What is the EU ETS and how is it changing?

The EU Emissions Trading Scheme (“EU ETS”) is a legislative scheme by which the EU caps emissions of greenhouse gases from certain industries by requiring emitters to surrender emission allowances to offset the gases they emit. A limited number of emitters are granted some free emission allowances, but most allowances must be purchased in auctions arranged by the European Energy Exchange (the “EEX”), which allowances may then be traded, before being surrendered to a competent authority by the emitters. Hence, the EU ETS is a “cap and trade” emissions scheme.

Change is underway to include certain emissions from shipping within the EU ETS, by phasing in requirements to report emissions and to purchase and surrender allowances for increasing proportions of carbon dioxide (CO2), nitrous oxides (N2O) and methane (CH4) emissions from shipping activity within the EU, between now and 2026.

How will the changes affect shipping companies?

Shipping companies have been required since 2018 to report certain carbon dioxide (CO2) emissions from voyages of cargo and passenger vessels over 5000 GT between ports within the EU, as well as emissions while in EU ports, and from voyages into or out of the EU.

As of the beginning of 2024 shipping companies will likely also have to purchase and surrender emissions allowances covering 40% of their intra-EU voyage and EU port CO2 emissions in that year, and covering 20% of emissions on voyages into or out of the EU. The percentage of CO2 emissions for which allowances need to be surrendered will increase gradually over 2024-2026 to 100% for intra-EU voyage emissions and 50% for voyages into or out of the EU, subject to certain exceptions. The obligations to report emissions and to surrender corresponding allowances will also expand gradually over 2024-2026 to cover emissions of nitrous oxides (N2O) and methane (CH4).  The requirements to report and to surrender allowances will also be extended to vessels servicing offshore installations over 2024-2026.

What’s the status of the EU legislation implementing these changes?

There is no final or consolidated piece of draft legislation yet. The EU Parliament and EU Council reached a provisional agreement on 18 December 2022 on amending the existing EU legislation in this area: Directive 2003/87/EC (the “EU ETS Directive”), Decision (EU) 2015/1814 and Regulation (EU) 2015/757 (on monitoring, reporting and verification (the “MRV”). A draft of the provisional agreement to amend this legislation was published on 8 February 2023. The finalised revised legislative framework is expected formally to be adopted and published by the EU Parliament during the first quarter of 2023.

Who will be responsible for complying with the legislation, and who will enforce it?

The draft legislation makes the shipping company, being the owner, bareboat charterer or manager of a vessel, responsible for registering with an ‘administering authority’ and surrendering emissions allowances to a ‘competent authority’. The definition of the shipping company under the EU ETS Directive matches the definition of the responsible person under the ISM Code. Previous drafts of the revised EU ETS Directive had left the door open for charterers also to be held responsible for compliance. However, the latest draft legislation seems to make it clear that the shipping company remains the ultimately responsible entity under both the EU ETS Directive and national laws implementing it, notwithstanding the existence of any contractual rights that shipping companies may have to be reimbursed by those, such as charterers, who purchase bunkers and direct their trading (see Article 3gaa of the draft amended EU ETS Directive).

The EU Commission intends to publish a list of shipping companies subject to the EU ETS Directive, specifying which administering authority they need to register with. This will likely be the authority of the Member State in which they are domiciled or, if domiciled outside the EU, the Member State their vessels visit most frequently. Enforcement of obligations to report under the MRV and to surrender allowances under the EU ETS will also be via Member States: draft amendments to the legislation permit Member States to impose fines, and to expel all the vessels of shipping companies which fail to comply for two or more consecutive years from all EU ports other than those of the vessel’s flag state.

Where will the funds raised from the sale of credits and penalties go?

Revenues from the EU ETS will be split between the EU Innovation Fund, which has the aim of investing in innovative low-carbon technologies and contributing to greenhouse gas reduction, and Member States. Member States will be obliged to use their share of revenue for activities designated in the EU ETS Directive, including sustainable transition to a low-carbon economy such as investment in developing energy-efficient maritime transport.