Maritime emissions: Navigating EU and UK regulations

Reed Smith partners Tallat Hussain and Nick Austin and counsel Julie Vaughan discuss the evolving landscape of emissions trading systems (ETS) and their impact on the maritime sector. Key topics include the EU ETS, the International Maritime Organization’s carbon intensity rating scheme, and the UK government’s proposal to extend its ETS to maritime emissions. They explore the implications for shipping entities and the potential for monetizing emissions reductions in the sector.

Transcript:

Intro: Trading Straits brings legal and business insights at the intersection of the shipping and energy sectors. This podcast series offers trends, developments, challenges and topics of interest from Reed Smith litigation, regulatory and finance laws across our network of global offices. If you have any questions about the topics discussed on this podcast, please do contact our speakers. 

Julie: Hello everyone and welcome back to Trading Straits. I'm Julie Vaughan, environmental counsel in the Energy and Natural Resources team at Reed Smith in London. I'm joined today by my colleagues Tallat Hussain, an environmental lawyer, and Nick Austin, a shipping lawyer, both partners based in our London office. In this podcast today, we'll be firstly recapping where things stand with implementing the EU emissions trading system for the maritime sector, including looking ahead to some changes that are approaching, and also touching on the role of the IMO, the International Monetary Organization's Carbon Intensity Rating Scheme and some challenges that it's facing. And then secondly, we're going to talk about the recent proposal by the UK government to extend the UK's emissions trading system that operates in Great Britain post-Brexit to also include maritime emissions. We'll be discussing some of the key features of that proposal and also potential international implications. So Nick, if we could come to you first, perhaps you could give us an overview of the current EU maritime ETS and highlight some of its central points for us. 

Nick: Yeah, I mean, last year we were talking on previous episodes of Trading Straits about changes to the EU ETS and its extension to shipping last year during the fourth phase of the EU ETS scheme running until 2030. And by way of recap, what has happened is that the maritime sector has been brought in to the scope of EU ETS, the wider EU ETS from the 1st of January last year, initially for ships, commercial ships of more than 5,000 gross tonnes. And listeners of this podcast will remember that what ETS does is impose obligations on the so-called shipping companies who have needed to set up new compliance procedures, open accounts, and ultimately buy and surrender EU allowances annually to cover emissions from voyages which are caught within the scope of the scheme. So I think my sense is that it remains a really big show in town, and it's having a significant impact in the sector, not the least of which, of course, is cost. And we've been working with clients on all of the mechanics of that, from setting up the accounts, making necessary registrations, negotiating charter clauses to suit the needs of owners and charterers. And I think that will continue throughout 2025, because, in fact, this year heralds a couple of new developments for EU ETS in shipping. First from January of this year, the 1st of January, the scope of EU ETS will expand further to include offshore vessels over 5,000 tonnes, which are calling it EU ports. And I think new challenges are remaining for the vessels which have been subject to the ETS already since 2024 in what I would call the next stage of compliance. And that means that the emissions data for the 2024 year has to be reported on and verified by an accredited verifier by the 31st of March this year, just some weeks away. And ship owners and operators then have a further six months until the 30th of September to submit the correct number, hopefully correct number, of EUAs, the allowances required to cover their emissions so verified for 2024. for. And a failure to do that can, of course, mean potentially hefty financial penalties. And those responsible in companies for ETS compliance will need to make sure that they're obviously well prepared to meet those deadlines. It's also worth remembering, and you touched on this, Julie, in your introduction, that the IMO is plowing its own furrow on decarbonisation quite separately from the EU and indeed the UK. And the CII, the carbon intensity indicator, was introduced now back in 2023. And that's, as we've said before, a rating scheme from A to E for vessels based on their so-called carbon intensity. And that's measured by an equation which, among other things, takes into account the size of a ship, its distance sailed. And 2024 was It's the first year in which ships were given actual ratings from A being the best, obviously, to E being the worst. And I think what's happened in recent months is that the operational realities of shipping have highlighted big challenges with CII, and there have been widespread calls in the industry for revision, most recently at the MEPC 82 meeting at IMO in London in September. And I think some kind of recalibration looks likely, particularly around the issue of idle time, ships sitting around doing nothing. Because one of the central challenges with CII is the impact of waiting on a vessel's CII rating as opposed to being on the move. And ships which frequently spend extended periods at anchor and port or perhaps undergoing maintenance without carrying cargo can be penalized. And I think the IMO and the industry have recognized that that may not be satisfactory. So there's a lot going on there too, and I think that's a space to be keenly watched. Tallat, let me bring you in, if I can. The UK is proposing itself to include maritime shipping emissions in the UK ETS. Can you tell us a bit about the context of that and the proposed new requirements? 

Tallat: Sure. Essentially, Nick, the UK is following in the EU's carbon footsteps. The maritime sector is proposed to be brought into the scope of the UK ETS starting in 2026, and this may have potentially significant implications for the industry in terms of cost of compliance, operational changes, and the impact on existing and future contractual arrangements. I'll just set up a bit of further context here. As maritime transport plays a critical role for global trade, whether in goods or commodities, and significantly in transportation of oil and gas, it has now become a target for regulatory change. But it's also because of the fact that it has and is a large and growing source of greenhouse gas emissions. According to the European Commission, if left unaddressed, global maritime greenhouse gas emissions could increase by up to 130% from 2008 levels by 2050. Which would undermine the global climate change initiatives that are being set under agreements like the Paris Agreement. So in the UK, while shipping is generally regarded as a carbon-efficient model for transporting freight, domestic maritime emissions in the UK account for about 5% of the country's total transport carbon emissions. And by way of comparison, that figure is estimated to be more than the domestic rail and bus emissions combined. So shipping emissions include more than carbon dioxide as well. And the proposal expands to maritime methane emissions as well as nitrous oxide emissions. And these are represented as carbon dioxide equivalents. So all of these elements of the maritime shipping sector are being included. And because of this, decarbonizing the UK maritime sector is considered to be even more crucial to the country's wider carbon emissions targets. Plus, as you're aware, 2024 was a busy year for shifting policies in the EU as well as in the UK. The UK government announced its most ambitious target yet to reduce carbon emissions by 81% by 2035. The proposed maritime expansion of the UK emissions trading system feeds into this. With the connection to the UK's international obligations for the expanded cap and trade system, the cap for the UK ETS will need to be adjusted. It's currently proposed to be around 2.4 million allowances per year between 2026 and 2030, but that's just the proposal right now. Of course, including maritime emissions is meant to reflect the government's long-term strategy for UK emissions trading, as well as concerns that the price of maritime fuels does not reflect externalities, like environmental costs. Although it's also intended to incentivize the adoption of fuel-efficient technologies and low-carbon fuels, which should have the co-benefit of growing the UK's low-carbon sector. But this is an ambition that we would have expected. And this, of course, should be encouraging efficiencies in operational practices for ships as well. But all of this, although it sounds like it's easily workable, may have operational and compliance challenges as well as transaction impacts. And you mentioned some consequences, Nick, under this comply or pay approach, allowances will need to be secured for each ton of carbon dioxide emissions from domestic maritime ship activity in the UK, including emissions caused by vessels both while at anchor and while moored as well as by vessels both at sea and at offshore structures. Unlike the UK ETS, currently the obligations are on operators but how to apportion responsibility is more complex when it comes to vessel ownership and chartering arrangements. The UK ETS proposal is that obligations will apply to the registered owner of the ship unless responsibility for the UK ETS compliance is somehow delegated contractually by the owner to the entity that operates the ship. Apportioning rights to green attributes, as we know, like carbon equivalent emissions reductions or obligations that go with them may need to be resolved on a contract-by-contract basis. Also like the EU ETS, the scheme is meant to run by calendar year from January 1 to December 31, starting in 2026. But unlike the EU Maritime ETS, the deadline for surrendering allowances is by April 30 of the following year, rather than September 30. The reporting deadline is the same, which is March 31. But it's not unlikely that non-alignment with any surrender dates may be a subject of comments in the consultation, especially considering that it may impact a proposed linking of the two systems. In terms of compliance mechanics, additional to the obligations to set up a registry account, covered entities will need to apply for approval of their greenhouse gas monitoring plan and appoint an independent verifier accredited by the UK accreditation system. The intention is for the UK Maritime ETS to align with the existing monitoring, reporting, and verification regimes and the international reporting requirements, with the intent of making it easier for transition for larger ships that are already subject to the MRV, as they have systems in place. Again, aligning the mechanics of the two systems will support any linkage of them. This shouldn't be a regulatory burden for ships over 5,000 GT. But there may be administrative processes to contend with. Interestingly, in the international context, application of the UK Maritime ETS hasn't escaped some of the lingering post-Brexit complexities. As Julie mentioned, these can't be avoided at this point. Julie, could you explain the current proposal and impacts of the application of the UK ETS to shipping emissions requirements in light of the Brexit issues, in light of what's happening between Great Britain and Ireland and considering the EU maritime ETS? 

Julie: Yeah, sure. This is quite a difficult one because the EU scheme covers 50% of international voyages between member state ports and ports outside of the EU jurisdiction. So that includes ships that are travelling backwards and forwards between ports in the Republican Ireland, which is, of course, still an EU member state. And ports in Great Britain, England, Wales and Scotland. But because of the deal struck when the UK left the EU, Brexit, which is known as the Northern Ireland Protocol, and subsequently adjusted through the Windsor framework to make it slightly more operationally workable, the EU environmental laws still apply in Northern Ireland as well even though of course Northern Ireland is part of the UK. So under the proposals for the extension of the UK scheme it's proposed to cover 100% of emissions between domestic and between UK ports. So the effect of this is that there would be a 100% cost of emissions for voyages between Great Britain and Northern Ireland, which would then be more than the 50% that's charged under the EU scheme between ports in the Republic of Ireland and Great Britain. And this has got the potential to distort trade between the two, with people possibly diverting goods down by land from Northern Ireland down to the Republic of Ireland to avoid the higher cost of then shipping them across. So one of the options the government is considering to avoid that negative consequence is to ask shipping companies to still monitor and report 100% of the emissions between the UK and countries within the EU system, including Northern Ireland, but only then to actually impose an obligation to surrender 50% allowances representing 50% of those emissions. The alternative, though, that's also under consideration is to charge all voyages to and from the European Economic Area 50% for their emissions. So that the 50% that we charge and the 50% that the EU charges would mean effectively that the rates charge between Northern Ireland and the UK, 100% under our system, and that which is paid by shipping companies for voyages to other EU countries, including Republic of Ireland, would be the same. The government hasn't actually reached a firm conclusion there. It's obviously a difficult one and they're still considering that sort of conundrum and they're open to further discussion as to what the best solution is for that. The UK has to be careful, though, not to discriminate between the deal that it's giving to individual third-party countries here, because it has to be mindful of the obligations that it's got under the World Trade Organization agreements as well. The government's also, though, considering a further expansion, so beyond the European economic area countries, to also bring in international voyages to and from the UK. But this isn't something it's going to do in the near term. It's ruled out doing that before 2026, certainly. And what it's doing is essentially what the EU itself did for a number of years was to wait and see if further, more stringent action is taken by the IMO. So such you might be able to avoid broadening the scheme to the international voyages. So Nick, with the EU context in mind and based on what you've seen so far with the implementation of the EU maritime scheme, where do you think UK shipping companies stand now in terms of the application of the emissions trading systems? 

Nick: Well, thanks Julie, it's an interesting question And I think if we're trying to understand, even in these relatively early days, how the UK ETS might be rolled out, and in particular what pitfalls may be sort of lying in wait, the unwary, I think we can learn a few lessons from how the EU ETS was implemented in 2024 and in the run-up to that. And perhaps the best example of that is where and how the EU decided to allocate non-EU registered shipping companies. And in the shipping industry, there are a lot more of those than there are ones based in the EU. But to allocate those apparently randomly to particular member states within the EU would then have the responsibility for administering and enforcing the scheme against that company. And a list was published where companies were allocated a member state and the connection between the member state and the company was supposed to be where ships owned by that entity had perhaps most frequently called or visited or had some other connection. But that gave rise to anomalies because of the complex way in which ships are owned and managed around the world by different entities, even within the same group. So we had the sight of Spain, for example, being lumped with dozens of largely Asian, not exclusively, but plenty of Asian shipping companies whose only connection with Spain was that one of their ships had at some point bunkered or taken on fuel, Algeciras or some other Spanish port. And that was seen as anomalous and gave rise to a considerable degree of uncertainty and threat in the shipping community. Coming back to the UK ETS, the consultation period is, I understand, now over. And one hopes there has been considerable and constructive feedback from the industry and from other stakeholders on the practical aspects of scheme participation. You've mentioned the Ireland-Northern Ireland issue, which is clearly a headache and will require some sort of resolution. And not only that, the regulatory regime, the account requirements, the operator requirements, monitoring, reporting, and verification, which I think, as Tallat said, will align to the existing rules that are in place already so-called points of obligation when you're obliged to do things guidance and so on all of that will need to be thought about very carefully in the run-up to 2026 now there's only one country to to register in but it will be critical to ensure that we in the uk do roll out a smooth and efficient set of procedures for registration and and and starting one's participation in the scheme. And one hopes that that will be done in a sensible manner to avoid some of the challenges that we have seen. And I know you, Julie and Tallat, have also seen and continue to see with global clients having to grapple with in the EU ETS scheme, in particular around setting up accounts in various countries throughout Europe. Last but not least, I think as the UK ETS gathers pace and we start to hear more about it and read more about it, we, as we did with the EU ETS here at Reed Smith, will start to get requests from owners and operators and charters and commodities companies to review wording for use in commercial contracts, commercial negotiations. And those points will need careful consideration, including in time charter parties, because there will be a cost, as there is with the EU ETS, and that cost will need to be allocated between those who are otherwise responsible for them. And we, in the time charter market, the market for the hire of ships for long periods of time, there was a challenge with EU ETS in understanding the mechanics of how and who that should be paying for those allowances. And you have the sort of tension between the payment, the requirement to pay the allowances, but also the fact that a time charter, someone who's renting a ship for a period of time, has the ability to wreck the vessel and use the vessel as it sees fit in commercial terms. So it's really the orders of the charters, which the ship owner is obliged to comply with, subject to a few exceptions, but the ship owner must do what the charter reasonably orders him to do in terms of the employment of the ship. And so it's the charter who is, in a sense causing the emissions to be created and therefore who under EU ETS is liable for the costs of that under time charter party arrangements. So that I think will come to the fore and it'll be important to get that right just as it was with EU ETS despite the more limited territorial application of UK ETS. And in my experience, there's no one-size-fits-all answer to these questions. As always, it depends on the commercial relationship and bargaining positions of people in the shipping industry. And I think a tailored approach will be needed. So we will see, is probably the shorter answer to that question, Julie. Tallat, do you have any particular take on that or those aspects we've discussed? 

Tallat: Yeah, Nick. I mean, I think the impact will be significant, as it will create pressure points in the interactions between shipping entities and regulators, potentially even lenders and other transaction counterparties. As we've said, the UK maritime ETS allowances will be tradable on the carbon markets, so there will be opportunities to monetize the value of the allowances, but the intention of emissions trading schemes generally is less about monetizing carbon value, but more about managing externalities that impact climate change, and in this case, as a result of maritime operations. That is, to ensure that the price of maritime fuels reflects their environmental costs. As a consequence the government is looking for a system to be in place that incentivizes the adoption of low-carbon fuels, of fuel-efficient technologies, and greener operational practices for ships, which, again, raise some of those conflicts that you've just mentioned. We expect that there will be more refinement based on the outcome of the consultation, and ideally that means that there will be a need for additional guidance. There may be some harmonization of standards and appropriate bodies for measuring and reporting, other efficiencies to ensure that there isn't an added compliance burden, which we know that the government has said that they're trying to remove all of that regulatory red tape in the UK right now. But as you said, Nick, charters and owners are going to have to keep up with the developing regulatory landscape around both the UK ETS emissions trading schemes around the world, including and especially the EU emissions trading scheme. It's the charterers of ships, as you said, that dictates the vessel's emissions. And this raises questions that will need to be addressed between the parties, including how data and information will be shared between parties, the mechanics of charterers transferring allowances to owners, for example, and what happens on the failure of transfers and other carbon trading related issues. Now that the consultation has ended for the UK's proposal, it will be interesting to see how this translates into the carbon emissions regulatory framework. Especially in light of the current geopolitical challenges on the horizon, none of which we've actually all anticipated or the government anticipated in the development of these rules in the first place. 

Julie: Indeed. Well, that brings us to the end of today's Trading Straits podcast. So thanks to Tallat and Nick, and thank you to you for listening. We hope you found our insights interesting and helpful too. If you have any questions, please do get in touch with any of us or your usual contact at Reed Smith. Thank you very much. 

Outro: Trading straits is a Reed Smith production. Our producers are Ali McCardell and Shannon Ryan. For more information about Reed Smith's Energy and Natural Resources or Transportation practices please email tradingstraits@reedsmith.com. You can find our podcasts on podcast streaming platforms, reedsmith.com and our social media accounts at Reed Smith LLP. 

Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers. 

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