of compliance

The EU has estimated that once the EU ETS has been fully extended to shipping in 2026, around 90 million tonnes of CO2 will be captured.

The cost per tonne of carbon within the EU ETS is not constant and the cost per tonne of CO2 in 2023 cannot be determined at this stage. It is noted, however, that the EU carbon price rose from €23 per tonne in October 2020 to €75 per tonne in November 2021. Assuming that 90 million tonnes of CO2 will be captured when the EU ETS is extended to shipping, this is an increase in the cost of carbon for the shipping sector from €2.25 billion to €6.75 billion in just over 13 months.

Penalties for non-compliance?

The proposed directive provides potentially onerous penalties for non-compliance with the EU ETS scheme.

• A shipping company which has not surrendered sufficient allowances by 30 April each year shall be subject to a financial penalty. This will be calculated at €100 per tonne of CO2 emitted for which allowances have not been surrendered. In addition, the shipping company will need to surrender the necessary allowance.
• Member states are obliged to publish the names of the shipping companies who have not surrendered sufficient allowances.
• If a shipping company fails to comply with the surrender requirements for two or more consecutive reporting periods, then an expulsion order may be issued against it. This would have the effect that all member states (save for a member state whose flag the ship is flying) would be obliged to refuse entry to any of the ships under the responsibility of the shipping company. If the ship flies the flag of a member state, the ship should be detained until the shipping company fulfils its obligations.

Given that a failure of compliance of one ship in a fleet could lead to all ships under common management being denied entry to any EU port, shipowners should ensure that if responsibility is divested to charterers or managers for EU ETS compliance, there is a robust system for monitoring and ensuring compliance.

It goes without saying that detention and expulsion orders are likely to lead to significant disruption and delays, and charterparties should provide who is responsible for any such costs and delay.

THE EU ETS and beyond

Now that the UK has exited the EU, UK ports do not fall within the EEA, and the EU ETS does not apply. Although this could result in an increase in trade to UK ports as vessels navigate around the EEA area and are deflected from neighbouring EEA ports, the UK’s Department for Transport recently confirmed that the UK is considering the extension of the UK ETS[3] to include shipping. It remains to be seen what these regulatory changes will look like, but it is advisable for stakeholders to start thinking ahead now, in order to reduce their exposure and costs.

Given the potential cost of the EU ETS, it is possible that ports close to, but outside the EEA will become attractive ports of transhipment. Although this may be attractive to the company responsible for compliance with the EU ETS, the cargo receivers and/or any passengers are likely to be faced with additional costs and administrative burdens, should the goods or passengers then be imported into the EU.

Although there remains a degree of uncertainty surrounding the precise scope of the regulations, it is clear that the costs of the EU ETS across the shipping sector will be significant. It is important that all involved in the operation and management of ships assess their exposure to the costs of the EU ETS and consider the contracts that dictate their commercial relationships.

Where the responsibility for such costs and any subsequent delays are uncertain, it is likely that disputes will follow. Penningtons Manches Cooper is already being asked to advise owners, charterers and traders in long-term charter arrangements on their potential exposure to costs arising from the EU ETS and other regulations aimed at the reduction of GHG emissions.

This article has been based on initial research by Elina Pavlidou.

[1] Regulation EU No. 2015/57

[2] Directive 2003/87/EC

[3] The UK introduced its ETS, which came into force on 1 January 2021, to replace its participation in the EU ETS.

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