The Waves of Change: EU Emissions Trading System

Introduction      

The EU Emissions Trading System, initially established in 2005 to address greenhouse gas emissions, has undergone a transformative expansion. Originally focused on energy-intensive sectors, recent negotiations and agreements have broadened its scope to include the shipping industry. In December 2022, provisional agreement extended the EU ETS to cover shipping. This extension was formally adopted and published in the Official Journal of the European Union on May 16, 2023.

Expansion to Shipping

From 2024 onward, the EU ETS will encompass shipping activities within the European Economic Area (EEA), requiring ship operators to monitor, report, and surrender allowances for emitted CO2. The updated law introduces a vessel-based carbon pricing approach within the EU ETS, regardless of cargo, impacting ships with a gross tonnage of 5,000 and above.

Applications and Exemptions

These obligations cover commercial vessels, including both the passenger (with exemptions for some ferries) and cargo ships, of 5,000 gross tons and above calling at EU ports, regardless of their flag or jurisdiction. Exemptions are outlined for offshore and specific ice-class vessels, with potential future expansions. Specific exclusions apply to certain vessel types, including military and non-commercial government vessels, non-mechanically propelled ships, wooden ships of primitive build, and fishing vessels. Also there are temporary exemptions until 2030 for specific passenger and ro-pax ships on small islands. Similar exemptions exist for ferries between Member States without a land border and voyages between outermost regions. Starting from January 1, 2026, the ETS regulations will expand to include emissions of nitrous oxide and methane.

The EU ETS now introduces a carbon pricing approach for ships engaged in voyages between EU and non-EU ports, covering emissions commitments that vary based on scenarios, for example, 100% of emissions for those within EU ports and 50% for voyages between EU and non-EU ports. Certain stops at EU ports are excluded, such as those for refueling, obtaining supplies, or relieving the crew, except for offshore ships. The determination of whether a port call or operation qualifies for exemption hinges on specific details and must be evaluated on a case-by-case basis according to many of the exemptions listed.

Defining the Shipping Company

The pivotal term in EU ETS compliance is the "Shipping Company," designated as the entity responsible for EU ETS complience and adherence to the International Management Code for the Safe Operation of Ships and for Pollution Prevention. Shipping Company only refers to Shipowner, bareboat charterer or manager. Although the definition of the Shipping Company creates many uncertainties, its determination is very important. Namely; With the determination of the Shipping Company, the Administering Authority, that is, the member state that will be held accountable for compliance, will be determined.

Technical managers as the "shipping company"

While the primary objective might seemingly place responsibility on shipowners, the connection to the Document of Compliance introduces a dynamic layer. The ongoing debate questions whether technical managers should be deemed the de facto "shipping company" due to their role in issuing operational directives. If the ISM manager is determined as the organization that ensures compliance with the International Management Code for the Safe Operation of Ships and for Pollution Prevention, it is accepted that it is the responsible person at this point. The intricacies of charter chains and management principles further complicate matters, necessitating a case-specific determination of compliance responsibility. To address the potential burden on technical managers for compliance, BIMCO has proactively taken steps by working on a new management contract, SHIPMAN 2024. This updated version will feature an Emission Trading Scheme Allowances (ETSA) Clause, aiming to clarify and manage these concerns.

Sharing the Compliance Load in Charter Chains

Although the term "Shipping Company" may be defined under a single responsible entity and may not encompass the ship charterers, liability for compliance, operational decisions concerning the vessel's route and speed, and essentially, parties impacting carbon emissions can be shared. Therefor Shipping Company should be entitled to claim reimbursement for the costs arising from the surrender of allowances from the “entity that is directly responsible for the decisions affecting the greenhouse gas emissions of the ship”.

In the presence of a time charter, collaboration between the owner (or bareboat charterer) becomes paramount. Shared verified data reflects their joint influence on the vessel's emissions. The orchestration of EU Allowances (EUAs) becomes a strategic commercial business decision. The owner/bareboat charterer may choose to acquire and transfer the cost of EUAs, or the time charterer might purchase and transfer the EUA allowance to the responsible party (i.e., the bareboat charterer/owner or technical manager). In instances of a voyage charter, where emissions are challenging to quantify pre-voyage, it is expected that calculations and settlements will occur at the voyage's conclusion.

Responsibilities of the Shipping Company

The entity accountable for adhering to the EU ETS is referred to as the "Shipping Company”.  Shipping companies that fall under the jurisdiction of the EU ETS are mandated to develop an approved monitoring plan for tracking and reporting annual emissions. The emissions data for a given year must be verified by an accredited verifier no later than 31 March of the following year (or by 28 February if requested by the Administering Authority).

Additionally, since 2018, shipping companies have been subject to obligations under the Monitoring, Reporting, and Verification (MRV) Regulation.

Additionally, the Shipping Company is mandated to submit the necessary EU Allowances to the competent authority according to their emmisions reported in 2024 starting from September 2025. The share of emissions that must be covered by allowances gradually increases each year:

2025: 40% of emissions reported for 2024 must be covered by emission allowances

2026: 70% of emissions reported for 2025

2027 and beyond: 100% of reported emissions

Defining the Administering Authority

Shipping Companies must register with an Administering Authority, determined by the company's place of registration. The Administering Authority oversees the company's monitoring and reporting of relevant parameters during a reporting period. For EU-registered companies, the authority is the member state of registration. For non-EU companies, it's the member state with the most port calls in the last four monitoring years, or, if no EU trade occurred, the member state of the first port call.

Commission Implementing Decision (EU) 2024/411, published in the Official Journal of the European Union on January 30, 2024, provides the list of shipping companies specifying the administering authority in respect of a shipping company in accordance with Directive 2003/87/EC of the European Parliament and of the Council. The list includes 2,245 Shipping Companies, whose Administering Authorities have now been determined. These Shipping Companies are required to apply to the Administering Authority, listed in the decision, within 40 working days (by March 26) from the publication date to request the opening of an account, known as an M(OHA), where their EU allowances will be held. Subsequently, the Administering Authority must evaluate this application within 40 working days to decide whether to open an M(OHA).

For Shipping Companies not listed in the decision, they are required to apply to the Member State within 65 working days from their first port of call in Europe to request the opening of an M(OHA) where their EU allowances will be held. Similarly, the Administering Authority must evaluate this application within 40 working days to decide whether to open an M(OHA).

Although the issuance of allowances will not commence until September 2025, the timeframe for opening accounts where allowances will be held has already begun.

EU Allowances and Auction Dynamics

Delving into the heart of EU ETS, the emissions cap, annually set and translated into allowances, crystallizes the financial dimension. Obtaining these allowances can be achieved through the primary market by direct participation in auctions organized by Member States.  There is also a secondary market in which allowances can be sold bilaterally or through various derivatives provided by financial institutions. The method of acquiring allowances is a commercial decision. To purchase ETS allowances, companies need to open a trading account or a maritime operator holding account.

Penalties for Non-Compliance

Shipping companies falling short of their EU ETS obligations face financial consequences designed to stimulate emission reductions.

-             Penalites: Failure to surrender allowances promptly incurs a penalty of EUR 100 per tonne of CO2 equivalent. It's crucial to note that paying this penalty does not absolve the company of its surrender obligation for the subsequent reporting period.

-             Expulsion Order and Potential Detention: An expulsion order, a formidable measure, can be issued, prohibiting the entry of ships under the control of the non-compliant Shipping Company in Member States. This stringent action may escalate further, resulting in the detention of ships in the flag state's ports. The severity of these consequences underscores the EU's commitment to enforcing emissions regulations.

-             Potential challenges may arise in the sale of the vessel and difficulties may be encountered in obtaining loans from banks.

-             Reputational Risks and Public Exposure: Non-compliance is not confined to financial and operational repercussions; it extends to the realm of reputation. Companies failing to meet EU ETS obligations face public exposure, risking reputational damage. In an era where corporate responsibility is under increasing scrutiny, the implications of a tarnished reputation can reverberate across the industry.

-             Risks for Sister Ships and Contractual Safeguards: The EU ETS's broad company-wide scope introduces risks for sister ships, particularly when technical managers assume the role of the "Shipping Company." Non-compliance can be stipulated as grounds for agreement termination, fostering accountability throughout the charter chain.

Anticipating Evasive Strategies

The EU foresees potential evasive actions, such as calls to non-EU ports and relocations of transshipment activities. These maneuvers, while detrimental to environmental goals, may be driven by attempts to circumvent regulations. In response, the EU proposes a strategic deterrent—a 300 nautical mile limit from a Member State's port. This measure aims to discourage evasive behaviors and uphold the environmental integrity of the EU ETS.

Conclusion

In conclusion, while the expansion of EU ETS regulations to encompass the maritime sector introduces complexities and uncertainties, it also underscores the imperative for responsible practices within the industry. By shedding light on the key stakeholders, obligations, and compliance procedures, this article aims to provide clarity amidst this evolving landscape. As Maritime Companies navigate these regulatory changes, they must remain vigilant in their efforts to mitigate emissions and adhere to EU ETS requirements, thereby contributing to a sustainable and environmentally responsible future for the maritime sector and beyond.