Navigating the EU ETS: The Impact of Carbon Emissions Legislation on the Shipping Sector

As shipping operators reckon with the implementation of the EU’s Emissions Trading System (EU ETS), questions are arising about how the legislation will impact businesses. Natixis CIB’s Marc Mourre and Claude Lixi, Co-Heads of Commodities Markets, discuss the challenges and opportunities that lie ahead for the sector.

In 2024, the EU ETS was extended to the maritime sector, covering CO2 emissions from all large ships (5,000 gross tonnage and above) entering EU ports. The regulation seeks to make polluters pay for their greenhouse gas (GHG) emissions, defining a cap – a maximum amount of greenhouse gases that can be emitted by a given sector – that is reduced on an annual basis in line with climate targets. To cover their emissions, businesses must purchase EU allowances (EUAs) on the EU carbon market. Failure to comply can result in hefty fines, as well as reputational damage. 

Within the shipping sector, legislation will apply to cargo and passenger ships and will come into force gradually over the next few years. In 2025, 40% of shipping companies’ carbon emissions will need to be covered by EUAs, with this threshold rising to 70% in 2026 and 100% in 2027.

Businesses will need to open a Maritime Operator Holding account and surrender allowances in the EU member state that corresponds to their administering authority. Emission allowances will be sold in the primary market through auctions on the European Energy Exchange (EEX) or on the secondary market.

In the immediate term, shippers will need to accelerate decarbonisation efforts to mitigate the financial impact of the new requirements. It is estimated that the operating cost of an average bulk vessel, aged 10 years and emitting roughly 16,000 tons of CO2 per year, would increase by EUR1.3 m in 2026 – assuming it only trades between EU ports. However, the industry has been accelerating its decarbonisation efforts for some time, and many are prepared to weather these changes.

The vast majority of new cruise vessels run on liquefied natural gas (LNG), with cargo and container shipping making a shift in the same direction. Alongside this, given newer vessels require several years for construction, older vessels have focused on using cleaner fuel, with the industry seeing a marked shift towards ultra-low sulphur diesel (ULSD) since 2020. Meanwhile, because ULSD is considerably more expensive than other fuel types, certain operators have invested in sulphur capture technology. These scrubber systems use chemical reactions to help remove sulphur particles and gases from exhaust streams to limit the negative environmental impact. While expensive to install – costing up to US$10 bn – overall costs are reduced based on long-term consumption.

Looking further ahead, the industry will seek to expand the use of LNG as its primary fuel source, while investment and research into electronification will continue. On this front, progress has already been made, with electric boats being introduced into shipping fleets globally.

Given the financial implications of the new regulation, criticisms of the EU ETS have emerged. In November 2023, ministers from Spain, Italy, Greece, Malta, Cyprus, Portugal and Croatia sent letters to the European Commission to call for an option to pause plans to include shipping from January 2024. They claimed that the legislation would reduce the competitiveness of EU ports and drive business away, while also encouraging shipping operators to divert routes away from the EU to countries with less stringent regulatory requirements, thus negating the environmental improvements.

However, criticisms have typically arisen from those representing the interests of large shipping companies that are reluctant to invest. Lloyd’s List estimates that, should EUA prices remain in the EUR80-90/mt range, total tax revenues from EU ETS could generate more than EUR7bn annually. Meanwhile, the introduction of the Carbon Border Adjustment Mechanism (CBAM) will help to mitigate the issue of companies shifting production and shipping to different jurisdictions – known as carbon leakage – as those importing into the EU must declare the carbon emissions embedded in their imports and give up the appropriate number of EUAs.

In addition, while it may become more expensive to conduct business in Europe, the trends exhibited by the rest of the world show that many other countries are starting to incorporate carbon emissions into legislation. Efforts are being made in California, Washington DC, Quebec, Australia and New Zealand, to encourage the implementation of carbon credit regulations, meaning shippers’ options will become increasingly limited if they hope to avoid regulatory costs altogether.

Further concerns have been raised about historic instances in other carbon markets, whereby firms have opted to pay fines rather than make the necessary investments to reduce carbon emissions. However, with environmental concerns in general becoming increasingly prevalent and companies being regularly called out for bad practice, the potential reputational damage of non-compliance will likely serve as a sufficient deterrent. Additionally, the banks and financial institutions that shippers rely on for investment face their own strict environmental targets, meaning avoiding regulation could also have a more damaging financial impact.

As legislation comes into effect, costs are set to rise across the sector. HSBC estimates that the EU ETS will incur a cost ranging from 1-5% of freight rates. And, based on the closest EUA price maturity to 2033, the unitary cost of steel and aluminium is expected to increase by 22% and 10% respectively, while CO2 prices could surpass current estimates for the next decade. As such, questions have been raised about who will foot the bill.  

To date, several shipping firms have announced surcharges for voyages to and from EU ports, averaging around US$30 per twenty-foot equivalent unit (TEU), indicating that costs will be passed down the value chain. The extent to which this will impact end consumers – who will ultimately feel the inflationary impact of higher shipping costs – remains to be seen.

In the longer term, the EU ETS will stimulate investment in green technology and alternative fuels, which should lower overall operating costs. For instance, there has already been a rise in Green Towage, with Fairplay Towage Group making plans to build six hydrogen-fuelled tugboats in Germany. Elsewhere, Boluda Towage will introduce battery-powered tugs, while Svitzer already powers 50 of its fleet on biofuel.

As other countries and regions begin to enact similar legislation, there will need to be a global consensus about the pricing of carbon credits to avoid individual nations establishing their own pricing mechanisms. This will not only avoid repeated arbitrage, but will ensure that legislation creates a sustainable path to a greener future.

Natixis CIB has a full trading and sales organisation in place to assist the maritime sector in fulfilling obligations and managing the carbon price risk.