Introduction
1. In May, the EU finalised its legislative process in relation to the extension of the EU Emissions Trading System (ETS) to the maritime industry, although a number of details are still to be clarified. In early July, the UK announced that it intends to follow suit, from 2026 onwards. This note summarises the most recent developments.
What is the EU ETS?
2. The EU’s Emission Trading System (“EU ETS”) is a “cap-and-trade” system that sets a limit on Green House Gas (“GHG”) emissions for certain sectors of the economy. The EU makes available a limited number of EU Allowances (EUAs) each year for trading in the market and this is reduced yearly in order for the EU to meet its target of a 55% reduction in GHG emissions by 2030 relative to 1990, and net zero by 2050. Each EUA gives companies the right to emit GHG emissions equivalent to the global warming potential of one tonne of CO2 equivalent.
How is Maritime Transport being included?
3. Shipping will be included in the EU ETS from 1 January 2024 onwards. There will be a three year phase-in period for the surrender of EUAs by a Shipping Company (see the section headed “who has responsibility for compliance” below for the definition of a Shipping Company):
a. for 2024, 40% of verified regulated GHG emissions;
b. for 2025, 70% of verified regulated GHG emissions; and
c. for 2026 and each year thereafter, 100% of verified regulated GHG emissions.
4. Initially, the EU ETS will apply to carbon dioxide emissions, but this will be expanded to include methane and nitrous oxide from 1 January 2026. Shipping Companies are already tracking their CO2, CH4 and N2O emissions in accordance with the European MRV Regulation. An emissions report will need to be submitted on an annual basis to the European Commission. The reported emissions will be assessed and verified by an independent verifier. 11 verification companies have now been approved as verifiers under the MRV Regulation.
5. The EU ETS will initially apply only to vessels over 5,000 gross tons (GT). However, the EU is already considering the expansion to smaller vessels. By 31 December 2026, the European Commission must prepare a report to the European Parliament and European Council considering whether vessels between 400 GT and 5,000 GT should be included.
6. There are exemptions for certain types of ship, such as fishing vessels, warships and government ships used for non-commercial purposes.
7. The EU ETS will apply to any voyages involving the transportation of cargo or passengers for commercial purposes, with emissions to be caught under the scope of the EU ETS as follows:
a. fifty percent (50 %) of the emissions from ships performing voyages departing from a port of call under the jurisdiction of a Member State and arriving at a port of call outside the jurisdiction of a Member State;
b. fifty percent (50 %) of the emissions from ships performing voyages departing from a port of call outside the jurisdiction of a Member State and arriving at a port of call under the jurisdiction of a Member State; and
c. one hundred percent (100 %) of emissions from ships performing voyages departing from a port of call under the jurisdiction of a Member State and arriving at a port of call under the jurisdiction of a Member State; and
d. one hundred percent (100 %) of emissions from ships within a port of call under the jurisdiction of a Member State.
8. A ‘port of call’ is defined as follows: “the port where a ship stops to load or unload cargo or to embark or disembark passengers, or the port where an offshore ship stops to relieve the crew”. A number of types of stops are excluded from the definition. These include: “stops for the sole purposes of refuelling, obtaining supplies, relieving the crew of a ship other than an offshore ship, going into dry-dock or making repairs to the ship, its equipment, or both, stops in port because the ship is in need of assistance or in distress, ship-to-ship transfers carried out outside ports, stops for the sole purpose of taking shelter from adverse weather or rendered necessary by search and rescue activities, and stops of containerships in a neighbouring container transhipment port.”
Who has responsibility for compliance?
9. The entity responsible for compliance with the EU ETS is the “Shipping Company”. This is defined as “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, set out in Annex I to Regulation (EC) No 336/2006 of the European Parliament and of the Council”.
10. The Shipping Company could therefore be any of the shipowner, the manager or the bareboat charterer (where either of the last two entities have assumed responsibility for the Document of Compliance (DOC) under the ISM Code the (ISM DOC Holder). Which entity of these will actually be the “Shipping Company” will be determined by the European Commission, who will publish a list of shipping companies, and will specify the administering authority for each shipping company prior to 1 February 2024 through an implementing act. The Administering Authority will be important because it will determine where the Shipping Company will need to open a registry compliance account in order to surrender EUAs (see below the section headed “surrender of EUAs”).
11. Charterers under a time or voyage charterparty will therefore not fall within the definition of the Shipping Company, and will not be responsible for surrendering EUAs. However, the legislation makes clear that the costs of compliance can be transferred from the Shipping Company to a third party in the following circumstances: “when the ultimate responsibility for the purchase of the fuel, or the operation of the ship, or both, is assumed by an entity other than the shipping company pursuant to a contractual arrangement, the shipping company is entitled to reimbursement from that entity for the costs arising from the surrender of allowances.”
12. It is recommended that parties start to think now about the allocation of the costs of EU ETS compliance in their charterparties, if they haven’t done so already.
Administering authority in respect of a shipping company
13. The administering authority in respect of a shipping company shall be:
a. in the case of a Shipping Company registered in a Member State, the Member State in which the Shipping Company is registered;
b. in the case of a shipping company that is not registered in a Member State, the Member State with the greatest estimated number of port calls from voyages performed by that shipping company in the preceding four monitoring years;
c. in the case of a shipping company that is not registered in a Member State and that did not carry out any voyage with an EU port of call in the preceding four monitoring years, the Member State where a ship of the shipping company has started or ended its first in-scope voyage.
14. The European Commission will publish a list of Shipping Companies and their administering authorities by 1 February 2024, and every two years thereafter.
15. Shipping Companies will be allocated an account for holding EUAs in the Union Registry: a Union Registry Account (URA). The European Commission will adopt implementing acts to clarify how URAs are administered, although it is expected that administration will operate in a similar way to the current system for power and aviation.
Surrender of EUAs
16. A Shipping Company must surrender the required number of EUAs to cover the relevant vessel’s verified emissions (or, for 2024 and 2025, the relevant proportion of such emissions) by 30 September each year. The surrender must occur from the entity’s own URA compliance account.
17. Anyone (including, for example, brokers, charterers or other entities which do not qualify as a Shipping Company) can open trading accounts for EUAs. However, participants should be aware that EUAs are financial instruments under MiFID, and therefore appropriate regulatory advice should always be taken when dealing with EUAs.
How to acquire EUAs
18. There are three primary ways to acquire EUAs:
Auctions
19. The European Energy Exchange (EEX) runs fixed price auctions several times a year on behalf of the EU. Companies must register with the European Commission to participate in these auctions. In practice, the main participants are large issuers, financial institutions and professional traders: these parties deal in large volumes and are able to meet the strict admission requirements.
Trading
20. Trading platforms match supply and demand for EUAs. In Europe, there are currently two key venues for the trading of EUAs and EUA derivatives: EEX (Germany) and ICE (Netherlands). An EUA future is an agreement to deliver a certain quantity of emission allowances on an agreed future date at an agreed price. There are contracts for delivery in the short term or further into the future. These futures can be traded on the trading platform until shortly before the time of delivery. Once the contract end date has passed, the seller delivers through the EU ETS Registry and the EUA will transfer to the account of the purchaser. Without an account in the EU ETS Registry, delivery contracts cannot be met. As with the fixed price auctions, participants in trading on the trading venues tend to be larger issuers, financial institutions and professional traders: the admission requirements of EEX and ICE may be a barrier for small issuers.
Bilateral Trading
21. EUAs can also be traded in bilateral transactions between two account holders, without intermediaries. For smaller account holders requiring a limited number of EUAs to meet their annual surrender obligation, it may be easier to buy allowances directly from another account holder, rather than through the official auction or through EEX or ICE. The seller may be an organisation that has spare emissions allowances and wants to sell them, or a trader who buys up allowances for a fee and sells them on to businesses that need them.
22. It is possible to bank EUAs for use in future years. This can be useful if an entity expects to have higher emissions in the future and wants to ensure it has sufficient allowances to offset those emissions. EUAs dated 1 January 2013 or later can be used to meet future surrender obligations, and do not have an expiration date.
23. The number of EUAs issued is decreasing annually by a factor of approximately 4% p.a.. The EU regulates the availability of allowances. During periods with large numbers of EUAs in circulation, the volume made available through auctions is reduced and EUAs are put into a market stability reserve (MSR). Similarly, when there is a shortage of EUAs, more can be released from the MSR to ensure a stable price. As of 2022, there were about 1.4 billion EUAs in circulation.
Penalties
24. Failure to surrender the required EUAs in a given year can result in a penalty (EUR 100 per tonne of excess CO2 emissions) as well as being obliged to make up the shortfall. There is also an adverse publicity risk as Member States are required to publish the name of any Shipping Company in breach.
25. Failure to surrender EUAs for two or more years in a row can result in an expulsion order, whereby a Member State can refuse entry to the offending vessel and all other vessels under the responsibility of the Shipping Company.
UK Developments
26. On 3 July 2023, the UK Emissions Trading Scheme Authority announced a package of reforms regarding emissions. One of the announcements concerned the inclusion of the maritime sector in the EU ETS from 2026. The UK government have confirmed that the scheme will be applicable to large maritime vessels only, i.e. those of 5000 gross tonnage and above. Reporting will utilise the existing MRV requirements.
Background
27. The UK ETS was launched in 2021 to replace the UK’s participation in the EU ETS. The UK ETS replicates the EU ETS very closely. The UK government ran a consultation from March to June 2022 and published its response to the consultation on 3 July 2023.
Consultation and Response
28. In the consultation, the ETS Authority outlined a primary option for expanding the UK ETS to include domestic maritime which was based on vessel activity. This would require maritime participants to monitor their emissions from eligible journeys, report their emissions from these journeys and surrender sufficient allowances to cover their emissions. The ETS Authority stated that this lead option would apply to domestic journeys only, which would be defined as a journey starting and finishing at a port located in the UK.
29. In the response, the ETS Authority has confirmed its intention to pursue an approach based on vessel activity. Emissions will include those at sea and those at berth in UK ports or at anchor. The ETS Authority aims to consult fully on a definition of an eligible domestic journey later in 2023.
How Cambitas can help
24. Cambitas has been tracking the EU and UK ETS developments and is working with the industry to help prepare. Please contact tom.hine@cambitas.com for further information.
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