Decarbonization needs in Maritime Transport driven by the European Union Emission Trading System (EU ETS)

Introduction to the EU ETS in maritime sector

The EU's approval of Net-Zero goals to be achieved by 2050 underscores its firm commitment to combating climate change. These goals target emissions across a wide spectrum of sectors, including energy, transportation, industry, agriculture, buildings, and waste management. At the heart of this endeavour lies the EU Emissions Trading System (EU ETS), a pivotal instrument designed to facilitate the transition to a carbon-neutral economy. Operating within the EU ETS framework, a cap is imposed on the total greenhouse gas emissions permitted from sectors covered by the system. Participants in the EU ETS are required to hold emission allowances, which can be traded among them. The revenue generated through the allocation and trading of these allowances finances EU initiatives aimed at fostering a greener economy.

Furthermore, there has been a recent expansion of the scope to include the maritime industry. Currently, maritime transport accounts for approximately 3% to 4% of the EU’s total CO2 emissions, totalling over 124 million tonnes of CO2 as of 2021[1]. This represents a significant portion of emissions within the transportation sector. As a result, the Commission has taken action to address this by extending the EU ETS.

Starting from January 2024, all shipping companies will be required to purchase and surrender one EU Allowance (EUA) for each tonne of reported CO2 emissions. To facilitate a seamless transition, the EU Emissions Trading System (ETS) will initially apply to large cargo and passenger ships (5000+ gross tonnage), with a requirement for 40% coverage of CO2 emissions reported in 2024 before expanding to full coverage for emissions reported in 2026. Subsequently, other types of maritime transport and additional GHGs such as methane and nitrous oxide will be gradually included (see illustration below).

The regulation applies to 50% of emissions from voyages starting or ending outside of the EU and 100% of emissions that occur between two EU ports. To streamline the enforcement and prevent circumvention tactics, the regulation specifically excludes certain activities from port calls[2], including transshipments, bunkering, emergency stops, and maintenance. Furthermore, it extends its jurisdiction to cover non-EU ports located within 300 nautical miles from any designated EU port.

While the default responsibility of monitoring and reporting the emission would lie with the ship owners, an ISM company (often a bareboat charterer) can also assume the responsibility provided in case of a written agreement with the ship owner. The entity which assumes the responsibility of compliance is referred to as Shipping Company.

To be compliant with the EU ETS the following four steps to be considered:

What kind of challenges shipping companies may face?

The introduction of the EU Emissions Trading System (EU ETS) has brought significant economic uncertainties to the maritime industry, especially with fluctuating EUA prices influencing both operational and strategic decisions. This will not only incentivise decarbonisation efforts but may also cause a structural shift in logistics and supply chain patterns. Some of these challenges are:

• High economic risks for shipping operators facing high ETS payments

As per EY forecast, the EUA prices are expected to rise steadily. Shipping companies, therefore, may face a substantial financial burden in future given no change in status quo. Moreover, shipping companies may face penalty for non-compliance of approximately €129[3] for each tonne of CO2 emitted for which allowance has not been surrendered. Until more affordable and environmentally friendly alternatives become available, the rising costs associated with CO2 compliance may either be transferred to consumers, leading to higher prices for goods and services, or absorbed by companies, resulting in reduced profit margins. This could potentially impact energy prices significantly, particularly considering that a large portion of LNG and crude oil in the EU is imported via sea routes.

• Procurement of EUAs

Managing the procurement of EUAs involves a special challenge given the recent fluctuations in EUA prices. To effectively manage the EUA price risk, companies would need to adopt a strategic approach that balances compliance needs with the fluctuating market prices. This entails determining the optimal strategy for acquiring EUAs, considering factors such as price, volume, timing of transactions, and other relevant issues. Companies would need to establish robust administrative systems to track fleet emissions, assess data quality, and allocate allowances or related costs accurately. Timely availability of data would be crucial, especially in voyage charter environments, to make informed decisions on EUA transactions. Forward trading would be a valuable tool to hedge against price changes, allowing companies to fix the price of EUAs for future delivery and mitigate risks associated with price fluctuations.

• Potential change in logistics and sea route patterns that may impact EU ports operations

The rise in shipping costs may trigger CO2 leakage, potentially prompting a shift from sea transport, now more costly under the ETS, to road or rail transport, currently exempt from similar regulations. This again will depend of course on a distance, however, it can still be relevant e.g., for Asia – EU connections. Alternatively, shipping routes may be redirected to non-EU ports, that are not subject to comparable costs. However, the likelihood of CO2 leakage hinges on the price of EUAs and the additional expenses associated with avoiding EU port calls. In this case an individual advising service to calculate the prices would need to be established.

• Fast change in contractual negotiations may be required

The ETS in a shipping industry will influence contractual renegotiations (e.g., leasing) within the industry. For instance, charterparties may need to include specific clauses that address the allocation of responsibilities and costs related to the emission allowances. This includes clarity on who should bear the costs of compliance and how these costs are managed between shipowners and charterers. Additionally, the practicalities of transferring allowances in cases of vessel sales or charter changes partway through a year are complex and require careful contractual planning. These changes can pose significant challenges, especially considering that contracts are typically structured for the long term and may entail penalties for unforeseen adjustments.

• Decarbonise needs in a short term with a high pressure from EU ETS

Shipping companies should explore avenues for decarbonisation with important levers being fleet transition, vessel retrofitting, fuel switching, and technology upgrades (described briefly below).

Decarbonisation levers in shipping:

For example, MSC has introduced the MSC Biofuel Solution which delivers CO2 savings by replacing conventional fuels with a second-generation biocomponent derived from used cooking oil. Similarly, Maersk has ordered several ships capable of running on carbon-neutral methanol and continues to explore other green fuels like green ammonia as part of its strategy to lower GHGs. French shipping line CMA CGM has invested in LNG-powered vessels as part of their decarbonisation strategy.

This means that, shipping companies should continuously evaluate investments in decarbonisation against the EUA costs. Many decarbonisation measures currently entail high costs in the form of high upfront capex as well as higher operational costs. Ship downtime during retrofitting and upgrade would also have financial implications.

As a summary, the introduction of the EU ETS poses a multifaceted challenge for the maritime industry, encompassing economic, operational, and strategic dimensions. Companies are therefore increasingly considering taking expert advice to navigate these challenges.

What are the opportunities under the EU ETS regulations for shipping companies?

The extension of the EU ETS regulations to the shipping sector indeed presents a range of compliance and business challenges, but it also opens various opportunities for innovation and sustainability.

• Decarbonization as a core component of business strategy

The EU ETS introduces economic incentives for decarbonization, encouraging shipping companies to align their strategies with global sustainability objectives. This alignment can significantly enhance their appeal to eco-conscious clients and partners, potentially leading to innovative collaborations and business growth. For instance, MSC has launched the Carbon Neutral Programme in collaboration with South Pole. This initiative allows customers to offset the unavoidable emissions associated with the marine and inland transportation of their goods by investing in high-quality climate action projects.

• Fostering Collaboration and Innovation

In an evolving regulatory and business landscape, triggered by increasing demands for decarbonization, forging strategic partnerships to innovate and gain a competitive edge will be critical. For example, the Getting to Zero Coalition is an industry-led partnership of more than 200 organizations across the maritime, energy, and infrastructure sectors, aiming to produce commercially viable zero-emission vessels by 2030.

• Enhanced Reporting and Data Management

The stringent reporting requirements mandated by the EU ETS can serve as a catalyst for improving emissions tracking and data management systems. Enhanced data capabilities not only ensure compliance but also unlock valuable insights into operational efficiency, leading to significant cost reductions and performance optimization.

• Access to Green Financing

Demonstrating a strong commitment to sustainable practices can significantly enhance the attractiveness of shipping companies to a growing pool of investors and financiers who prioritize green projects. This becomes more critical as financial institutions increasingly place sustainability at the core of their lending and insurance coverage decisions. For example, 35 leading banks, representing significant proportion of global shipping finance, are signatories to the Poseidon Principles framework, which aims to integrate climate considerations into lending decisions to promote the decarbonization of international shipping.

Navigating the EU ETS – How to Overcome Hurdles and Leverage EU ETS to Your Advantage?

EY has been working on sustainability issues for over 30 years with a global network of professionals dedicated to ESG-related services. The firm has inhouse experts with specialized knowledge in various aspects of regulation impact assessment & compliance, sustainability, climate change, social responsibility, and governance. Therefore, our experts can navigate you in the EU ETS regulations and identify the best solutions for your business.

a.?????? Establish a compliance Management

• Navigating the complexities of the EU ETS requires a thorough understanding of regulatory frameworks and their impacts on maritime operations. EY can guide you through the dynamic landscape of environmental regulation, ensuring their operations remain compliant and competitive.
• We help you to establish and manage Monitoring, Reporting, and Verification (MRV) systems to ensure compliance with the EU regulations, offering continuous support in managing and submitting necessary documentation within compliance timelines.

b.?????? Contractual Review and evaluation of potential solutions

• In the regulated environment of the EU ETS, it is crucial to align contractual obligations with compliance and strategic objectives. EY can assess the obligations in chartering agreements to identify commercial and financial risks, ensuring alignment with client’s strategic goals and EU ETS compliance requirements.

c.?????? Identify Risks and create Mitigation measures

• Participating in ETS markets and managing related financial risks are integral to optimising the cost of compliance. EY can develop robust strategies to protect your operations from the volatility of carbon pricing and regulatory uncertainties.
• EY can support you in participation in CO2 markets, develop strategies to mitigate risks, and provide advice on effective hedging strategies to manage financial risks related to carbon trading.

d.?????? Sustainability Strategy – Fleet Decarbonization

• As regulations tighten and the push towards sustainability grows, effective fleet decarbonization strategies become critical for long-term success. EY can analyse client fleet and operations to identify key areas for emissions reduction, recommend technologies and practices that reduce fuel consumption and enhance energy efficiency, and assist in acquiring technologies and vehicles that meet operational needs and sustainability goals.
• Additionally, EY can help you to secure financing or incentives for fleet decarbonization projects and manage the implementation process to ensure compliance with sustainability targets and provide ongoing performance evaluations.

For any further questions and cooperation opportunities please contact:

Daniel Eisenhuth [email protected]

Viktoriia Betina [email protected]

#ey #EYCarbon #maritimedecarbonization #ESG #reporting #EUETS #sustainability #strategy #fleetdecarbonization #developingcountries #europeansupport #eupolic

Simon Fahrenholz Florian Huber Christian Hell Andrea Weinberger Bianca Schick Marie Catherine Dollhofer Carmen M. Sprus Matthias Brey Gregor Walscheid Frank Burkert, LL.M.

[1] European Commission - https://climate.ec.europa.eu/eu-action/transport/reducing-emissions-shipping-sector_en

[2] A port of call is the port where a ship stops to load or unload cargo, to embark or disembark passengers, or where an offshore ship stops to relieve the crew (European Commission)

[3] Penalty for base year 2012 is €100 which is adjusted for inflation using HICP index till 2023