Maritime Transport and The European Union - Emissions Trading System EU ETS

Background and Overview of the ETS

Members whose vessels are trading to the EU will be aware that the requirements of the European Union Emissions Trading System [EU ETS] will apply to maritime transport from 1st January 2024. The imminent arrival of this regime in the maritime sector has given rise to a many questions, particularly concerning practical aspects of the scheme, which this article will seek to address.

The EU ETS, which was established in 2005, is the EU’s principal tool to mitigate the effects of climate change. It reflects the fact that significant financial resources are required to achieve the goals, initially of the 1997 Kyoto Protocol, and subsequently the Paris Agreement on climate change.  In order to generate the necessary resources, the EU ETS imposes a financial cost upon the greenhouse gas (GHG) emissions of entities operating in the European Union. Further, the EU ETS has the objective of reducing EU economy-wide GHG emissions to enable the EU to meet its commitments under its “Fit for 55” package. That involves reducing EU GHG emissions by at least 55% compared to 1990 levels by 2030. 

The EU ETS is referred to as a “cap and trade” system. Each year a limit or cap is set on the number of emission allowances. These allowances (EUA) are financial instruments that can be bought and traded. Each EUA confers the right to emit one tonne of CO2, or the equivalent amount of other GHGs, such as Nitrous Oxide, Methane or Perfluorocarbons (PFCs). The cap decreases each year to ensure that total emissions reduce. To provide some context, the total supply of allowances for 2022 was around 1.46 billion MtCO2e. This represented a decrease of a 103MtCO2e compared to 2021. The system operates on the “polluter pays” principle, and entities are therefore required to monitor, report and verify their annual emissions, and then surrender sufficient allowances to cover those emissions. The cost associated with this and the progressive reduction in the annual allowance cap provide the incentive for emissions to be reduced. To accommodate the extension of the EU ETS to maritime transport, an additional 80m allowances are to be introduced.

The revenues generated by the EU ETS should be used for climate and energy related purposes. States are required to report their usage and the European Commission has reported that during Phase 3 of the EU ETS (2013-2020) approximately 75% of all ETS EU revenues were spent on “climate action”. Revenue from EUAs also supports two funds – the Innovation and Modernisation Funds. The former supports the development of innovative low carbon technologies and is funded principally from the revenues of 450m allowances auctioned between 2020 and 2030. The Innovation Fund also has a focus on the decarbonisation of the maritime sector. The Modernisation Fund supports 10 lower income member states in modernising their energy sector and improving energy efficiency.

The Application of the EU ETS to Shipping

New rules came into force on 5th June 2023 which extended the EU ETS to encompass maritime transport emissions from the beginning of 2024. From that time, the ETS will apply initially to cargo and passenger ships of 5,000 GT or more making port calls in the territory of the European Union. The geographical scope of the EU ETS includes all 27 EU Member States, plus Norway, Iceland and Liechtenstein, albeit the latter has no relevance for shipping. Offshore ships are not initially included but it is intended to extend the scheme to such ships from 1st January 2027. There are also certain exemptions for ferries. In due course it expected that the system will be extended to include smaller vessels.

Monitoring Reporting Verifying Emissions (MRV)

Detailed review of the MRV requirements it outside the scope of this article. Members with vessels trading to the European Economic Area should already have established plans to monitor emissions. 

These plans need to be updated, assessed by accredited verifiers – typically classification societies undertake this role – and then submitted to Administering Authorities by 1st April 2024. The need for the plans to be updated is because of revisions to the MRV regulations to include methane and nitrous oxide emissions. The updated plans need to follow revised templates that will be published by the European Commission by the end of 2023. Further information on MRV requirements can be found in the following link:

Reducing GHG emissions - MRV Regulation Changes - EMSA - European Maritime Safety Agency (europa.eu)

Emissions Falling Within the Scope of the EU ETS

The EU ETS will encompass the following emissions:

• 100% of emissions from voyages starting and ending at EU ports
• 100% of emissions whilst at berth in EU ports
• 50% of emissions from voyages which start or end at EU ports with a destination or starting point outside the EU.
   

From 1st January 2024, only CO2 emissions will fall within the scope of the EU ETS. However, methane and nitrous oxide will be included from 2026.

Evasion of the EU ETS requirements is a point of concern for the Commission, particularly evasive calls to ports outside the EU, and the relocation of transhipment activities to ports outside the EU. To address that risk there is an exclusion from the definition of a port call for stops at ports outside the EU where that port is within 300 nautical miles from a port under the jurisdiction of an EU Member State. Container ships stopping in transhipment ports outside the EU/EEA but less than 300 nm from an EU/EEA port, need to include 50% of the emissions for the voyage to that port as well, rather than only the short leg from the transhipment port. The EU will be publishing a list of  transhipments ports since such ports are those where the transhipment of containers accounts for most container traffic.

Administering Authorities

Each shipping company will be connected to the administering authority of one EU Member State. The European Commission will publish a list by 1st February 2024 of the companies and the respective Member States undertaking the EU ETS administration. In accordance with the Rules in the relevant Directive:

• In the case of a shipping company registered in an EU Member State, that State will undertake the administration.
• Where a shipping company is not registered in an EU Member State, the administration will be undertaken by the State with the greatest number of port calls by the vessels of that company over the last four monitoring years.
• For a shipping company whose vessels have not called at a port in an EU Member State in the previous four years, the administration will be undertaken in the EU Member State where a ship has arrived or started its first voyage within the scope of the EU ETS Directive.

Opening an Account in the Union Registry

The rules of the Union Registry are being revised to reflect the extension of the EU ETS to maritime transport, and to create new Maritime Operator Holding Accounts. Shipping companies need to open such accounts in the EU Member State of the companies’ Administering Authority. The following link provides more information about the Union Registry:

Union Registry - European Commission (europa.eu)

The price of EU Allowances varies according to market conditions. At the time of writing 1 EUA, which is equivalent to 1 MtCO2e, was valued at approximately €69. 

EUA Futures Pricing (ice.com)

Monitoring Reporting and Surrendering Allowances

From 1st January 2024, shipping companies should monitor their emissions in accordance with the revised monitoring plan that has been verified by accredited verifiers and approved by the administering authority.

Once a year companies must submit a report for each of the ships under their responsibility, as well as a report at company level which aggregates the emissions data for the purposes of the EU ETS. These reports must be verified by an accredited verifier by 31 March of the following year (or by 28 February if so requested by the responsible administering authority).

The EU ETS has adopted a phased approach for maritime transport and shipping companies only have to surrender allowances for a proportion of their emission in the initial phase-in period as follows: 

• 2025: for 40% of their emissions reported in 2024;
• 2026: for 70% of their emissions reported in 2025;
• 2027 onwards: for 100% of their reported emissions.
   

The required quantity of allowances must be surrendered by 30th September of the year in which the report submitted. That transaction should be completed through the shipowner’s Union Registry account.

Buying Allowances

Emission allowances (EUAs) can be purchased in the primary market either through periodic auctions or on the European Energy Exchange (EEX). See the links below for further information:

Auctioning - European Commission (europa.eu)

European Energy Exchange AG (EEX)

There is also a secondary market in which allowances can be sold bilaterally, or through various derivatives provided by financial institutions.

EUAs issued after 2013 do not expire and can be banked for future years. However, once an allowance has been surrendered it cannot be recovered.

Change of Vessel Ownership

The shipping company is responsible for surrendering allowance to cover the emissions of vessels during the time they were under the company’s responsibility. Consequently, if there is a change of ownership mid-year from Company A to Company B, it will be the responsibility of Company A to surrender allowances to cover the emissions of the vessel between 1st January of the year of sale and the date ownership was transferred.

Penalties for Non-Compliance

If the required number of allowances are not surrendered in due time a penalty of €100 for each missing allowance can be imposed. This is in addition to the cost of each missing allowance. Non-compliant companies will be publicly identified.
In cases where a company has failed to comply with the surrendering obligations for two or more consecutive reporting periods, and where other enforcement measures have failed to ensure compliance, the competent authority of the EU Member State of the port of entry, after giving an opportunity to the company concerned to submit its observations, may issue an expulsion order. Companies that fail to comply for two or more consecutive periods may be denied entry in the EU for all ships under its responsibility.

Further information can be found at the following frequently asked questions page of the European Commission’s website:

FAQ – Maritime transport in EU Emissions Trading System (ETS) - European Commission (europa.eu)

Alternatively, please contact either the Managers’ Loss Prevention Department or your usual Club contact for any further information that may be required.