August 2, 2023

What Does EU ETS Mean For The Shipping Industry?

With careful planning and the right tools, the European Union Emissions Trading System (EU ETS) presents an opportunity to improve environmental outcomes and increase competitive positioning for proactive shipowners.

By placing carbon emissions on the balance sheets of all shipping companies that voyage to and from ports within the European Union, the EU ETS incentivizes owners and charterers to improve efficiency and reduce greenhouse gas emissions (GHG). As the expected launch date approaches, gathering the right information and preparing the best strategy will be pivotal to success.

In this article, we unpack the EU ETS and explain how data-driven technology can de-risk and reduce the cost of complying with the world’s largest and most impactful maritime cap-and-trade system to date.

What is EU ETS?

Launched in 2005 as part of the EU climate policy, the EU ETS began as a ‘cap and trade’ accounting mechanism for placing carbon levies on the European industrial sector. Historically, shipping and the aviation industry were excluded, but as the climate emergency has intensified, so too has a European determination for action and the industry’s exemption has ended. If the emissions intensity of shipping activities grows as projected, it would undermine the objectives of the Paris Agreement, a global framework to avoid dangerous climate change by limiting global warming to well below 2°C and pursuing efforts to limit it to 1.5°C.

EU ETS builds on the Monitoring, Reporting, and Verification (MRV) system, which came into force by the European Commission in 2018. These measures form part of the EU’s ‘Fit for 55’ package, which provides a regulatory pathway towards a 55% reduction in carbon emissions by 2030. Within the environmental policy, the commission made several proposals to address the climate impact of maritime transport, including: 

  • Extending the EU Emissions Trading System to maritime transport, thereby creating a carbon price signal
  • Accelerate the demand for renewable and low-carbon fuels in a move away from fossil fuels by setting a maximum limit on the GHG content of energy used by ships calling at European ports
  • Improving alternative fuel infrastructures which would set mandatory targets for shore-side electricity supply
  • Advance the supply of renewables in Europe through a revision of the Renewable Energy Directive (RED)
  • Revising the existing Energy Taxation Directive (ETD) which aims to align the taxation of energy products with the EU’s climate objectives and remove outdated exemptions, such as those for the intra-EU maritime transport sector

Scheduled for the 1st January 2024, the EU ETS will apply to all vessels of 5,000 GT or greater, engaged on voyages to or from ports within the European Union. Vessel owners will need to pay, or “surrender”, one carbon credit (called an ‘EU Allowance’ or ‘EUA’) from a dedicated carbon account for each tonne of in-scope carbon dioxide (CO2) emitted.

The EU plans to auction 78.4 million carbon credits from the European carbon market to the shipping industry, generating nearly EUR 8 billion (US$9 billion) in the first year. These proceeds will be invested in European fleet renewal programs and distributed among member states to support national transport EU emission reduction schemes. In preparation, some carriers have already announced ETS surcharges, while others might favor absorbing the cost in exchange for market share and competitiveness.

Ship owners expect to submit their first annual emissions reports by 30th September 2025, but the cost ratio applied will increase incrementally over the first three years. During this adjustment phase, owners will be charged the equivalent of 40% of verified emissions reported for 2024, 70% for 2025, and 100% from 2026 onwards. 

Owners will be entitled to buy and sell unused credits on the open market, which could represent an additional revenue stream for fleets capable of trading excess emission allowances. Presently, the market price for each credit is at about EUR 100 (US$112).

How can shipowners reduce their exposure to EU ETS?

It is clear that when in force, the EU ETS will result in higher costs on EU routes. Owners looking to minimize their exposure should consider two initial courses of action:

  1. Putting in place an emissions data collection and analysis system that satisfies emission reporting requirements and, ideally, highlights opportunities to reduce in-scope carbon emissions.
  2. Careful preparation of contract architecture to allocate and handle EU ETS charges fairly across charter parties.Collecting and analyzing accurate EU ETS emissions data will become increasingly important. EUA prices are likely to increase in line with demand. In fact, the price has already increased by over 900% since 2018. Without a coherent plan for reducing in-scope emissions, per-tonne costs could impact Time Charter Equivalent (TCE) earnings significantly. This is most obvious in depressed freight rate environments. But even with stronger cargo demand, balancing the speed-consumption ratio to account for the bunker price and the carbon price will become critical to profitability.

As for contract architecture, shipowners will ultimately be responsible for EU ETS payments, but in cases where the owner is not responsible for the emissions of the ship, they may claim back those costs from the charterer. 

BIMCO has already prepared a standard clause to assist with the EU ETS process. While this might sound straightforward, charter parties will need a single point of truth to avoid costly disputes about EU ETS liability. This source will need to be trusted by the shipowner, charterer, financier, and charging authority and its transparency will be key to aligning stakeholders on EU ETS overhead calculations. Getting this right will reduce contract management costs, but with the right tools in place, the same source data could also be used to minimize in-scope carbon emissions. 

While energy-saving devices (ESDs) and alternative fuel technologies represent costlier long-term solutions, digital twin technology can provide a ready method of combining transparent data analysis with many additional benefits. In short, digital twins can calculate real-world emissions data, provide a single data window for charter parties, and simulate voyage profiles to plan optimal voyages and minimize exposure to EU ETS costs.

What are cost-effective levers to reduce their carbon tax exposure and meet emissions reduction targets?

Digital twin technology applies machine learning to build highly accurate digital replicas of physical assets, including ships. By processing complex high-fidelity data sets, digital twins can mirror ship performance characteristics to an astonishing level of accuracy.

A digital twin can perform highly accurate emissions calculations by applying real-world data, including weather and sea conditions, cargo loading, shaft power, routing information, and other source data. These calculations can be used to simulate voyages before they are carried out and to understand a voyage’s carbon footprint.

This testing and iteration capability allows users to determine the optimal cost-reducing voyage profile. Digital twin-based platforms like Green Charter by Nautilus Labs provide unique insights and a powerful way of de-risking and reducing cost exposure on EU ETS in-scope routes.

Digital twins also make it possible to overhaul legacy charter party agreements with clauses that promote efficiency and better environmental and commercial outcomes. Gaining access to real-time performance reporting and optimization recommendations, charter parties no longer need to tolerate misaligned incentives. Shipowners and charterers gain access to performance benchmarks to collaboratively drive technical and operational performance. As we move to a time when stack emissions carry direct cost penalties, a more collaborative approach to efficiency becomes vital among charter parties.

Success beyond EU ETS compliance to help fight climate change and cut CO2 emissions

The EU emissions trading scheme represents a new era in European shipping. The initiative sets obvious intentions to reduce environmental harm from maritime industrial processes and transportation. The EU emissions trading system is accompanied by global regulations – such as CII (carbon intensity indicator) or EEXI (energy efficiency index) – as well main emissions reduction targets, hence it is crucial for shipping companies to reduce their total emissions.

This new situation requires a fresh approach to voyage performance and charter party contracts. Shipowners, charterers, and managers need confidence in their decision-making and reliable oversight of GHG emissions and their developing commercial impact. 

Decarbonization is no longer just a moral imperative but a commercial one too. Having an intelligent, technology-backed strategy for absorbing the EU ETS and other schemes, will be pivotal to minimizing cost exposure and remaining competitive in the years ahead. Now is the time for shipping companies to onboard their chosen solutions without delay.

Digital twin technology is readily available to make market-based emission reductions a success story for merchant shipping. But this technology can help with more than just compliance. It can find new efficiencies and this can save time, reduce bunker consumption, and minimize EU ETS cost exposure. The question will soon be: is it even possible to operate European routes competitively without the right supporting technology?

The European Union consists of 27 EU member states: Austria, Belgium, Bulgaria, Croatia, Cyprus, Czechia, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, and Sweden.

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