The EU ETS and Shipping – updates and unanswered questions

Since the European Commission on 14 July 2021 proposed to extend the scope of its Emissions Trading System (EU ETS) to include emissions from shipping, several stakeholders have evaluated, commented on and assessed the proposal. This article examines some of the most debated and uncertain aspects.

The EU ETS is a “cap and trade” system. Each year, emitters within the sectors included in the scheme have to surrender allowances which fully cover their greenhouse gas emissions. If emissions exceed that permitted by its allowances, the emitter must purchase more allowances. Conversely, if a company has excess allowances at the end of the relevant trading period, it may ­auction off its leftover credits. The total amount of allowances issued is reduced yearly. Emitters in the included ­sectors therefore have an financial incentive – as well as a duty – to reduce their emissions.

The European Commission has suggested to revise the EU ETS to include inter alia emissions from the shipping sector. In essence, the proposal entails that shipping companies have to surrender allowances for all emissions that occur on voyages between ports within the EU and whilst ships are at berth at EU ports. Moreover, the Commission’s proposal also requires shipping companies to surrender allowances for 50% of all emissions stemming from international voyages to or from ports within the EU. The EU ETS will apply regardless of whether the ships fly an EU flag or whether the shipowner is incorporated in the EU.

In this article, we turn our attention to the most prominent recent developments with regards to the expansions, namely the Special Rapporteur’s Draft Report (the “Report”) and the suggestions of The European Parliament’s environmental committee. We will also assess some key uncertainties concerning how the directive will ­ultimately affect relevant stakeholders within shipping.

The Special Rapporteur’s Draft Report

On 24 January 2022, Special Rapporteur Peter Liese presented his Report. Regularly appointed during substantial parliamentary considerations, a Special Rapporteur is a MEP which is awarded chief responsibility to review and update a legislative proposal from the European Commission. The Report contains several amendments compared to the proposal put forward by the European Commission 6 months prior.

In general, the Report entails that the EU ETS will be greener, sooner. For instance, the full application of the directive is moved forward from 2026 to 2025, with shipowners having to surrender allocations for a larger percent of their emissions from 2023 to 2025. Moreover, a duty is imposed on the European Commission to assess the impacts of greenhouse gases other than CO2 and CH4. Finally, the Report also recommends implementing an “Ocean Fund”, which shall go towards i.e. improvement of energy efficiency in ships and ports and investments in zero-emission propulsion technologies.

Main issues

The Report underscores that the EU ETS will most likely impose more onerous requirements after the EU Parliament has concluded its review. Still, many questions remain unresolved. Some of them will be reviewed in the following.

The Responsible Entity

One issue which has been heavily debated is the division of responsibilities and liabilities under the EU ETS. Both the EU Commission and the Special Rapporteur’s Report assign accountability to the “Shipping Company”, as defined by the ISM Code. The “Shipping Company” is the entity that has assumed the responsibility for the operation of the ship. Although this definition is found in other international regulations and therefore should be established, concerns have been raised regarding its applicability to the EU ETS, inter alia because the responsible company may change over the reporting period.

The Special Rapporteur has proposed a new article obliging companies to enter into contractual relationships: If an entity other than the Shipping Company has assumed “ultimate responsibility” for the purchase of fuel or the operation of the ship, the Member States shall ensure that that entity is contractually responsible to surrender allowances. The Report defines the entity ultimately responsible for the “operation of the ship” as the operator determining the cargo carried by, or the route and speed of, the ship.

The somewhat vague definition of which entity has the ultimate responsibility for the purchase of fuel or the operation of the ship could create uncertainty with regards to what entity is ultimately responsible to cover the costs under the Directive. For instance, whilst the route of the vessel may be decided by the charterer or the commercial manager, the purchase of fuel may be left to the technical manager. It is also uncommon for the EU to infringe on the principle of freedom of contract to this extent. We therefore believe that the entity responsible under the EU ETS will be subject to further debate.

Some shipowners may not want the responsible company under the ISM Code to be responsible for the duties under the EU ETS. If the Special Rapporteur’s proposal is not approved, shipowners may contractually regulate an alternative and clearer allocation of responsibilities inter partes. For instance, BIMCO has drafted an “ETS Clause”, which will apply to the EU ETS and potential similar legislations from other countries. The basis of BIMCOs clause is that the party providing and paying for the fuel under the time charter is the party that is responsible for providing and paying for emissions trading allowances: "The owners must monitor the ship’s emissions and provide the relevant emissions data and the basis of calculations to the charterers. Using this information, the charterers transfer the appropriate allowances to the owners monthly. The clause addresses the adjustment of allowances due to offhire events and what happens if the charterers fail to transfer allowances when due."

The Scope of the EU ETS

The international aspects of the directive may also cause uncertainty. Both the EU Commission and the Special Rapporteur have underlined the importance of international action through the International Maritime Organization (IMO). However, whilst the Commission only stated that the EU should consider amendments to the EU ETS if a global market-based measure is approved by the IMO, the Special Rapporteur has proposed further commitments. Firstly, the Report contains an obligation for the EU Commission to engage with the IMO, as well as bilaterally with third countries, to establish agreements to cover all the emissions. Secondly, if a global market-based measure leading to a reduction of emissions in line with the Paris Agreement is not reached by 2028, the EU Commission shall put forward a legislative proposal which covers 100 % of emissions from ships on international sailings, departing from or arriving at an EU port. This would be highly contentious – both legally and politically.

Public law issues might be accentuated as other jurisdictions plan to introduce similar schemes. For instance, the United Kingdom has currently extended a public consultation process to receive feedback regarding a proposed expansion of their emissions trading system to domestic maritime emissions. The more countries outside of the EU that introduce similar schemes, the more difficult it would be for the EU to legitimize an expansion of the EU ETS to include extraterritorial emissions from non-EU flagged vessels.

The scope of the Directive is also of importance for its effectiveness. According to a recently published report from CE Delft (on behalf of the Port of Rotterdam), the regulation is open to circumvention through adding a port call just outside of the EU or feedering from nearby ports. Unless a global measure is agreed, we expect that there will be several attempts to side-step the full effect of the EU ETS, which will result in corresponding amendments from the EU.

Further speeding up

The European Parliament’s environmental committee (ENVI) voted in a meeting mid-May to speed up the inclusion of shipping to the union’s Emissions Trading System (ETS) even further. The ENVIs suggestions include inter alia deleting the phase-in period (100% of emissions from 2024), extending the geographical scope of the scheme (50% of extra-EU routes from 2024-2026 and 100% from 2027 onwards),  allowing shipowners to pass on the carbon cost to the charterer, expanding the type of emission to not only cover CO2, but also include methane (CH4) and nitrous oxide (N2O), and making the ETS scheme applicable to ships of 400 gross tonnage and above (comparted to 500 GT in the original proposal).

The report is scheduled for a vote at the plenary session on 6-9 June after which the EU Parliament will be ready to start negotiations with member states.

Read our latest articles on Shipping Offshore

  • Shipping Offshore, Sustainability

    2022

    MARPOL Annex VI: EEXI and CII – can your contracts cope?

    Amendments to MARPOL Annex VI aimed at improving the technical and operational efficiencies of all types of ships were adopted by the IMO in June 2021. These amendments will enter into force on 1 January 2023. The amendments introduce the Energy Efficiency Existing Ship Index (EEXI), a technical measure concerned with a ship’s design, and the Carbon Intensity Indicator (CII), an operational measure concerned with a ship’s trading and operation.

  • Shipping Offshore, Sustainability

    2022

    The EU Taxonomy in the maritime transport industry

    In the maritime sector, several measures are needed in order to reduce emissions to the extent necessary, and the EU Commission approach this challenge by presenting a basket of measures, one of them being the EU Taxonomy. By setting harmonised criteria for determining whether an economic activity qualifies as environmentally sustainable, it is intended to incentivise the greening of the sector.

  • Shipping Offshore, Sustainability

    2022

    Key aspects of the new FuelEU Maritime proposal

    On 14 July 2021, the European Commission presented a package of proposals aimed at ensuring that the European Union achieves its goals of cutting greenhouse gas emissions by at least 55% by 2030. The proposals include, among other things, the new FuelEU Maritime initiative, specifically aimed at the shipping industry.