Part 1
Introduction
The FuelEU Maritime Regulation (Regulation (EU) 2023/1805) (the Regulations) is the most recent addition to the European Union’s “Green Shipping” package.
The Regulations work alongside the EU Emissions Trading Scheme (EU ETS) and EU Monitoring, Reporting and Verification (EU MRV) Regulations to decarbonise maritime transportation. The Regulations have been introduced as part of the EU’s aim to achieve a 55% reduction in greenhouse gas (GHG) emissions by 2030 and to encourage the sector to switch to renewable and sustainable fuels.
In order to achieve this goal, the Regulations provide GHG intensity targets that vessels within their scope must adhere to in respect of the energy used on board. Essentially, vessels must continually record their energy usage (regardless of whether they are at berth or sea), report annually and verify this data and not exceed the applicable limit for that time period. Vessels are expected to reduce their yearly GHG intensity by 2% in 2025 with this percentage increasing every five years until 2050.
In order to determine the GHG intensity of a vessel, the Regulations provide methodology at Annex 1 taking into consideration the amount of GHG emissions per unit of energy. It is key that companies use the same monitoring methodology and data sets each year so that the data is comparable. It is equally as important that this data is recorded on the specifically designed FuelEU database alongside being stored and retained for five years.
Due to the type of fuel used, engine systems and methane slip, only certain vessels will be compliant from the start. It is likely that VLSFO and MGO vessels will immediately be at risk of non-compliance due to their GHG intensity. Over time, more and more vessels will become non-compliant due to the increasingly stringent targets. It is therefore crucial for those responsible for the ship’s compliance to fully understand the Regulations, what they need to do to make their vessel compliant and if necessary, how they can attempt to avoid the penalties.
The Regulations apply to all ships over 5,000 gross tonnage that carry either passengers or cargo for commercial purposes. For Intra-EU voyages where the arrival and departure port are both Member State (MS) ports, the Regulations apply to 100% of the energy used. Whereas for voyages where the arrival or departure port is located in an outermost region under jurisdiction of a MS, or for voyages between a MS and a third country, the Regulations only apply to 50% of the energy.
Scope
The emissions that fall within scope are CO2, methane and nitrous oxide. However, for ease, all emissions are converted into CO2 equivalent. Unlike the EU ETS which only focuses on CO2 emissions from tank to wake, FuelEU takes into consideration the full lifecycle of the fuel, covering well to wake. Well to wake includes extraction, production, supply of the fuel to ship’s tanks and combustion. Accordingly, more thought needs to be given to the broader impact of the fuel used.
When calculating a vessel’s GHG intensity, the well to tank phase and the tank to wake phase are considered separately. While calculating the well to tank emissions, companies are forced to use the default values provided in Annex II of the Regulations (a separate formula is provided for Biofuels and RFNBOs). In comparison, when calculating the tank to wake aspect of the GHG intensity (i.e. the combustion of the fuel), companies are able to depart from the default values found in Annex II provided they are able to either get the actual values certified by lab testing or direct emissions testing.
Companies are strongly encouraged to make the move to renewable fuels of non-biological origin. These are synthetic fuels that are produced by way of renewable energy or carbon capture and are therefore much more sustainable and environmentally friendly. In order to incentivise this move, the Regulations stipulate that the energy from RFNBOs counts twice towards a vessel’s GHG intensity. If there is not a convincing uptake whereby at least 1% of fuel used by ships is RFNBOs by 2031, there will be a minimum use annual sub target of 2% for all vessels from 2034 onwards.
Biofuels on the other hand can assist with reducing GHG intensity but, due to their biological origins, are not as sustainable and each pose their own environmental issues as a result of their production and combustion. For example, an ethanol-gasoline mix may ultimately produce lower GHG emissions. However, due to it having higher evaporative emissions, it can in fact increase smog.
Further, although a biofuel is less likely to require an expensive retrofit, there are a wide variety of feedstocks used to create and develop new biofuels which have not yet been tested in marine engines. There is, therefore, a high risk of possible claims arising in the future as a result of incompatible biofuels being burnt in vessel engines.
Responsibility for compliance
The Regulations provide that it is the document of compliance (DoC) holder that is responsible for ensuring a vessel’s compliance with the Regulations. Given that the DoC holder is likely to be the owner or manager of the vessel, this aspect of the Regulations evidently raises concerns and is a gateway to potential future disputes.
A vessel manager has limited control over the operational decisions of the vessel. A similar situation arises under a time charter, where the charterer will decide where the vessel trades as well as being responsible for bunkering, navigation and operational decisions relating to the vessel. Essentially, the charterer will control whether or not the vessel is compliant. Despite this, it will be the owner or external manager who are the party that has to bear the risk of the non-compliance penalty.
The Regulations themselves do not provide assistance with passing the burden of the fines/penalties to the actual polluter and so the possible methods for overcoming this will be discussed later in this article.
Compliance
If a vessel’s emissions fall within the intensity target limit, they will be in a surplus and therefore compliant.
Those vessels that have positive emissions, will receive a DoC by 30 June of the verification period after each reporting period. All ships trading within the EU and the European Economic Area (EEA) will need a DoC that confirms their compliance with the reduction targets and overall regulations.
If a vessel is in a compliance surplus, they may choose “Banking” as a means of storing this excess by rolling it over to use for the next reporting period. This will be beneficial for those vessels that are compliant to start with but risk not being able to meet the later more stringent reduction rates. Notably, any intention to carry over surplus must be approved by the verifier in advance.
Non-compliance
On the other hand, if a vessel’s emissions exceed the target set by the Regulations, the DoC holder will receive a penalty. The amount of the penalty will be calculated using the formula laid out in the Regulations taking into consideration the difference between the required and achieved GHG intensity and based upon EUR 2,400 per tonne of VLSFO equivalent.
Essentially, the higher the GHG emissions, the higher the penalty.
Once a penalty has been paid, the vessel will then be considered compliant and will therefore receive a DoC that they can then use to demonstrate their compliance when trading within the EU and EEA over the forthcoming reporting period.
If a vessel is non-compliant for two consecutive years, they are considered a repeat offender and will therefore receive a harsher penalty. The penalty will increase by 10% every consecutive reporting period until the vessel obtains a surplus that resets the increase factor. An offending vessel that enters a MS port will be at risk of detention if they are flying that MS’s flag, as it is the MSs that are responsible for enforcement. Alternatively, they will be at risk of an expulsion order if they are flying a different flag.
This is the first of two articles on the Regulations. In the second article, we will discuss how the FuelEU penalty can be avoided, future issues that may arise for managers, owners and charterers alongside how they may choose to deal with these issues. We will also consider the impact of the Regulations on LNG fuelled vessels.
For further information, please contact:
Beth Bradley, Partner, Herbert Smith Freehills
beth.bradley@hilldickinson.com
