What is the EU ETS update?
What are the main provisions of the updated EU ETS?
What are some of the main uncertainties related to the EU ETS's application to shipping?

What is the EU ETS update?

The EU emissions trading system (EU ETS) is a trading system for emissions allowances. All EU and European Economic Area (EEA) countries have been a part of the EU ETS since 2008. Under the "cap and trade" principle, a maximum cap is set on the total amount of greenhouse gases that can be emitted by participating installations and sectors. Allowances are allocated for free or are auctioned off and can subsequently be traded. Installations must monitor and report their greenhouse gas emissions, ensuring that they have sufficient allowances in hand to cover their emissions. If emissions exceed that permitted by its allowances, the relevant installation must purchase more allowances. Conversely, if an installation has allowances remaining at the end of the relevant trading period, it may auction off its leftover credits. The included installations and sectors therefore have a financial incentive – as well as a duty – to reduce their emissions.

As part of its Fit for 55 regulatory package, on 14 July 2021 the European Commission presented a proposal to include maritime emissions in the scheme. After extensive negotiations with the European Parliament and the European Council, an agreement was finally reached on 18 December 2022. Although the directive is yet to be formally approved and the press releases outlining the agreement are brief, the fact that emissions from shipping will be included in the EU ETS from 1 January 2024 has finally been confirmed.

What are the main provisions of the updated EU ETS?

The main duty imposed by the EU ETS with regard to shipping is that shipping companies must acquire and submit allowances for their carbon dioxide (CO2) emissions. The duty to submit allowances applies to all emissions on trips between EU and EEA ports (including emissions while ships are at berth), as well as 50% of the emissions from trips between the European Union or the EEA and third countries. If a company does not surrender enough allowances for the preceding year by 30 April in the following year, it will be penalised. One likely sanction is that the company will have to pay an excess emissions penalty of €100 per tonne of unaccounted emissions.

The EU ETS's application to shipping will follow a staggered approach. Shipping companies must submit allowances for 40% of their emissions for 2024, rising to 70% for 2025. The directive will apply fully from 2026. From 2026, shipping companies will also have to submit allowances for emissions of methane and nitrous oxide, in addition to CO2.

The directive will, at the outset, only apply to select groups of vessels over 5,000 gross tonnage. Offshore vessels over 5,000 gross tonnage will be included in from 2027; however, from 2025 shipowners are already obliged to monitor, report and verify the CO2 emissions of these vessels under the EU Monitoring, Reporting and Verification Regulation. Finally, in 2026, the European Union will review whether the scope of the EU ETS should be expanded to also include emissions from general cargo vessels and offshore vessels between 400 gross tonnage and 5,000 gross tonnage.

Allowances will mainly be auctioned off by member states, and can subsequently be traded between shipowners and other industry stakeholders in need of allowances. Revenues generated from the auctioning of 20 million allowances will be earmarked for projects related to decarbonisation and improving ships' energy efficiency.

Finally, the directive will be "revisited" in light of similar regulation from the International Maritime Organisation (IMO). Although the IMO's work has been considered slow and insufficient, there are indications that global regulation may be implemented. For instance, progressive debates regarding the adoption of a carbon levy were held at the December 2022 meeting of the Marine Environment Protection Committee, the sub-group tasked with adopting greenhouse gas reducing measures within the IMO.

What are some of the main uncertainties related to the EU ETS's application to shipping?

Because the final, authoritative text has not yet been published, several details remain unclear. It is uncertain:

  • how the share of international emissions will be calculated and ascertained;
  • if and how free allowances will be distributed; and
  • how the relevant stakeholders will practically acquire, trade and submit allowances.

There are also uncertainties on a more general level. For instance, the duty to submit allowances is placed on the "shipping company", defined as the entity that has "assumed the responsibility for the operation of the ship from the shipowner". This could be the shipowner, the manager or bareboat charterer – however, as this definition is identical to the definition used in the International Safety Management (ISM) Code, it is likely that the same company will be considered responsible. This means that the ship's management company, as the document of compliance-holder under the ISM Code, will likely be considered the "shipping company".

From a more legal perspective, it remains to be seen whether other countries or regions challenge the directive, particularly as it relates to taxing of emissions occurring outside EU territory. Several other countries, including Japan and the United Kingdom, have been considering establishing a similar emissions trading scheme for shipping. For the United Kingdom, this was only suggested for domestic emissions. However, in future, the question of whether the European Union has overstepped its judicial competence could become a contentious issue. This will depend on a multitude of factors, including the potential introduction of similar greenhouse gas reducing measures from the IMO.

For further information on this topic please contact Fredrik Roald Brun at Wikborg Rein by telephone (+47 22 82 75 00), fax (+47 22 82 75 01) or email ([email protected]).The Wikborg Rein website can be accessed at www.wr.no.