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.

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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 right...