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EU ETS explained: The EU’s green shipping initiative and its impact on Australian industry

11 June 2024

6 min read

#Transport, Shipping & Logistics

Published by:

Jonathon Parkin

EU ETS explained: The EU’s green shipping initiative and its impact on Australian industry

Since 1 January 2024, all ships travelling into EU waters are covered by the European Union Emissions Trading System (EU ETS). This extension has several immediate impacts on the Australian shipping industry, both in terms of ship owner’s compliance obligations and the cost to exporters.

In this article we look at what the implementation of Directive (EU) 2023/959 and Regulation (EU) 2023/957 means for Australian participants in European shipping markets.

What is the EU ETS?

EU ETS is the European Union’s (EU) greenhouse gas (GHG) offset initiative.

Under the EU ETS, the EU annually issues a fixed number of ‘EU allowances’ (EUAs) for particular economic or industry sectors. Entities operating in that sector must then purchase a sufficient number of EUAs to offset their annual EU ETS GHG emissions. In essence, EUAs are a licence to proportionality emit.

As part of EU ETS’s extension to the shipping industry, ship owners must report their emissions within a certain period (the reporting period) and then offset those emissions with an equivalent amount of EUAs by 30 September of the year following that reporting period.

EUAs must be surrendered to an ‘Administering Authority’. For EU companies, the designated authority is in the Member State in which they are registered and for non-EU companies, the authority is in the place where their ships have called most frequently in the previous four years.

Which ships does it apply to?

All ships to whom the EU ETS applies and who are travelling into EU waters will need to comply with the EU ETS. Incrementally, the EU ETS will apply to cargo, passenger and offshore ships of 5,000 gross tonnage and above, as well as offshore and other general cargo ships with a gross tonnage between 400-5,000.

How does it apply to the shipping industry?

Importantly, the percentage of emissions which are subject to the EU ETS regime is flag neutral and route dependent:

  • 50 per cent of emissions when a ship departs from a port of call in the EU bound for a port of call outside the EU
  • 50 per cent for the reverse of the above scenario
  • 100 per cent of emissions from ships performing voyages within the EU
  • 100 per cent of emissions from ships when they are docked within a port of call in the EU.

However, shipping operators will not be required to offset all such emissions immediately. Instead, the application of the EU ETS to the shipping industry will be incremental, with the transitional rates being:

  • 40 per cent of reported emissions for 2024
  • 70 per cent of reported emission for 2025
  • 100 per cent of reported emissions for 2026 and beyond.

In demonstrating the EU ETS’s transitional application, it is useful to consider the following example.

In 2024, a ship subject to the EU ETS regime departs from the port in Newcastle, Australia, for Rotterdam in the Netherlands. During its voyage it emits approximately 8,000 tonnes of carbon dioxide. Since the ship is travelling from a non-EU port to a port within the EU, half of its emissions (4,000 tonnes) will be subject to the EU ETS regime. As the year is 2024, the ship owners must set-off (with EUAs) 40 per cent of those emissions. This equates to an offset amount of 1,600 tonnes of carbon dioxide.

What are the consequences for non-compliance?

The EU ETS system is compulsory for all ships falling within its ambit. As such, non-compliant ships face a number of serious penalties, including:

  • a EUR 100 fine per metric tonne of emissions – the non-compliant ship travelling in the Newcastle to Rotterdam example above would be subject to a EUR 160,000 penalty. Importantly, such fines are in addition to and do not extinguish liability to surrender EUAs
  • expulsion orders denying non-EU registered ships entry to EU ports
  • detention of EU registered ships until the fulfilment of surrendering obligations.

The EU ETS also employs an innovative mechanism to deter the evasion of obligations under the EU ETS, whereby certain ports within a 300 nautical mile limit of the EU are excluded from the definition of ‘port of call’. As EU Directive (EU) 2023/959 notes on the need for such measures:

“Evasive port calls to ports outside of the Union and relocation of transhipment activities to ports outside of the Union will not only diminish the environmental benefits of internalising the cost of emissions from maritime transport activities but can also lead to additional emissions due to the extra distance travelled to evade [such requirements]”.

Importantly, this mechanism only applies to container ships and doesn’t apply to stops for the purposes of refuelling, obtaining supplies, relieving the crew (apart from offshore ships), going into dry-dock or making repairs, distress calls, taking shelter from weather, search and rescue activities and ship to ship transfers outside of port.

Who must pay?

By default, the ship owner is responsible for ensuring compliance with EU ETS obligations and surrendering EUAs.

However, given that the EU operates under the ‘polluter pays principle’, which recognises that the person causing environmental harm is the person who should bear its cost, it may be possible for ship owners to recover the cost of their offsetting obligations under the EU ETS from operators and charterers. As the European Commission notes:

“In case the responsibility for the purchase of the fuel and/or the operation of the ship is assumed by an entity other than the shipping company pursuant to a contractual arrangement, the shipping company is entitled to reimbursement from that entity for the costs arising from the surrendering of allowances…”.

Therefore, a sensible way for ship owners to control the allocation of EU ETS compliance expenses is through their contractual arrangements with the ship charterer or ISM-company. Where costs are re-allocated, parties must sign a ‘mandate letter’, a pro-forma of which has recently been released by BIMCO . It is important to remember that even where costs are re-allocated, the ship owner remains responsible for surrendering EUAs.

It is also expected that shipping companies will recover their compliance costs directly from customers. Indeed, Maersk has announced that it will pass on costs in the form of an ‘Emissions Surcharge’ which will be applied to all bookings on a voyage that is subject to the EU ETS (see here for Maersk’s current surcharge rate).

How can I buy EUAs?

The EU ETS system operates on a ‘cap and trade’ basis, allowing EUAs to be bought on primary, secondary and futures markets.

On the primary market, EUAs can be bought for a fixed price at auctions arranged by the European Energy Exchange, whereas on the secondary and futures markets EUAs are traded by EUA owners who are in an excess or deficit of EUAs.

Companies who deal in EUAs in Australia should be wary that where they facilitate EUAs trades on behalf others (e.g., on behalf of owners or charters), they may be required to obtain or apply for an exemption from holding an Australian Financial Services Licence (AFSL).

If you would like assistance with understanding your compliance obligations under the EU ETS or need help in allocating your compliance expenses, please contact Geoff Farnsworth or Nathan Cecil from our Transport, Shipping & Logistics team.

The information in this article is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.

Published by:

Jonathon Parkin

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