Decarbonisation and Shipping: EU Emissions Trading Scheme
Details
SECOND UPDATE: On 22 June 2022 the EU Commission published a third proposal for the inclusion of emissions from shipping in the EU Emissions Trading Scheme. That proposal supersedes the proposed regime discussed below and is discussed here.
UPDATE: On 14 July 2021 the EU Commission published a new proposal for the inclusion of emissions from shipping in the EU Emissions Trading Scheme. That proposal supercedes the proposed regime discussed below and will be the subject of a forthcoming article
Political will to take action on climate issues has increased in recent years. As appreciation of the need to stop our planet warming uncontrollably mounts, so too emissions reduction strategies and targets are multiplying, becoming increasingly ambitious, even competitive, as they do.
In relation to greenhouse gas (GHG) emissions from shipping, a current debate in the industry is whether local level regulation is helpful in accelerating the global reduction of emissions or whether it is disruptive to global efforts to reduce emissions.
At international level, most of the world’s shipping fleet is regulated by the maritime division of the United Nations, the International Maritime Organization (IMO). The IMO is committed to reducing greenhouse gas emissions from shipping and is pursuing a globally applicable strategy to achieve this. See our previous articles, Decarbonisation and shipping – the coming change and Decarbonisation and shipping: International Maritime Organization ambitions and measures for more details.
While there are clearly advantages to regulating a global industry at global level, consistency and global certainty being among them, a criticism sometimes levelled at the IMO is that, as a member organisation including almost every nation in the world, and one that operates by consensus, it is simply not capable of moving fast enough to respond effectively to the current climate crisis.
One tool the IMO intends to deploy in its strategy for reducing GHG emissions, alongside technical and operational measures, is the use of market-based measures. These measures are essentially economic and are used to manipulate the market to drive a shift towards desirable (non-polluting) behaviour. However, the IMO is not scheduled to consider such measures until 2023 and beyond. Meanwhile, the EU, which also has ambitious GHG emission reduction goals has recently surged forward on this front with a vote to apply a significant market-based measure to shipping in the EU, by way of including emissions from shipping in the EU Emissions Trading Scheme, with effect from 1 January 2022 onwards.
This is a move that has divided opinion in the shipping community. It has been met with applause from some, who welcome the application of market based measures to shipping at the earliest opportunity, and by concern from others, who believe a global industry should be regulated at global level and fear that a patchwork landscape of regional regulation may undermine international efforts to control emissions, distort global trade and potentially create confusion and challenges to compliance.
So, what is the EU’s Emissions Trading Scheme, and how might the inclusion of emissions from shipping affect the shipping industry?
EU Emissions Trading Scheme (EU ETS)
Established in 2005, the EU ETS was the world’s first international emissions trading scheme. It operates on a cap and trade system whereby a cap on emissions is set and companies buy at auction, and then trade, emissions allowances permitting them to produce emissions within the cap. In addition to the ‘penalty’ for polluting imposed by the initial cost of purchasing emissions allowances for anticipated emissions, the ability to trade allowances means companies are further rewarded or penalised within the market for their ability to keep their level of actual emissions within the anticipated level, either by the revenue from sales of spare allowances or by the cost of purchasing additional allowances. Furthermore, if a company produces emissions outside of its allowances, heavy fines are imposed, acting as a further incentive for companies to strive to reduce their emissions.
Over time, the cap on emissions is reduced, meaning that fewer and fewer emissions are permitted. As the allowances are sold initially at auction the price of allowances is set by market demand. In the early years of the scheme it can be anticipated that, while the tide of behaviour is still turning from polluting to clean, emissions allowances will fetch a high price because companies anticipate producing large quantities of emissions. As it becomes increasingly easy for ships to produce fewer GHG emissions, it can be anticipated that, over time, demand for allowances will slacken and the price may drop. Although, as the number of allowances available in the market will also decrease over time, the price is unlikely to fall drastically and could in fact increase, despite a reduction in total demand over time.
The auctioning of emissions allowances, together with the imposition of fines on companies exceeding their allowances, will generate revenue for the EU Commission.
Currently, it is anticipated that 50% of this revenue will go towards a Maritime Transport Decarbonisation Fund, established specifically to support decarbonisation of the maritime sector, and that 50% will go to supporting the EU’s wider climate strategy and its recovery from COVID-19.
Impact on shipping
Once shipping is included in the EU ETS, voyages from 2022 onwards falling within the remit of the scheme will carry an additional cost – the cost of emitting CO2. Parties engaged in shipping touching the EEA will also carry an additional regulatory risk – that of exceeding their permissible level of emissions. Assuming the EU ETS framework will mirror to a large extent the EU Monitoring Reporting and Verification Regulation (EU MRV) - which has laid the groundwork for shipping’s inclusion in the EU ETS by establishing the necessary data collection system - the voyages subject to emissions caps will be those into or out of the EEA, or between ports in the EEA, made by ships over 5000 gross tonnes which are loading or unloading cargo or passengers in the EEA.
It remains to be clarified which party in the shipping chain will have responsibility for ensuring compliance with the EU ETS, and which party’s allowances will be used in respect of any single voyage. However, the EU MRV includes scope for various entities with responsibility for the operation of the ship to fulfil the monitoring, reporting and verification obligation. If the EU ETS requirements are aligned with the EU MRV requirements, it can be anticipated that time and bareboat charterers, as well as ship owners and managers, may bear responsibility for compliance with emissions caps and for holding sufficient allowances for voyages touching the EEA.
Where there are a number of potential candidates responsible for compliance in any shipping chain, it will be prudent to insert provisions in charterparties that clarify which party is to bear responsibility for compliance and how liabilities arising as a result of failures in compliance are to be dealt with.
Another area to be clarified is how additional emissions costs will be absorbed along the shipping chain, and whether they will be felt in consumer markets. Research undertaken by the NGO Transport & Environment indicates that, even if costs were passed directly to consumers, the final impact on the price of goods would be insignificant, given the economies of scale achieved by moving goods by ship, and that emissions costs per voyage would add only a few cents per item to the price of goods such as bananas, iPads and diesel (1ltr) in consumer markets.
A further point of speculation is whether emissions costs in the EU will drive a preference for calls in ports outside, but close to, the EEA. If the EU ETS applies to inward and outward voyages to the EEA, and if there is a cost attached to those voyages proportionate to the amount of fuel burned, this in theory creates an incentive for shipping parties to minimise emissions costs in the EU by shortening the inward and outward journeys to the EEA, as far as possible, by calling at ports nearby but outside the EEA in preference to calling in the EEA, or before proceeding to or from the EEA.
Whilst in many instances factoring in a port call in preference to, or outside of, the EEA may result in no net economic benefit to shipping parties, due to the extra fuel burned, time lost or lack of comparable market, there will be some cases where a change in the order of port rotations will be possible and may result in economic benefits. For example, a container ship sailing regularly from the US to a non-EEA port close to the EEA and a port in the EEA, and due to discharge cargo in both, may find there is an advantage to be gained by calling in the non-EEA port first, so as to shorten the inbound journey to the EEA port and thereby pay a lower sum in emissions allowances.
Given that the UK will have completed its exit from the EU ahead of the EU ETS becoming operational for shipping, and that the UK is geographically very close to the EEA border, it remains to be seen whether the inclusion of shipping in the EU ETS will cause an increase in trade in UK ports as it is deflected from neighbouring EEA ports. If so, this development might increase the overall number of port calls in the UK and increase the attractiveness of the UK as a transhipment hub for deep sea vessels.
Upcoming
In our next article we take a look at the UK’s position on GHG emissions from shipping, how this relates to international ambition and regulation and what impact this may have on shipping.
View our next article on decarbonisation and shipping.
