Weight of Freight: ETS could be shipping’s ‘first experience’ of carbon costs: SSY

Author Nicholas Watt, Americas Freight editor

The shipping industry, with more than 50,000 ships on the water and 2-3pc share of global emissions, is a relative newcomer to the energy transition with scant incentive to reduce its carbon footprint.

But with new regulations from the International Maritime Organization (IMO) and the EU starting next year, importers and exporters around the globe are growing concerned about how these regulations will affect freight rates for the commodities they buy and sell.

Argus spoke with Derek Langston, head of research at shipbroker SSY, about the regulatory landscape and what to expect.

The IMO’s Carbon Intensity Indicator (CII) and the Energy Efficiency Existing Indicator (EEXI) regulations take effect next year, with the CII meant to regulate a ship’s operational efficiency and the EEXI focusing on a ship’s design efficiency. The inclusion of shipping in the EU’s ETS (emissions trading system) also has the attention of the shipping industry. Could you give a brief overview of these three regulations?

The IMO’s decarbonisation regulations will apply globally. The EEXI aims to measure the energy efficiency of existing vessels on a given engine rating, in other words the design efficiency of the vessel. The principle of the EEXI is the same as the IMO’s Energy Efficiency Design Index, (EEDI) which aims to improve the design efficiency of newbuildings. The EEDI requires vessels reduce their emissions performance by a certain percentage relative to a series of baselines and is the only currently existing IMO measure on decarbonisation.

The CII system will rate vessels from A-E every year according to operational efficiency (based on a calculation of fuel consumption relative to both distance travelled and vessel dwt) as of 2023. An annual reduction factor of -2pc (against 2019 levels) will then be applied in the following two or three years after an initial -5pc reduction in 2023.

So, the CII rates the vessel’s CO2 emissions based on actual, annual operations.

The inclusion of shipping into the EU’s ETS on the other hand could well be the first experience the shipping industry has of carbon-related costs.

The ETS, which already includes industries such as aviation and power, operates under a “cap and trade” principle, whereby a cap is set on emissions. Companies are obligated to pay for each tonne of CO2 they generate using EU allowances. Starting in 2023, all vessels above 5,000 gt calling at an EU port will have to surrender allowances for emissions on intra-EU voyages and time spent at berth, as well as a portion of emissions from voyages starting or ending outside of the EU. The volume of shipping emissions covered in the ETS will be gradually phased in from 2023.

While this is only likely to have a modest impact on vessel earnings during its initial stages, the additional costs of the ETS are expected to increase significantly and will be partly determined by the efficiency of a vessel’s ballasting leg.

As the scope of a ship’s emissions in the ETS will be progressively expanded, the first year represents the thin end of the wedge in terms of costs.

Are there any other regulations that market participants should be aware of?

Yes, other market-based measures are under discussion by various working groups, such as levies on bunkers and carbon emissions. A clean Arctic fuel initiative is under discussion.

There is also scope for other authorities to implement their own ETS in the future, for example, if they view the EU’s efforts as successful and desirable.

Generally speaking, how do you expect these regulations to affect ocean-going freight rates in the next year? In the next two years? Are you seeing any impact now? The tanker market has been in a deep depression since mid-2020; perhaps this would increase rates?

One of the ways for currently non-compliant vessels to meet the requirements of upcoming IMO legislation is to reduce steaming speeds, so lowering the overall carrying capacity of the fleet.

There are other indirect impacts. One such is the apparent hesitancy of some shipowners in the dry bulk, for example, to place newbuilding orders given uncertainties over the optimal vessel newbuilding designs of the future. This will, in turn, help lower the overall carrying capacity of the fleet, so tightening vessel supply/demand balances.

Some charterers have indicated a preference for employing only ships with high efficiency ratings. Is there a chance we’ll see a two-tier chartering market, with carbon intense ships achieving discounted rates?

Yes, that may well happen, but we would emphasise that historical operational performance of a vessel is not necessarily a good indicator of future operational performance by the same vessel.

At least one shipowner, Klaveness Combination Carriers, indicated last year interest in using a carbon pricing mechanism in a chartering contract, such that the company would financially benefit by making an energy-efficient voyage in the form of a higher rate. Some charterers seem to be willing to pay a premium for such “green” journeys. Is this something you see catching on?

There will certainly be greater awareness of these issues going forward. It has always been the case that ships burning less fuel get a premium, and in this instance the difference is that we are talking about carbon efficiency as opposed to overall fuel consumption.

How do you expect the EU’s inclusion of shipping in its ETS to affect freight rates for shipments into and out of the EU in the near and medium term? I know the ETS will come into effect gradually. Are there any specific dates to look out for?

Carbon costs will form a part of the voyage rate, so in that sense, yes, there will be a rising additional cost.

At present the scheduled date of entry for shipping into the EU ETS is 1 January 2023. However, amendments to the scope of emissions included in the ETS, shortening the phase-in period to 2025 (instead of 2026) have been proposed by the European Parliament’s lead MEP on the ETS. It has been reported that a vote on the final amendments can be expected around June 2022.

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