The impacts of the inclusion of the maritime sector in the EU ETS

The enforcement of a regional Market-Based Measure (MBM) such as the EU ETS may provide financial incentives to shipping operators to reconfigure their networks and avoid voyages inside the European Economic Area (EEA).

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As informed, the paper investigates the risk of container vessels engaging in evasive port calls by replacing EEA transshipment hubs with nearby non-EEA competitors. A cost–benefit analysis calculated the cost of EU Allowances (EUAs) for several international services and compares it with a relocation scenario.

The case studies focus on the Piraeus–Izmir and the Algeciras–Tanger Med scenarios and identify the EU carbon price turning point that will render the switch of the transshipment hubs a cost-effective choice for the operator. The results show that the preference of a non-EEA hub will become attractive for carbon prices well below 25 EUR per metric ton of CO2.

Further, in all cases, the hub switch results in a rise in the overall carbon emissions attributed to the service which amplifies the risk of carbon leakage. The results show that the relocation would lead to revenue loss for the EU ETS and penalization of the EEA transshipment hubs in close proximity with hubs outside the EEA, thus posing a threat to their economic activity and development

Scope of the EU Emissions Trading System

On 14 July 2021, the European Commission (EC) proposed to extend the scope of the EU Emissions Trading System (ETS) to also include greenhouse gases (GHG) emissions from the maritime sector. The revision of the EU ETS is part of the ‘‘Fit for 55’’ package and aims to embrace the EU gal of reaching net-zero GHG emissions by 2050. Except for the inclusion of shipping in the EU ETS, the legislation includes the FuelEU Maritime Initiative, which sets GHG intensity targets and fuel standards for ships, the Energy Taxation Directive, that eliminates fuel tax exemptions within the sector and the Alternative Fuels Infrastructure Regulation, that aims to increase the availability of shore side electricity and Liquefied Natural Gas (LNG) in ports.

As a Market-Based Measure (MBM), the EU ETS aims to enforce the ‘‘polluter-pays principle’’ and, thus, provide monetary incentives to stakeholders to reduce their carbon footprint. The ETS builds on the ‘‘cap and trade’’ principle, where a cap on the total amount of GHGs is set and then split among the regulated entities in the form of EU Allowances (EUAs). The Directive does not yet define the method according to which EUAs will be distributed among the Member States (MS). Each company shall report their allowances through their registered MS and purchase their EUAs through auctioning based on their previous year’s carbon emissions and in compliance with the reduction targets of the EU ETS. Since the EU Monitoring, Reporting and Verification system (EU MRV) is effectively the foundation of accounting the EU emissions from ships, the extension of the EU ETS utilizes the key principles of the EU MRV establishing the shipping companies and the countries that they are registered to, as the regulated entities.

However, it remains to be seen how charter parties will be involved in the EU ETS regulatory framework. Since for time charter contracts it is the charterer who bears the cost of bunkering and thus the decision on the vessel’s service speed and the respective CO2 emissions, new clauses shall be introduced to protect the shipowner from excessive carbon charges due to the charterer’s non conformity with the scheme. According to the Directive, the obligation of surrendering emissions allowances will be phased starting from 20% in 2023 and reaching 100% in 2026. The inclusion of shipping will cover 100% of the CO2 emissions occurring while sailing between ports of the European Economic Area (EEA), 100% of the CO2 emissions at berth of an EEA port and 50% of the CO2 emissions from international voyages between an EEA and a non-EEA port.

At the end of each year, shipping companies should demonstrate a balance between allowances and verified emissions and in case of exceeding their purchased allowances, they will need to buy the excess amount from the carbon market. EUAs can be purchased through either the primary market i.e., auctions by the MS through the European Energy Exchange (EEX), or the secondary market by trading of the EUAs through the EEX. Last but not least, the extension of the scope of the EU ETS also to include shipping is only a proposal from the EC. The final form of such measure will have to go under an ordinary legislative procedure which will depend on the outcome of negotiations among the various EU regulatory bodies (Commission, Parliament and Council) and maritime stakeholders.

The proposed EU ETS structure raises the issue whether shipping companies in the container sector that perform ship-to-ship transshipment at EU ports can reduce their payments into the EU ETS by switching their transshipment hub from an EEA transshipment hub to a non-EEA hub. This paper aims at identifying that risk by looking at the Piraeus vs Izmir and Algeciras vs Tanger Med case studies and considering all the parameters that affect the choice of a transshipment hub while designing a liner shipping network. To that effect, it was performed a cost–benefit analysis that calculates the newly introduced EU carbon costs of several international services already calling at EEA ports and assesses the costs arising from relocating their EEA transshipment hub.

Data from the European Environment Agency (EEA) was retrieved on the evolution of GHG emissions from 1990 to 2018 attributed to EU’s domestic aviation, international aviation and international maritime transport. The figure below shows that despite the inclusion of aviation in the EU ETS in 2013, GHG emissions at both international and domestic level kept increasing. This outcome is a strong indicator that regional schemes may be inadequate in regulating global sectors and can further lead to unfavorable effects such as market distortions and carbon leakage.

Carbon leakage results from the increase in global GHG emissions due to shifting operations outside the regional scope of the rule in the absence of an global climate agreement. Sectors that trade internationally are prone to evade a regional legally binding treaty by reconfiguring their businesses to avoid compliance with the rule. As climate change depends on aggregate global emissions, carbon leakage threatens to undo the effects of unilateral policy efforts.

Prospects and challenges

The European Parliament (EP) contemplated a more robust version of the European Commission’s (EC) proposal, namely to include 100% of the CO2 emissions between EEA and non-EEA ports instead of 50%. Even though it is unclear what the final version of the proposed legislation would entail, this being the outcome of negotiations among the EC, the EP, and the Council, the 100% version would surely provide a stronger economic incentive for container operators to relocate their transshipment hubs outside the EEA.

Since a shipowner is the responsible party for compliance but has no financial interest on the cargo itself, it is natural that there will be some negotiations between the shipowner and the cargo owners when it comes to the allocation of carbon costs. There is an expectation that commercial charter party terms to include carbon pricing in the near term. The latest signals from the EC are that in time charter contracts, the charterer will pay the ETS carbon costs.

According to the report, fully 61% of the world fleet is not owned by an EU company. Looking at the statistics in the baseline period for the EU MRV it was that 46% of these port calls were from vessels owned by companies outside the EU. So there will be some administrative work in setting up registry accounts, managing these obligations, and trading emissions allowances.

In the context of the EU ETS, speed reduction in route legs under the EU ETS jurisdiction may be a second-order effect of the proposed legislation, and complement the transshipment hub relocation response, which would be the first-order effect. Such a speed reduction would indeed reduce CO2 in the intra-EU legs, however in other legs, the reduction might be lower. In fact it is conceivable that to catch up and recoup delays caused by speed reduction, vessels would sail faster in the non-EU legs and thus would increase the overall CO2.

Alternatively, the speed reduction in the EU legs may necessitate the inclusion of additional ships into the service to maintain trade throughput, and this might entail a reconfiguration of the lines’ networks and schedules. Whether or not such a reconfiguration would be cost-effective would depend on the cost of adding more shipping capacity, among other factors. The study of all these second-order effects is outside the scope of this paper.

There is also a third-order effect of the proposed legislation, which might result from the second-order effects. Speed reduction in the areas under the EU ETS jurisdiction may result in shifts to road-based modes, to the extent that these are alternatives to intra-EU maritime traffic. This would run contrary to the EU policy of shifting cargo from land to sea. Papers that examine such modal shifts include Psaraftis and Kontovas (2010) in the context of speed reduction in intercontinental shipping, and Zis and Psaraftis (2019) in the context of EU sulfur legislation. The study of the third-order effect is also outside the scope of this paper.

To remind, in July 2021, the EC proposed to include shipping into the EU ETS as part of a package to reach its intermediate targets of reducing at least 55% of EU GHG emissions by 2030. The enforcement of regional MBMs such as the EU ETS to regulate sectors that operate at an international level entails a high risk for policy evasion.

Conclusions

The paper focused on container routes and examined the scheme’s effectiveness in achieving GHG emissions reductions. According to the results, the inclusion of shipping in the EU ETS entails significant side effects such as carbon leakage, loss of ETS revenue and penalization of the EEA ports. It also focused focused on the container sector, the dominant source of maritime GHG emissions, and investigated the potentials for liner network reconfiguration under the prospects of evading the EU ETS.

Since the choice of the transshipment hub is significantly affected by port location EEA ports that are in close proximity with ports outside the EEA and are or may have the potential to become advanced transshipment hubs were selected. As proximal transshipment hubs compete for the traffic related to a specific region or economic area, there are solid financial drivers that may lead liner operators to use alternative competing hubs outside the EEA to commence transshipment operations and avoid surrendering their EU carbon allowances.

Such a decision could penalize the EU ports and lead to a corresponding revenue loss for the EU ETS. This study focused on several international services that call two of the key EEA transshipment hubs in the Mediterranean Sea, namely the Piraeus port in Greece and the Algeciras port in Spain. The model calculated, among other things, the EU carbon costs for each of the examined services and the costs attributed to the relocation scenario. These are the extra bunker fuel costs and the cost due to transshipment tariffs differential for each case.

In all cases, the switch of the hub implies an increase in the overall sailing distance of the vessel. Since the respective new voyage will be entirely or partially excluded from the EU scheme, there are not enough incentives for reducing the GHG emissions while sailing towards the competitor non-EEA port. To absorb the time lost due to the extra sailing distance the vessel can increase the service speed, which leads to an increase in total carbon emissions for the service and further amplifies the risk of carbon leakage.

The estimation of the EU carbon turning point that renders the relocation of the hub cost-effective allows us to quantify the risk of evasion of the scheme. The first case study compared the hub of Piraeus with the nearby ports in Turkey (Izmir area) and concluded that the risk of evasion of the system is real at a price of less than 25 EUR/MT of carbon. Furthermore, the plans to expand the Izmir terminals further encourage the operators to shift their transshipments to the nearby non-EEA port. The second case study of this paper focused on the comparison between the Algeciras port in Spain and the Tanger Med port in Morocco.

The ports that have been major competitors on transshipment volumes have also been included in the impact assessment (IA) of the EC proposal published in October 2021. The IA alerted that a preference to Tanger Med will become viable in the medium term; however, the paper showed that the switch might become in the nearest future especially with the prominent expansion of the Tanger Med 2 terminal. This model indicated that the relocation of the hub is possible at prices as low as 6 EUR/MT of CO2.

All of the above seem to amplify the results of this paper and indicate that the inclusion of shipping into the EU ETS may very well be a project with very good intentions, however it may entail significant side-effects that should be considered very carefully before the relevant legislation is enacted. In addition, such an inclusion might undermine the IMO discussion on MBMs, as it may be difficult to connect a regional MBM such as the EU ETS with a global MBM such as a levy, which is one of the options under discussion at the IMO, and the preferred option of the shipping industry.

CLICK HERE TO READ THE PAPER ON EU ETS

The views presented are only those of the author and do not necessarily reflect those of SAFETY4SEA and are for information sharing and discussion purposes only.

Prof. Psaraftis referred to this report during the 2022 GREEN4SEA Forum, where he gave a presentation on the status and prospects for shipping decafbonization. Explore more in the video below