Greenhouse Gas Legislation Landscape: The EU Makes Its Move

The European Union (EU) has launched a flurry of activity around maritime greenhouse gas (GHG) emissions in the last few months in a move that the industry has awaited with baited breath. This week saw the EU unveil a proposal that would create an EU-wide legal framework for collecting and publishing verified annual data on CO2 emissions from all large ships (over 5,000 GRT) that use EU ports, irrespective of where the ships are registered.

In addition to this, earlier in the year, the European Commission (EC) published a highly anticipated study that focused on the current proposals to monitor GHG emissions from shipping, entitled  ‘Support for the impact assessment of a proposal to address maritime transport greenhouse gas emissions’ (Ref: CLIMA.B.3/SER/2011/0005 Report for European Commission DG Climate Action), also known by its shorter title of “Impact Assessment of Maritime GHG proposals”.

With the Commission currently holding a proposal to monitor GHG emissions from shipping, and with further discussions around addressing GHG emissions from shipping set to take place through the International Maritime Organization (IMO), this week Fathom addresses and dissects what cards are on the table for the shipping industry and which cards might be played?

The EU Makes it’s Move

We may as well all get used to the abbreviation “MRV”: the acronym for “monitoring, reporting and verification”. Last week the European Commission proposed a regulation which would establish an EU-wide system for the monitoring, reporting and verification (MRV) of CO2 emissions that will require owners of ships of 5,000 GRT and up using EU ports to monitor and report the ships’ annual CO2 emissions. Under the proposal, owners will also be required to provide other information, such as data, to determine the ships’ energy efficiency.

The enforcement mechanism would see a document of compliance issued by an independent verifier be carried on board ships and will be subject to inspection by Member State authorities.

The proposed regulation, if installed, would take effect from 2018 onwards.

Connie Hedegaard, EU Commissioner for Climate Action, commented at the time of the press release distribution:

“Today we are charting a clear course towards reducing maritime greenhouse gas emissions. The EU monitoring system will bring environmental and economic gains for the shipping sector by increasing transparency about emissions and creating an incentive for ship-owners to cut them. This initiative is fully in line with the latest proposals on global fuel efficiency standards and market-based measures being discussed in the International Maritime Organization. Robust monitoring, reporting and verification of emissions is an essential precondition for informed discussions in Europe and worldwide on reduction targets for the sector.”

The EC says that the European system is intended as a building block for a global system. The proposed rules are designed to support a staged approach towards setting global energy efficiency standards for existing ships, as proposed by the United States and supported by other members of the IMO. The EU rules would be adapted to the global standards if and when a global system is set up.

The EC asserts that there will not be any penalties associated with the decision, quite the contrary, as it predicts that the new regulation will further incentivise the uptake of ship efficiency technologies leading to fuel cost savings that will outweigh the cost of monitoring, reporting and verification of emissions. This would lead to net cost savings of up to €1.2 billion a year by 2030, it asserts.

The system would reduce emissions by up to 2%. The EC believes that though ship efficiency measures are “not sufficiently used” they attribute this to market barriers, namely lack of information and lack of access to finance.

It does not make clear however how the EC can assist the industry with either of those problems. The draft Regulation requires approval by the European Parliament and Council to become law.

Two recent studies were used to prepare the proposal for MRV of CO2 emission from ships: one supporting the preparation of the impact assessment and a second looking in more detail at market barriers for the uptake of energy efficiency technologies in the maritime transport sector. Both studies confirmed earlier research identifying signification abatement potentials by implementing existing technologies at no or even negative costs.

Both studies are available on the EC website:

“Impact Assessment of Maritime GHG proposals” January 2013

http://ec.europa.eu/clima/policies/transport/shipping/docs/ghg_maritime_report_en.pdf

“Analysis of market barriers to cost effective GHG emission reductions in the maritime transport sector” September 2012

http://ec.europa.eu/clima/policies/transport/shipping/docs/market_barriers_2012_en.pdf

The Study: Impact Assessment of Maritime GHG Proposals

The decisive study, published in January 2013, was borne from the EU target to reduce GHG emissions by at least 20% by 2020 compared to 1990 levels, or by 30% in the context of a global deal. The EC wants to reduce emissions from maritime bunker fuels by 40% (if feasible 50%) by 2050 compared to 2005 levels.

In a move to develop regional policies that can support the IMO process, the EC has assessed four potential policies that would support the monitoring of emissions in shipping in the EU. Each policy has the aim of reducing administrative burden and can be reported annually only.

The study identifies regulatory and market failures, which further justify EU intervention.

“The cost of carbon emissions from shipping is not internalised and there are barriers – lack of information and lack of financing – preventing the widespread uptake of ship efficiency technology,” it states.

The Method

To assess the impact of the policies, the EC used a TIMES energy model built specifically for the white paper which characterises the available routes within/into/out of Europe and available technological and logistical choices out to 2050. In places, they also supplemented the energy model with model analysis.

Policy Option 1: Emissions Trading

A cap and trade Emissions Trading Scheme (ETS) would limit overall emissions but allow the industry to auction off emissions allowances, thereby rewarding companies that have invested in ship efficiency technologies, and provide a disincentive to companies making less of an effort without being unnecessarily harsh.

Because the cap is centred on an overall emissions limit, it offers a greater degree of certainty that this goal will be reached in contrast to other methods. This new ‘trade’ would also hand back a certain element of self-determination to ship owners and operators who in recent times have been subject to a deluge of imperatives from outside sources.

Impact: Regardless of the type of ETS adopted – whether closed with free allocations, open, or open with full auctioning, the EC estimates a reduction in emissions of 9.9%.

Compared to the baseline, the closed ETS system with free allocations represents a reduction in cost of €49.2bn, whilst an open ETS clocks in at €51.9bn and the open ETS with full auctioning would be a reduction in costs of €22.6bn. A closed scheme is expected to lead to higher carbon prices than an open scheme.

Policy Option 2: Tax

A tax would levy a charge on some defined basis (e.g. fuel supplied or CO2 emitted), which would apply to fuel suppliers or vessels (as appropriate) operating within the scope of the scheme. A major downside to this proposal is that the tax increases the cost of voyages, either through taxing on the basis of fuel use or emissions.

Without investment in ship efficiency technologies, and unable to recoup the cost of the tax via freight rates, this is a direct threat to the ship owner/operator’s bottom line. “The scale of this impact will depend on the ability to pass these additional costs or savings through the maritime supply chain by changing freight rates,” the document acknowledged of its overall assessment of the economic impact of its suggestions.

Whilst the tax will provide cost certainty, it cannot provide reduction certainty as vessels may simply decide that it is more profitable to pay the extra tax – or evade the tax altogether, leading to an unlevelled playing field.

Impact: Low taxes will result in reductions of 4.2% and mean savings of €26.7bn relative to the baseline. A high tax meanwhile will achieve 9.7% reductions, but would mean €153.9bn increase in costs for the industry.

Policy Option 3: Compensation Fund

The EC proposes two possibilities for policy option number three: a mandatory EU-level compensation fund, or an industry fund. The EU compensation fund would purchase emission reduction offsets, which would be funded either by a levy on EU fuel purchases or contributions from ship owners/operators based on the emissions.

Based on the International GHG Fund imagined in IMO’s MEPC 59/4/5, companies would become members of the Fund and as a condition of membership, they would submit an emissions reduction plan and pay the Fund according to emissions performance.

The Fund would finance emission reduction measures thereby creating a virtuous emissions cycle, in addition to buying credit from the international carbon market. The problem with buying credits on the international market however is that whilst the emissions figures themselves will drop in line with targets, the actual air quality in the EU will not be impacted – regardless of what the balance sheet says.

Based on a similar scheme already in place in Norway, the second option is to set up a legal entity to ensure emissions reduction so that individual vessels are not liable. Instead, the industry as a whole must act together via the Fund. The capital could be generated either from contributions in line with emissions performance, or more closely target-based, in which a target would be set by the EC and all vessels required to pay membership, whilst those that do not have membership would be charged a penalty.

Impact: The target-based compensation fund achieves the same level of reductions as the ETS at 9.9% and cost €22.6bn less than the baseline, whilst the contribution based compensation fund will achieve reductions of 4.2% and reduce costs by €26.7bn.

Policy Option 4: Mandatory Emissions Reductions

Policy option 4 would be based on specifying a mandatory emission reduction per ship. One way of doing this would be via a command and control measure in which low emissions vessels would not need to pay activity charges. Emissions reductions could either technical, operational, or a combination of the two.

The second approach would involve credit trading, with eco-friendly ships generating them and high emissions ships having the option to buy them. The credit scheme is a good way of incentivising operators to go the extra mile to become more efficient than is needed so that the efficiency itself doesn’t just become money saving, but money generating.

However, this wouldn’t work if the whole market tried to do this; it would be interesting therefore if there would be the potential to trade this credit internationally.

Impact: The EC does not provide specific impact data for option 4.

Fathom asks the European Commission: 

From our analysis of the policy options presented in the EC study, it appears to indicate that the high tax solution is not favoured, and instead concludes by acknowledging the advantages of ETS and the overall economic benefits that will be made available through the adoption of fuel efficiency technology across the different scenarios. As a result, all of the options, the EC asserts, creates incentives for the adoption of emissions abatement technologies because they all save money. However, one thing that is not clear is that, whilst the EC is creating incentives, how is it responding to the market barriers it identifies?

Fathom asked a representative of the European Commission:

The EC in your press release states that ship efficiency measures are “not sufficiently used”, which it attributes to twin market barriers: Lack of information and lack of access to finance. How will the EC help address these two barriers to uptake?

The market barrier of lack of information would be fully addressed by the implementation of MRV as has been proposed by the Commission on 28 June. The proposal foresees the publication of information on emissions and efficiency. In particular the latter would provide market-relevant information on expected fuel consumption and costs of specific ships to charterers who could make better choices considering the ship’s efficiency. Investments into ship efficiency would also be better rewarded on the secondary market as higher demand and prices for more efficient ships could be expected.

The monitoring of fuel consumption and emissions would provide reliable information to ship owners and charterers to identify existing potentials to be more fuel efficient.

The MRV proposal also contributes to addressing the market barrier of lack of access to finance as it is today difficult to attract financing for energy-efficient solutions in the absence of trusted data on the economic benefits of low-carbon technologies.

To finance investments into ship efficiency, the EU investment support facilities available from the European Investment Bank could be used by ship owners. Furthermore, the Commission is further developing its policies to support the development of infrastructures for port electrification and LNG supply through financial incentives and regulatory measures. For more details please see Commission Communication on Clean Power for Transport: A European alternative fuels strategy (COM(2013) 17 final).

Conclusion

In a nutshell, we hear at conferences across the world the cry from members of the shipping industry that a global policy to reduce CO2 from shipping would be far more preferable and effective than a regional policy.

And it would seem that the EU is taking steps to formulate a suitable global policy, as they state that the proposed monitoring ‘MRV’ system is intended as a building block for a global system. The EU rules would be adapted to the global standards if and when a global system is set up.

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