The EU ETS expands to shipping
One of the most talked about and controversial aspects of the EU’s proposed “Fit for 55” package is the European Commission’s proposal for a revised Emissions Trading System (EU ETS). This article examines the proposal and details its potential impact on the shipping industry.
The EU ETS was launched in 2005 and is in essence a trading system for emissions allowances. Under the “cap and trade” principle, a maximum (cap) is set on the total amount of greenhouse gases that can be emitted by participating installations and sectors. The scheme includes energy-intensive installations and sectors such as oil refineries and steel works, as well as commercial aviation within the EEA. Included sectors account for about 45% of EU greenhouse gas emissions. Allowances are allocated for free or auctioned off and can subsequently be traded. Installations must monitor and report their greenhouse gas emissions ensuring that they have sufficient allowances in hand to cover their emissions. If emissions exceed that permitted by its allowances, then the relevant installation must purchase more allowances. Conversely, if an installation has allowances remaining at the end of the relevant trading period, it may auction off its leftover credits. The included installations and sectors therefore have a financial incentive – as well as a duty – to reduce their emissions.
As well as all EU countries, Norway, Iceland and Lichtenstein have been a part of the EU ETS through the EEA-agreement since 2008.
The inclusion of shipping in the EU ETS
As part of its “Fit for 55” package, the European Commission has proposed extending the EU ETS to also cover emissions from shipping starting from 2023. The proposal entails that shipping companies have to surrender allowances for all emissions that occur on voyages between ports within the EU, as well as emissions that occur whilst the 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. To ensure the effectiveness of the regulation and to avoid shipowners seeking to avoid the scheme by flagging outside the EU, the EU ETS will apply to emissions from all ships calling at EU ports, regardless of whether the ships fly an EU flag or whether the shipowner is incorporated in the EU.
To ensure a smooth transition, the proposal suggests a phase-in period where shipping companies only have to surrender allowances for a portion of their verified emissions increasing on a sliding scale as follows:
- 20% of emissions in 2023
- 45% of emissions in 2024
- 70% of emissions in 2025
- 100% of emissions in 2026
Responsibilities and penalties
The proposal sets out requirements on shipping companies, defined as the shipowner or any other entity such as the manager or bareboat charterer that has “assumed the responsibility for the operation of the ship from the shipowner”. This definition is in line with similar definitions used by the IMO, for example, in its 1994 international safety management code for the safe operation of ships and pollution prevention (the ISM Code). Shipowners that wish to hold other entities responsible for penalties and other losses which may occur in connection with the EU ETS proposal will therefore need to ensure that this is clearly specified in their contracts. The relevant responsible company must then surrender enough allowances at the end of each year to cover their ships’ emissions for the preceding year.
Member States will be responsible for administering the scheme for shipping companies incorporated in their jurisdiction. For shipping companies incorporated outside the EU, the responsibility will lie with the Member States that the non-EU shipping company had the greatest estimated number of port calls at in the last two years. If the shipping company did not carry out any voyage to the EU in the last two years, the Member State from which the ship first departs will be responsible.
If a company does not surrender enough allowances for the preceding year by 30 April in the following year, it will be held liable for the payment of an excess emissions penalty. The excess emissions penalty is currently proposed at 100 euros per tonne of CO2 equivalent emissions the company did not surrender allowances for.
On average, a container ship falling within the scope of the proposed EU ETS emits 24 400 tonnes of CO2 annually (based on data from 2019). Assuming a calculation year of 2026, if a shipping company fails to surrender allowances for 2500 tonnes of CO2, approximately 10% of a container ship’s average annual emissions, the excess emissions penalty would amount to 250 000 euros. Even minor deviations from the proposed directive could thus result in the responsible company incurring significant financial penalties.
If a company does not comply with the EU ETS for two or more consecutive years, Member States may issue expulsion orders against the company’s ships. The ships can consequently be detained in the Member State in which they are registered or denied entry into a port of another Member State.
Several aspects of the EU’s proposal to include maritime emissions in the EU ETS remain unclear. For instance, the proposal does not detail how free allowances will be allocated to shipping companies. Moreover, it is still not clear how the revenues from the expanded EU ETS will be utilised and to what extent this will benefit the individual shipping companies or the shipping industry at large.
Although the EU Parliament and the EU Council are yet to consider the proposal, it is assumed that it will not be heavily amended. It is therefore likely that shipping will be included in the EU ETS by 2023. Shipping companies and others affected should therefore start planning ahead and ensure they have processes in place to ensure compliance with the EU ETS.