Optimising the EU ETS’ scope of shipping emissions coverage and revenue use could support the decarbonization of the shipping sector

2 December, 2021 — A new report by UMAS for Environment Defense Fund Europe (EDF Europe) stresses the need to refine the design of the EU Emission Trading System’s (ETS) inclusion of shipping to effectively reduce greenhouse gas emissions from maritime shipping and advance zero-carbon alternative fuels. Reforms to its design such as an expanded scope, a sectoral emissions cap, and reinvesting revenues in shipping decarbonisation would all help build a stronger system able to generate meaningful emissions reductions in this decade.

The new report, titled “Harnessing the EU ETS to reduce international shipping emissions”, assesses some of the economic impacts most pertinent for understanding the potential for the EU ETS to reduce international shipping emissions and stimulate investment in zero-emissions fuels. The EU ETS is the Union’s flagship cap-and-trade mechanism that has been in operation since 2005 to promote the reduction of greenhouse gases across the EU.

The EU’s proposal to include shipping in the EU ETS is a positive step to ensure that a portion of the global shipping industry is subject to a carbon price this decade — a key time period for the decarbonisation of shipping. However, the report finds that in its current proposed format, the EU ETS’ extension to global shipping may not contribute to significant emissions reductions or incentivise investment in Scalable Zero Emissions Fuels (SZEF). SZEF are a subset of fuels with the potential to produce zero emissions throughout their lifecycle and that have scalable production processes, capable of competitively supplying shipping’s expected future demand.

In addition to fuel and infrastructure policies, a higher carbon price is needed to incentivise crucial efficiency improvements while making nascent zero-carbon fuels more attractive. The study found that the EU ETS carbon prices, even at the record levels of €67.75/tonne CO2 observed recently, would not make a significant impact to close the gap between fossil shipping fuels and zero-carbon fuels. Recent analysis by UMAS for the Getting to Zero Coalition shows that an average carbon price of just under US$200/tonne CO2 is required to fully decarbonise the shipping sector by 2050.

The report also stresses the potential benefits of widening the scope of the scheme’s emissions coverage. The EU’s current proposal aims to cover maritime emissions from voyages within the European Economic Area (EEA) and half of the emissions from voyages into and out of the EEA from the rest of the world. Because vessels that trade internationally such as bulk carriers, containers, and tankers spend little time sailing within the EEA, the international or extra-EEA coverage is important to the success of the scheme. Further extending ETS scope from 50% to 100% of extra-EEA voyages could increase the emissions covered under the system by 70%.

Even under the full scope, the EU ETS may not provide a sufficient price incentive to drive investments in energy efficiency measures or SZEF. This is because most EEA related emissions come from ships which spend a relatively short period of time on EEA-related voyages during the year. Considering this annual trading pattern of ships, the average ‘effective carbon price’ (in the 50% and 100% extra-EEA voyages) is well below the historical variability in bunker fuel prices, when averaged across all ship types. For example, under a $103/tonne-CO2 price scenario in 2030, the average effective global price reduces to $22/tonne-CO2 or about 20% of the ETS price level because the majority of EEA-related emissions come from ships which spend a relatively short period of time on EEA-related voyages during the year.

In its current form, the low carbon price may lead to insufficient or unintentionally harmful outcomes. The price could incentivise purchase of allowances in the ETS market and potentially lead to some speed reduction on voyages with the EEA, which can help generate revenue and fuel savings but are not enough to drive significant emissions reductions. Additionally, the low-price level and the exemption of methane emissions from the EU ETS could incentivise the uptake of LNG-fuelled ships, which can lead to environmental and policy cost-effectiveness risks.

A reform for consideration is the use of sector-specific caps on emissions. As a cap-and-trade system, the EU ETS has an overall emissions cap that applies to all sectors in the system combined rather than on individual sectors. It is this ‘hard cap’ that ensures that across the ETS sectors, emissions decline at a linear rate consistent with the EU’s climate targets. Implementing a sectoral cap on shipping emissions could support in-sector decarbonization more directly.

Dr Sophie Parker, Principal Consultant at UMAS, lead author of the report said, “The shipping sector’s high abatement costs point to the need for an ETS which is tailored to support in-sector abatement. In the absence of a global carbon price, this could come from either a shipping ETS that places restrictions on the purchasing of out-of-sector allowances or coupling the EU ETS proposal with supply-side policies like subsidies which incentivise the uptake of scalable zero carbon fuels.”

A final important design opportunity is around the use of ETS revenues. Revenue is raised when ship owners purchase allowances from other sectors that find emissions reductions economically feasible at lower carbon prices, such as power generation. Currently, the EU directs revenue raised from the ETS to an Innovation Fund for low carbon innovation projects. This creates an opportunity to ring-fence an adequate amount of funds generated from shipping’s inclusion in the EU ETS for stimulating R&D and early adoption of SZEF, leading to a more cost-effective transition. Other opportunities to allocate the funds should also include addressing disproportionately negative impacts on States and supporting a fair, inclusive and equitable transition.

“The EU Emissions Trading System’s inclusion of shipping is a can’t-miss opportunity to clean up the climate impacts of shipping. If we optimise this system to cost-effectively incentivise zero carbon fuels and reduce greenhouse gas emissions, it could create a domino effect toward decarbonisation,” said Panos Spiliotis, Manager of International Climate at Environmental Defense Fund Europe. “The EU modeled climate leadership when it decided to include shipping in its ETS. Now, it has the opportunity to model climate ambition by designing this system to optimize impact.”

The proposal to include shipping emissions in the EU ETS is a step in the right direction toward the decarbonization of the hard-to-abate sector. By considering the above mentioned recommendations, the EU has an opportunity to strengthen shipping ETS when work begins on its Fit for 55 proposals.

Read the full report: Harnessing the EU ETS to reduce international shipping emissions

Join the fireside chat with the authors at 1000 GMT on 8th December 2021