International shipping’s inclusion this year into the EU ETS is raising demand for insurance solutions that can transfer the potential credit risks.
The scope of the EU ETS, the union’s cornerstone policy for combatting climate change, was expanded to include international shipping this year, forcing the registered owners of ships of 5,000 gross tons or greater to purchase carbon credits to offset their greenhouse gas (GHG) emissions when using EU ports.
The regulation is designed to gradually reduce GHG emissions from Europe’s industries and align them with the global ambitions of the United Nations' Paris Agreement. The inclusion of shipping features a three-year phase-in that gradually increases in scope by mandating owners to offset or reduce emissions by 40% in 2024, 70% in 2025 and by 100% in 2026.
The regulation requires shipping companies to purchase and surrender (use) credits (EU allowances), for the ship emissions they report. The administering authorities are tasked with verifying this and ensuring compliance. In doing this, the EU ETS has effectively set a cap on GHG emissions and steered companies on a path toward greater energy efficiency and low-carbon solutions.
The carbon markets comprise of compliance and voluntary markets. Compliance markets are regulated through international, regional, or sub-national carbon reduction schemes and include the EU ETS. Governmental organizations issue carbon emission allowances to their domestic firms and sectors and they are governed by cap-and-trade regulations. A cap or limit is set on the total amount of specific greenhouse gases that can be emitted and the cap is reduced over time so that total emissions fall.
The compliance markets have strict guidelines regarding the types of credits that are eligible under their schemes; carbon credits purchased from the voluntary market cannot be used for EU ETS compliance purposes. EU Allowances (EUAs) are the carbon credits used in the EU ETS scheme. EUAs can be purchased in the primary market through auctions on the European Energy Exchange (EEX). There is also a secondary market in which allowances can be sold bilaterally or through various derivatives provided by financial institutions. Counterparty credit risk non payment linked to those derivatives contracts can also be insured within the credit insurance market.
The voluntary carbon markets, which work in parallel, are markets whereby buyers and sellers operate on a voluntary basis; without having to comply with legally binding obligations. Insurance solutions for the voluntary carbon markets are currently available.
The EU ETS rules state that the shipowner is the responsible party for purchasing and surrendering EUAs. Some shipowners retain the risk and keep the liability on their balance sheet however in some cases the responsibility is granted to the managing agent (a third-party operator) through a standard ETS Mandate 2024 form.
With additional responsibility, there's a chance of financial risks. This can happen when shipowners of managing agents buy and give up allowances. The risks identified are:
Shipowners and managing agents are looking at insurance as well as other forms of bank guarantees as a means to protect these liabilities.
Shipowners may face regulatory risks associated with the legislation’s maturation process. According to recent reports, the current EU ETS regulation clearly state that the registered shipowner is responsible for ensuring compliance. However, it's sometimes not clear when these responsibilities can be transferred to charterers and ship managers according to reports.
From an environmental perspective, the stakes are as high as they are well known. Shipping is responsible for about 3% of global emissions, a proportion that was estimated by the Organization for Economic Co-operation and Development (OECD) at 858 million tons of CO2 in 2022. The industry must cut down on its emissions by 15% before 2030. This is important if the industry wants to reach its goal of net zero emissions by 2050, according to the International Energy Agency (IEA).
From the EU ETS perspective, the cost to shipowners will depend on the energy efficiency of their ships, the distances they travel and, initially, the associated number allowances needed to achieve compliance. Global estimates of those costs vary greatly.
One widely cited report, by OceanScore, suggested that Asian shipowners will face EU-ETS related emission liabilities for trips to Europe of around €500 million this year, when they will be liable for 40% of their ships’ emissions. By 2026, when they will be liable for 100% of their emissions, that figure could reach €1bn, depending on the fluctuating price of carbon trading in Europe.
Any way you slice it the financial and credit risks to shipowners and their managing agents associated with the EU ETS are significant and can be expected to escalate as demand for allowances increases.
The inclusion of shipping into the EU ETS has highlighted the innovation needed in the insurance industry to design risk transfer products specifically for the maritime sector. WTW has been working with managing agents and exploring solutions to the credit risks imposed on them by the shipowners of vessels, partnering with carbon insurers as well as credit insurers to seek bespoke solutions to the managing agents’ portfolio of risks.
Tailored protection against carbon credit and related credit risks can help to provide shipowners and their third-party operators with the financial confidence to purchase the emissions allowances they need to meet their obligations and mitigate some of the risks that may be out of their control.
WTW is aiming to support industries that are regulated to purchase emissions allowances with insurance solutions that will build confidence in the EU ETS.
To find out more about how WTW can help to transfer your risks, including portfolio cover for all vessels managed on behalf of an owner, please contact us.
Trevor McGarry, Head of Cargo & Specie, GB, discusses the current market conditions for the Marine industry.
