Implications of the EU’s Emissions Trading System, Fuel EU Maritime Regulation

Texas Lawyer

On Jan. 1, 2024, for the first time a large segment of commercial merchant vessels (cargo and certain passenger ships above 5,000 gross tons) will be subject to an emissions-cap-and-trade system. Implemented by the European Union, the Emissions Trading System (ETS), which has been in effect for many years, will now require each vessel trading exclusively within the Euro Zone to pay a tax to cover the CO2 emitted by the vessel. For vessels trading to and from the zone, each will be required to pay a tax covering 50% of such emissions. The tax will be phased in over time (40% of CO2 emissions in 2024; 70% in 2025; and 100% in 2026). In 2026, the ETS will extend to Methane and Nitrous Oxide emissions. As well, the EU has adopted a new Fuel EU Maritime regulation, which will gradually introduce lower GHG-emitting bunker fuel to power vessels with the goal of reducing GHG emissions in bunker fuels by 80% by 2050. The EU’s near-term goal is to reduce GHG emissions by 55% by 2030 from 1990 levels.

The mechanism to pay the tax is the EU Allowance (EUA), which are authorizations to emit a certain level of CO2 emissions administrated through a central online database known as the Union Registry run by the European Commission. EUAs are currently available for purchase to maritime stakeholders. The Registry is creating new Maritime Operator Holding Accounts. EUAs may be bought and sold on the market, and sellers may sell them across all regulated industries, including the power sector and aircraft operators. EUAs may be bought in the primary market through auctions on the European Energy Exchange (EEX). EUAs relating to merchant vessels may be surrendered starting in 2025 to compensate for emissions from the previous year. Emission reports are due by March 31 of the following year.

A fundamental question is: Who is responsible for reporting emissions and paying the attendant ETS tax? The EU says it is the “shipping company,” which it defines as “the shipowner or any other organization or person, such as the manager or bareboat charterer, that has assumed responsibility for the operation of the ship from the shipowner” and has agreed to assume the responsibilities for compliance with MARPOL Annex I, relating to vessel emissions. Yet, the ETS provides that if the responsibility for fuel purchases or vessel operations is assumed by an entity other than the “shipping company,” then the shipping company is entitled to reimbursement from that entity for costs arising from surrendering of allowances. So, the reporting and upfront payment obligations lie with the “shipping company.” In a time charter, the obligation to buy bunker fuel customarily falls upon the time charterer, and we would expect owners to demand that such charterers reimburse them for ETS EUA costs. Yet, whether and to what extent reimbursement happens remains to be seen.

The charter agreement between the parties governs the contractual relations between owner and charterer, and such charters rarely provide for the application of EU law. Nevertheless, new charter clauses coming into play in the marketplace look to transfer the ETS payment responsibility from the vessel owner to the time charterer. The owners’ rationale for shifting that responsibility is that the time charterer owns and is responsible for the fuel consumed aboard the vessel, the time charterer (usually through a voyage charterer) directs the vessel’s movement to or from the EU, and the ETS entitles the “shipping company” to reimbursement.  Time charterers’ view differs because it is the energy efficiency of the vessel’s propulsion system that determines how much CO2 is emitted into the atmosphere, and the law governing the charter provides for no such reimbursement. The ETS clause market standard is still in the works as these clauses are more fully negotiated in 2024 and beyond.

ETS and EU’s new bunker fuel requirements, coupled with the IMO’s Energy Efficiency Standards for new and existing ships and carbon intensity indicator regulations will increase vessel owners’ operational costs, which they will pass along in higher freight and hire rates to shippers and charterers, if not in ETS reimbursement costs. Time charterers buying bunker fuel for merchant ships will see their costs rise, both through higher bunker fuel costs and ETS taxes that they assume. The EU’s new bunker fuel requirements likely will spread globally as merchant vessels transiting in international commerce will need to adapt. Owners will face the quandary of which fuels to use in transiting worldwide and the physical constraints of how many kinds of fuels their vessels can carry. In this light, it seems more likely that they will acquiesce to meeting the most stringent demands imposed by the marketplace, which suggest that if the EU’s bunker regulations impose those requirements, they will eventually become the market standard. GHG emissions standards in the maritime supply-chain will drive up transportation costs and may create inflationary pressure. Certainly, the cost of transportation within, to and from the EU will rise, which will drive the cost of that bloc’s goods higher, especially as more stringent GHG standards drive older vessels out of the market in favor of newer, more-fuel efficient vessels. Whether higher freight/hire, bunker and ETS costs will alter voyage and trade patterns to or from the EU or create “carbon leakage” where production of goods starts shifting from the EU to other countries where standards are laxer will be closely scrutinized in the years ahead. With the EU’s maritime GHG programs coming online, big though gradual changes are in the offing for vessel owners and charterers. It will be interesting to see whether and how those changes extend beyond the EU.

"Implications of the EU’s Emissions Trading System, Fuel EU Maritime Regulation" by Keith Letourneau was published in Texas Lawyer on November 27, 2023.

Reprinted with permission from the November 27, 2023, edition of the Texas Lawyer © 2023 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited.