Introducing FuelEU Maritime: Contractual implications

Starting 1 January 2025, ­vessels subject to the FuelEU ­Maritime regulations must monitor and report the green­house gas intensity (GHG intensity) of the fuel used annually, with maximum allowable values gradually decreasing from 2025 to 2050. The aim is to reduce the GHG intensity by up to 80% by 2050 through the ­adoption of renewable and low-carbon fuels. While the technical aspects of the regulations have understandably already been given particular attention, and ship operators have been busy on implementing compliance measures,  contractual frameworks between stakeholders – such as ­shipowners, managers, and charterers – also requires careful attention and timely adjustments.

Background law position 

The ”shipping company”, which is the entity legally responsible for compliance with FuelEU Maritime, is the ISM company – the holder of the Document of Compliance (DoC holder). Whilst the EU ETS framework initially placed responsibility on the registered owner, and ­allowed a  transfer of responsibility to the technical manager or bareboat charterer, responsibility for FuelEU Maritime remains with the ISM company, which in many cases is the technical manager of the vessel.

This may initially seem counterintuitive, given that the technical manager is rarely responsible for selecting or paying for the fuel of the vessel, or for deciding how and where the vessel trades. However, it is important to differentiate between the party that holds public regulatory responsibility vis-a-vis the authorities and the party that ultimately bears contractual liability within a contractual chain.

In line with the polluter pays principle, the charterer should in our view eventually be ­contractually liable for complying with the require­ments and the costs incurred to ensure compliance or pay fines for non-compliance. In practice, this will firstly require that the technical manager, in their manage­ment agreement with the shipowner, states that that the technical manager will handle and report the vessel’s GHG intensity, while the shipowner will be financially responsible for compliance with the FuelEU Maritime regulations. Secondly, the shipowner should stipulate in their charter agreements that the charterer is responsible for ensuring the vessel uses a ­combination of fuels that meets the GHG intensity requirements or to compensate the shipowner for the consequences of non-compliance.

BIMCO released their time charter clause for FuelEU Maritime on 25 November, and we expect that they will also release a standard clause regarding liability allocation between the technical manager and the shipowner by the end of the year. Involved parties should promptly begin discussions with their contractual counterparts to ­address distribution of responsi­bility and compensation.

Management agreements

As the technical manager (DoC holder) will be responsible towards the authorities for complying with the FuelEU Maritime regulation, additional responsibilities related to administration and reporting needs to be agreed in both existing and new management agreements. These additional obligations would typically result in an additional fee to managers as a compensation for the added scope of work.

Because the consequences of non-compliance of the regulation include fines of EUR 2,400 per ton of fossil fuel exceeding the current limit, managers will also need to consider obtaining cash coverage for any compliance deficit on an ­ongoing basis or proper security from shipowners.

Equally, shipowners are likely to require the right to issue instructions to managers on utilisation of any compliance surplus that could be banked for compliance in future years or utilised under the pooling mechanism discussed below.

It should also be noted that the shipping company (technical manager) who has the ­responsibility for operation of the ship on 31 ­December will be responsible for the entire reporting period of the preceding year. This means that in the event of a change of shipping company or sale of the vessel within a reporting period, shipping companies are advised to consider including provisions on exchange of information relating to GHG intensity and cash coverage or security for any compliance deficit for the reporting period in good time before any transfer of ownership or management. 

Time charters

New time charter parties and clauses in existing charters should include specific contractual provisions stating that the charterer is responsible for complying with the FuelEU Maritime scheme and the financial consequences. Because the FuelEU Maritime establishes a regime that creates both direct ­penalties if there is a compliance deficit and indirectly benefits that potentially could be capitalised if there is a compliance surplus, the regulation could be prove to be quite complex with a need to address:

• What benefit should be transferred to charterers if the GHG intensity exceeds the vessels’ target in the relevant period and creates as compliance surplus – which in turn depends on how the consequential benefit should be capitalised and calculated;
• What cost should be transferred to owners if the GHG intensity is below the vessels’ target in the relevant period and creates a compliance deficit – which is likely to be equal to the fines issued for non-compliance; 
• Calculation of relevant periods, as the reporting period from 1 January to 31 December is unlikely to match the time charter period;
• Adjustments, e.g. off-hire ­under the time charter, ­flexibility ­mechanisms under FuelEU Maritime and intensified penalties for several years of ­compliance deficit; and
• When the owner or charterer should transfer the benefit or cost.

Whilst we, as a general starting point, will expect that the broadly adopted solution is that the ­charterer receives a benefit for achieving a GHG intensity exceeding the vessels’ target, this may of course differ in bespoke commercial relationships. If the choice of fuel is a key factor, e.g. for dual fuel vessels, the charterer may well have good arguments that they should get a part of the upside when choosing the fuel generating a compliance surplus. However, a shipowner that constructs a newbuild vessel with a propulsion system likely to generate a significant compliance surplus, may have included the benefit of that surplus in the calculated earnings of the vessel and thus insist on retaining the same. 

Flexibility mechanisms – Pooling agreements

The EU has introduced three flexibility mechanisms in the new regulations – being (1) borrowing compliance capacity from the following year in case of a compliance deficit in the current year; (2) banking current compliance surplus for subsequent years or (3) pooling of compliance among vessels. Arguably the most intriguing of these is the option to pool multiple vessels to meet the target GHG intensity, which is possible irrespective of type of vessel, ownership or flag. Industry players may be well advised to begin evaluating whether to pool their vessels and consider the appropriate contractual structure for such pooling agreements.

Agreements may take the form of ”traditional pooling agreements” among specific vessels or ”derivatives” where the compliance surplus is somehow tokenised and traded in order to match vessels to establish compliance pools at the time of reporting. Important considerations in this respect include access criteria for participants, lock-in period for the number of reporting periods and exit opportunities. The structuring of benefits should be addressed, deciding whether participants will receive derivatives/tokens, cash, or other instruments. 

It is also crucial to consider the relationship to other flexibility mechanisms, knowing that vessels participating in pools will be cut off from using the borrowing mechanism. Participants may still bank their compliance surplus, which is why provisions in pooling agreements must also address the allocation of any compliance surplus. Finally, the consequences of non-compliance should be clarified, particularly if assumptions regarding the quantity of surplus or deficits are incorrect.

Summary

As we enter the new year, FuelEU Maritime will be the latest decarbonisation requirement hitting the shipping industry. Its effect will be significant and only increasing in years to come. The regulation also require industry participants to ­actively consider its specific effects for their vessels and include adequate regulations in their contracts. The carrot and stick approach underpinning the regulation also implies that there may be commercial opportunities alongside the general actions needed to ensure compliance.