The EU ETS’ Impact on the Maritime Sector

THE EU ETS’S IMPACT ON THE MARITIME SECTOR

If the European Council votes to formally extend the EU ETS to shipping beginning from 2023, the maritime industry will get its first taste of what a low-carbon economy looks like.

Despite its status as a regional regulation, the EU ETS will have a significant impact on international and intra-EU shipping. It will initially raise costs for shipowners and will usher in a carbon market that could in part reshape vessel financing and operations.

While the long-term effects should be positive for the environment, the establishment of a maritime carbon market will create as many challenges as opportunities.

The EU ETS, which would apply to all ships of 5,000 gt or more, will put a price on carbon and lower the cap on emissions every year. Its goal is to align the EU ETS with the EU's ambition to reach a mandatory 55 percent reduction in net emissions by 2030, as part of the continent’s Fit for 55 package.

The EU ETS makes the party responsible for the operation of the ship under the International Safety Management (ISM) Code liable for its CO2 emissions. The scope of the EU ETS expansion includes 50 percent of emissions from vessels arriving at and departing from EU ports on international voyages.

Shipping is scheduled to be phased into the EU ETS from 2023, with a wider inclusion by 2025. During the first three years of operation, carbon will not be traded; the EU ETS will effectively be a tax on vessel emissions. The first year will require the owner to surrender allowances equivalent to 33.3 percent of verified emissions, increasing to 66.6 percent in the second year and 100 percent by 2025.

The penalties include fines levied against shipping companies and the blacklisting of vessels for non-compliance.

The initial proposed regulation drafts for EU ETS in maritime and FuelEU, along with their amendments during the public consultation phase, provide us a guideline for an initial impact assessment for some typical vessel types that are trading in Europe and are likely to be affected by these measures. The different vessel configurations with alternative fuels like liquefied natural gas (LNG) and methanol will have a different economic impact from such measures, which make the various business cases for energy transition to alternative and low-carbon fuels a viable solution in the mid- and long-term.

To understand the impact of the EU ETS, ABS modeled a representative kamsarmax bulk carrier, calculating the direct impact of carbon emissions, fuel carbon intensity and consumption for voyages in, out and within European ports under the phased adoption from 2023 to 2025.

For this vessel to use heavy fuel oil (HFO), the owner would be required to surrender allowances equivalent to €330k in 2023 through 2025. With no carbon trading taking place, the emissions are a straightforward calculation based on EU monitoring, reporting and verification (MRV) data, rather than a variable amount.

The clear challenge is that shipowners — especially operators of smaller fleets who are less able to implement energy efficiency measures, or to consolidate or pool emissions across a fleet — may find their operational costs increasing sharply.

For an operator of a very large crude carrier (VLCC) with a high Carbon Intensity Indicator (CII) performance using conventional fuel, owners could be called upon to surrender €340k by 2025, a similar level to that for a large LNG carrier, according to ABS analysis. The operator of a 14,000 twenty-foot equivalent unit (TEU) containership with a high CII performance could be liable for as much as €700k in allowances by the end of 2026.

COST COMPLICATIONS

The situation is further complicated by the closely related FuelEU Maritime proposal. Designed to accelerate the maritime industry's decarbonization through the adoption of renewable and low-carbon fuels and technologies, it will apply a goal-based reduction of GHG energy intensity from 2025.

A further complication is that FuelEU Maritime employs a well-to-wake or life-cycle assessment methodology to measure the carbon intensity of fuels from production to consumption, whereas the EU ETS employs the tank-towake measure currently used by the IMO.

Under FuelEU Maritime, the kamsarmax would incur penalties immediately if powered by methanol or HFO, but those would only start from 2035 if it was powered by dual fuel/LNG. If the VLCC was powered by dual fuel/LNG, it would start incurring penalties around 2035, while dual fuel/methanol and HFO fall into the deficit range. A similar performance is expected for the 14,000 TEU containership powered by dual fuel/LNG.

The fines under the FuelEU Maritime penalty scheme are derived from a GHG intensity limit that tightens over time and could represent significant additional capital costs; non-compliance with the requirements of FuelEU could add up to €1.5m in penalties by 2040. However, FuelEU Maritime allows for pooling of carbon intensity, meaning owners can average emissions across a fleet and hedge by borrowing intensity allowances from next year to compensate for shortages.

For the operators of larger fleets, every year they spend in surplus is an opportunity to offset their wider carbon footprint, pool efforts across their fleet or even consolidate operations with smaller owners, for whom the regulatory burden proves too onerous. Cash-rich owners already have made investments in renewable energy to provide similar revenue and offsetting opportunities.

Once the EU ETS becomes fully tradable, further opportunities will arise in financial markets and ship finance, as well as in the new carbon and hydrogen markets that will develop as regulation and market forces drive the decarbonized maritime economy.