There is growing interest in expanding existing emission trading schemes to include international shipping in the EU, China, and Japan, among other countries. Although its application to shipping is still being debated, owners and charterers should begin to consider how they will cope with ETS once it is implemented as reported by Gard.
Tax on source of pollution
On a nation-state level, governments can impose taxes on the sources of pollution at the point of production or sale, e.g. on petrol, with the aim that the taxes generated will cover the cost of dealing with the resulting pollution and incentivise reduced consumption.
With such cooperation looking very unlikely in the near term, governments are now looking at imposing costs on emissions, rather than at the point of sale.
An emission trading scheme (ETS) is a tool that governments and regulators are expected to use increasingly often in the fight to reduce the pollution created by international shipping.
Of course, increasing the cost of pollution also creates an incentive to create less of it.
The price of the allowances will change over time to reflect the balance of supply and demand, and emitters then are incentivised to find the cheapest (ie. most efficient) ways to reduce emissions.
The EU Emission Trading Scheme
Launched in 2005, the EU’s ETS works as a “cap and trade” scheme were emitters of CO2 in certain sectors have to purchase allowances to cover their carbon emissions during the relevant trading period. The number of allowances at any one time is fixed, but they reduce each year so that emissions within the EU also fall.
How the scheme will be applied to shipping is still under discussion, but if current proposals are adopted, the key features will be:
- Application to all vessels over 5,000 GT trading within EU waters, irrespective of flag
- Start date 1 January 2024 (pushed back from 1 January 2023)
- Full implementation right away, with no phase-in (originally suggested phase-in until 2026)
- 100% of intra-EU voyage emissions to be covered by the scheme
- 50% of EU in-bound/out-bound voyage emissions will be covered, increasing to 100% from 2027
- The ‘shipping company’ (defined as owner, manager or bareboat charterer) will be responsible for surrendering the allowances
- The ETS will cover carbon dioxide, methane and nitrous oxide
- 30 April deadline for the surrender of allowances for the previous calendar year (ie. 30 April 2025 deadline for 2024 emissions)
- Non-compliance can lead to penalties and expulsion orders
Several parts of the scheme are still unclear, and questions have been raised about two particular areas relating to shipping. First, in the Special Rapporteur’s report of 24 January 2022, it says that where a ship is on charter and the owner is not responsible for purchasing fuel or making decisions about the vessel’s speed, cargo or route, then:
“… a binding clause should be included in such arrangements for the purpose of passing on the costs so that the entity that is ultimately responsible for the decisions affecting the CO2 emissions of the ship is held accountable for covering the compliance costs paid by the shipping company under this Directive.”
Private contractual arrangements
Whilst many vessel owners would support the motivation behind this, it is far from clear how EU law would impose such a clause in private contractual arrangements between parties that may not be based in EU states.
What happens if the charter party contains no such clause?
Might it result in some voyage-charterers being forced to pay for EU ETS allowances even though they did not supply the fuel?
The second area of discussion is how voyages into or out of the EU are to be determined, and if operators may seek to evade the full application of the EU ETS.
For example, if a vessel calls at an intermediate port just outside of the EU shortly after leaving EU waters, that may result in the outbound voyage being assessed as much shorter than one from/to the actual next load port.
Emission trading schemes and time charter parties
Operating vessels under an ETS is a completely new situation for vessel owners and time charterers, so the learning curve will be steep. The issues under each scheme may be different, but the following points are likely to be of general relevance, not just the EU scheme.
In the first instance, the practical steps needed to comply with ETS requirements are likely to fall on vessel owners. This will include
(i) registration with the scheme,
(ii) recording, documenting and submitting the vessel’s emissions data needed for compliance, and
(iii) opening an account to receive, hold and surrender the necessary allowances. It may be that some of these tasks can be handled by a third party, such as a vessel manager or broker.
How a vessel owner and charterer share the costs of complying with an ETS, i.e. purchasing the allowances, is more open to negotiation. The general view seems to be that as ETS costs will be directly linked to the fuel used by the vessel, as between an owner and a charterer, whoever is responsible for the cost of the fuel should also cover the cost of ETS compliance, e.g. buying allowances. This seems logical as the cost of ETS allowances could be seen as just part of the fuel cost and may in fact be included in bunker prices if bunker sellers decide to sell fuel and allowances together.
New BIMCO clause
BIMCO is in the process of drafting/finalising a clause for use in time charter parties, which is expected to be published soon.
The arrangement is likely to be that the charterer is responsible for purchasing allowances to cover the vessel’s actual emissions used in ETS areas while on hire.
Ideally, the clause published by BIMCO will be wide enough to apply to any scheme around the world and to cover any greenhouse gas that may be subject to a scheme, not just carbon.
One issue that some vessel owners may also wish to consider is if they want similar principles to apply for ETS allowances – e.g. to avoid allowances being transferred in arrears, and instead require the charterer to transfer enough allowances upfront to cover the bunker fuel to be used under the ETS, to be topped up as/when the vessel receives new fuel.
Voyage charter owners will need to build something into their freight/demurrage rates for ETS costs.
What to do now?
The applicability of the EU ETS to shipping is currently being debated, and the final terms may not be known for several months. Even so, when time charter parties are being finalised that will extend into 2023, 2024, and beyond, owners and charterers should consider how to cope with ETS concerns. The BIMCO ETS clause will be useful once it is published, but parties are free to come up with alternate solutions. For more information or advice, please contact your defence case handler.
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