The shipping industry will sail into the uncharted waters of the EU Emission Trading System in 2024. Kasia Klaczynska Lewis shares what the carbon pricing mechanism might look like and the impact for shipping companies, reports EY.
EU Emission Trading System
In 2024, maritime activities will be included in the EU Emission Trading System, or ETS, which will effectively mean that shipping companies will need to pay for at least a portion of greenhouse gas emissions generated during voyages to and from the EU. In addition to the underlying costs related to effective compliance with the EU ETS, new policies and procedures may need to be implemented and a dedicated carbon management function may need to be set up.
If the shipping industry were a country, it would be the world’s sixth-largest GHG emitter. However, when it comes to existing domestic, national, and subnational carbon pricing regimes, very few address emissions from maritime operations. Where emissions are addressed, it’s in connection with inland voyages. Domestic compliance carbon markets are unlikely to mirror the EU ETS and require maritime operations to bear the associated cost of emissions.
Instead, carbon pricing for the maritime industry is set to be regulated at a global level under the framework being developed by the International Maritime Organization (IMO).
Predicting Carbon Pricing Measures
In July, during the 80th session of the Marine Environment Protection Committee (MEPC), the IMO confirmed its intention to implement global carbon pricing for the shipping industry. The policy is expected to be finalized in spring 2024, adopted in autumn 2025, and entered into force in 2027.
Several countries, market participants, and international organizations have developed and submitted policy proposals to the IMO. Proposals range from a global shipping cap-and-trade system (advocated by Norway) to a carbon tax-like mechanism proposed by three different interest groups (Japan, Marshall Islands, and the Solomon Islands, and the International Chamber of Shipping). All these proposals involve part of the funding going directly toward rewarding low or zero-emissions ships and voyages. There are significant differences in the level of detail between the proposals, the design and complexity of the schemes, and the suggested (if any) amount of the levy.
The IMO can implement one or a combination of these measures, or formulate a different design that might not even involve emissions trading or a carbon tax, such as mandatory energy efficiency standards enforced by tradeable certificates, as proposed by the US.
Aviation’s Head Start
When considering what the maritime industry might do, it’s worth looking again at the aviation industry. A global carbon pricing regime has existed for the aviation sector since 2016, namely the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). From 2027, participation in the scheme will become mandatory for flights, with very few exceptions.
This system does not put a price on carbon per se, but instead requires airlines to offset their emissions through the purchase of credits. One credit represents one tonne of reduced or removed carbon dioxide or other greenhouse gas equivalent, and the underlying activity can take place outside of the aviation value chain.
CORSIA maintains a list of the types of credits, that it will recognize per compliance period about their issuing body, which can be either a public or private entity, for example, a national government such as China’s GHG Voluntary Emission Reduction Program, or a private standard, such as Gold Standard and Verra. As long as credits are considered eligible, the price at which they were acquired is not relevant. This provides regulated entities with a significant level of control over the ultimate compliance costs, but in parallel, compels them to enter and operate in a new marketplace dedicated to carbon offsets.
Unlike the EU ETS, this market has a global reach with little or no regulatory oversight. However, this is expected to change. On the one hand, countries are starting to make policy interventions, and on the other hand, there is the emergence of a global carbon market framework under the Paris Agreement. It remains to be seen whether the IMO will follow the lead of CORSIA and include offsetting in its carbon pricing design.
How Much is at Stake
The three carbon pricing design options outlined above—cap-and-trade, tax, and offsetting—can lead to vastly different levels of financial exposure. If the IMO opts for a carbon tax or levy, levels can be set as desired, and some proposals are reaching new heights ($637 per tonne by 2040 in Japan). For emissions trading schemes, authorities have some influence over the price and can introduce corrective measures, for example with price floors and ceilings. However, the price is in essence determined by the marketplace, and as of September 2023, the EU ETS price is approximately $90. In voluntary carbon markets, the cost of an offset is the result of its attributes, including geography where the project was developed, type of technology, standard that issued the offset, etc.
In a recent report, the World Bank indicated that carbon pricing in international shipping could rise between $1 trillion and $3.7 trillion by 2050 and that these revenues should support shipping decarbonization, enhancing maritime transport infrastructure and broader climate aims.
Regardless of the route chosen by the IMO, shipping companies need to understand the role of carbon markets; in particular, the role they can play in reducing the emissions footprint of voyages, especially as “companies want to buy decarbonized shipping now.
Trading in carbon offsets requires careful consideration and understanding of their complex legal, tax, and accounting nature, how policy trends impact their monetary value, public perception of offsets, and the potential related mandatory and voluntary claims.
A Starting Point
Addressing new EU ETS compliance obligations may fall to tax, legal, finance, or other functions, or a combination. It’s important to develop a good understanding of the market forces—the EUA price triggers—to decide on purchase strategies (spot, futures, options) and whether to hedge the carbon price risk. These teams will also have to decide which price forecasts ring true in the short, mid, and long term, considering that currently, the EUAs don’t have an expiration date.
A recent stress test study by the European Central Bank concluded that by 2030, a carbon price of $300 (compared to the present circa $100) was needed to ensure global warming is limited to 1.5 degrees Celsius.
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