The past months, a wide range of developments have been carried out in the world of regulatory affairs within logistics, says a press release on their website.
To reduce emissions of greenhouse gases (GHG) from international shipping, the International Maritime Organization (IMO) and the European Union (EU) are considering mandatory measures to accelerate decarbonization.
Other jurisdictions are also exploring measures to a similar effect, but the EU measures are likely to be the first ones to enter into force.
Moreover, it should be noted that the EU measures carry a large degree of extra-territoriality potentially affecting cargo moving outside of the EU’s borders.
It has been nearly one year since the European Commission presented its proposal for a carbon price for shipping.
Below, we focus on this specific measure to provide a brief overview of the proposal, the process, and the implications foresee for their customers.
On 14 July 2021, the European Commission presented its Fit for 55 package.
As part of several legislative proposals, the Commission suggested including shipping in the EU Emissions Trading System (ETS).
Given that the proposal is still being negotiated, the description below is thus based on the Commission proposal.
Supply chain sustainability
The EU ETS works using a ‘cap-and-trade’ principle.
A cap (limit) is set on the total amount of greenhouse gas emissions that can be emitted by the factories, power plants, ships and other entities that are included.
Over time this cap is reduced, resulting in a gradual reduction of total emissions.
Within the cap, the different entities buy allowances which they can trade between themselves.
At the end of each year, all entities must hand in allowances equal to their emissions. In this, each allowance counts for one ton of CO2.
Price per allowance
Since both the greenhouse gas emissions allowed in the cap as well as the greenhouse gas emissions from the entities are not fixed numbers, the price per allowance is not fixed but fluctuates according to the market demand and supply of emission allowances.
In the European Commission’s ETS proposal, only CO2 emissions are covered.
As a market-based measure, the concept allows for an entity that reduces its emissions to keep spare allowances for future needs or sell these to others.
The intention is that the carbon price promotes and rewards investment in decarbonization technology.
Voyages play a key role for carbon pricing
For shipping, the concept of voyages plays a key role.
The Commission’s ETS proposal follows vessels and not cargo.
This means that it requires that shipping companies purchase allowances for:
– 50% of emissions from voyages departing from an EU port to a non-EU
– 50% of emissions from voyages departing from a non-EU port to an EU port
– 100% of emissions from voyages between EU ports and
– 100% of emissions from ships at berth in an EU port
Lower carbon cost
This, in turn, determines the number of allowances which the shipping company must hand in at the end of the year.
Note that the 50% figure for voyages between EU and non-EU ports means that these voyages will incur a lower carbon cost in ETS than a voyage between two EU ports.
Carbon pricing introduced for shipping
Historically, new sectors joining the ETS have benefited from a gradual inclusion through several free allowances in the first years.
The free allowances have unfortunately proven to be counter-productive and as such the European Commission has decided that shipping should not benefit from any.
However, the European Commission proposes a phase-in period where shipping companies are required to hand in allowances corresponding to a percentage of their emissions.
This phase-in means that shipping companies would be required to hand in allowances according to the schedule below:
– 20 % of verified emissions reported for 2023
– 45 % of verified emissions reported for 2024
– 70 % of verified emissions reported for 2025
– 100 % of verified emissions reported for 2026 and each year thereafter
The phase-in means that the carbon price per ton CO2 applied to shipping gradually increases until 2026.
A work in progress
Nearly one year after the European Commission presented its ETS proposal, the legislation is yet to be adopted.
The legislative process in the EU requires that the Council of the European Union (EU Member State government ministers) and the European Parliament (directly elected representatives) both agree on a joint legislative text.
This process requires that agreement is first reached internally within each of the two bodies.
Introduces significant changes
On 22 June 2022, the European Parliament adopted its version of the legislation.
In the text, the assembly introduces significant changes to the proposal of the European Commission.
Most notably for shipping, it suggests changes to voyages between EU and non-EU ports, where the percentage is increased to 100%.
This significantly increases the reach of the EU ETS beyond Europe.
The aim is to seek to reduce a higher number of GHG emissions, but it of course comes with a financial impact for shipping as compliance costs increase.
Furthermore, the version of the European Parliament abolishes the phase-in period, instead applying the ETS for 100% of emissions from 2024.
The position of Parliament also introduces the concept of a port at risk of carbon leakage, de facto applying the ETS carbon price to ports within 300 nautical miles with a transhipment share exceeding 60%.
This means that the cost of shipping could also increase for voyages to/from ports that meet these criteria, even if they are further outside the EU, in essence pushing the geographical spread of the last/first port before/after the EU.
Positively, the assembly proposes that carbon pricing for shipping is applied not only to CO2 emissions, but also to emissions of methane and nitrous oxide.
While this has little financial impact now, it would send an important signal to encourage the use of renewable fuels in the future.
Phase-in of allowance requirements
On 29 June 2022, the Council of the European Union adopted its version of the ETS legislation.
In its text, Council suggests retaining the Commission phase-in of allowance requirements, resulting in a gradual increase in the number of allowances needed and thereby the carbon price.
The Council position also includes the port at risk of carbon leakage-concept, like that of Parliament, and using the same parameters, thereby de facto extending the geographical spread of the last/first port before/after the EU.
The text agreed by EU Member States in Council also includes non-CO2 emissions (nitrous oxide, methane) for reporting from 2024 with the option to subsequently include these in the ETS carbon pricing. This addition would more accurately price the climate impact of future fuels.
With both European Parliament and the Council of the European Union both having adopted positions on the ETS proposal, the legislative process can enter the next phase.
During this phase, the two institutions, together with the European Commission, need to reach a compromise before the proposal becomes legislation.
Given the differing positions on elements such as the phase-in period, the percentage for voyages between EU and non-EU ports and when carbon pricing begins, as well as other non-logistics related issues these negotiations will take some time.
We expect that political agreement can be reached towards the end of 2022.
The cost of compliance with the ETS will likely be significant therefore impacting the cost of shipping.
It is expected that the volatility of the European Union Allowance (EUA) traded in ETS may increase, as the revised legislation comes into effect.
To ensure transparency, we plan to apply these costs as a standalone surcharge effective Q1 2023.
Based on the latest developments, below are estimates of cost increases (in EUR) per FFE for selected trades with the following considerations.
– Price of the European Union Allowance (EUA) to be around EUR 90
– Obligation to purchase allowances is considered 100% since the ETS proposal version of the European Parliament abolishes the phase-in period
– Emissions of CO2, Methane and Nitrous oxide proposed in the assembly
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