In January 2023, the International Maritime Organisation’s Carbon Intensity Indicator (CII) regulation entered into force. In essence, the CII is an efficiency rating per vessel that rates each vessel larger than 5,000 gross tons into rating categories from A to E. Shipowners are required to keep their vessels in a C rating or higher.
Consequently, in order to avoid negative impact on their business and the value of their vessels, shipowners around the globe now have to monitor closely how the CII ratings across their fleet are developing in the course of a calendar year.
And, depending on the way they charter out their vessels, they have to agree with their charterers on how to keep the CII in C or higher.
At the same time the European Union has decided to extend the mandatory Emission Trading System (EU ETS) to shipping. The first year for which emission certificates will have to be surrendered is 2024. 40% of EU-emissions will need to be compensated then. In 2025 it will be 70%, in 2026 100%. EU-emissions will be defined as emissions from voyages between EU-ports (100%) and between a EU-port and a non-EU-port (50%).
The EU ETS will thus in essence increase direct voyage costs for trades into and within the European Union. Shipowners around the globe who send their vessels to Europe will need to understand how ETS changes their competitive position - more efficient vessels will be cheaper to operate in Europe than less efficient vessels.
In any case, owners will try to roll over ETS costs to their charterers who in turn will try to roll over costs to shippers and cargo owners.
Now, shipping knows (next to some others) two major forms of charter agreements: time charters and voyage charters.
The time charter case
In a time charter, the charterers take over the vessel for a defined period of time and operate the vessel according to their own needs. They are fully responsible for the schedules and trades and thus can be defined as the main “polluter” when it comes to carbon emissions: While the ship’s technical efficiency does have an impact on emissions, the actual operations are mostly considered as more relevant for total emissions. For CII this is even more true as the actual trade has a very high impact on the rating (compare zero44 guidebook article I).
Consequently, BIMCO has proposed that both for CII and EU ETS, the charterer in a time charter contract shall be responsible for keeping CII ratings in line and purchase the ETS certificates (thus bearing the financial risk from price fluctuations).
The picture above describes how ETS will change the charterer’s cost position. Please note, that in a time charter, voyage costs are borne by the charterer. ETS will be an add-on to voyage costs, another reason why it makes sense to put ETS costs on the charterer’s side.
Overall, ETS costs will be no joke: In our example with actual data from 2020 and a hypothetical market price of 80 USD per ton of CO2 the charterer will face additional costs of USD 1.3m per year.
2023, as the first year in which the CII is in force, has just started. It has started in a time where the time-charter-markets have seen a shift in supply and demand, currently to the disadvantage of the owner. There is more supply of container tonnage than there is demand and many owners find it difficult to convince their charterers to agree on the BIMCO clause for CII. Many operators rather request the owner to invest in vessel efficiency first before they might be willing to adapt schedules to keep the CII in “C”. Most companies are currently observing the situation rather than actively intervening. If you are looking for a lean way to keep an overview of your CII exposure, contact us at zero44 to learn more.
Will we see the same thing happening once ETS comes into force? How can cost sharing work in practice? We will be happy to discuss our ideas on this with you, so please reach out to us if you are interested.
The voyage charter case
In a voyage charter the charterers book a specific voyage for a specific cargo. The cargo can fill the whole vessel, then there is one charterer per voyage - or it can just take up part of the vessel, then multiple charterers might be counterparties to the owner who is performing the voyage. Obviously, owners and charterers will still agree on a schedule - however how this schedule is put into practice, what fuel is used, etc. is completely up to the owner. The “polluter” in a voyage charter is rather the owner than the charterer.
Voyage charters put the voyage cost on the owner’s side as the picture below shows. The owners will calculate the freight rate for the charterers accordingly and make sure that the voyage will be profitable for them. They might use bunker surcharges to account for fuel price changes to make sure their calculation does not rely on too much uncertainty. Consequently, the same will be done with ETS costs: they will be either directly included in the freight rate or rolled over via an ETS surcharge.
For CII the owners are actually in full control of their vessels’ ratings. However, they have to make sure that the voyages they execute aren’t ruining their rating. In order to do that they need to make conscious decisions on how to deploy the vessel next. If you are looking for support in planning and optimizing future voyage charters with respect to CII and EU ETS, reach out to us at zero44 to learn more.
In summary, CII and EU ETS bring significant changes to charter agreements. For costs to be rolled over across the value chain of shipping, data transparency and data sharing will be key to avoid legal conflict. Keeping an overview of all the transactions and making sure that after a year your CII target is met and your compliance account at the Union Registry (the registry used by the EU to claim the EU allowances for carbon emissions) is filled with the right amount of allowances requires continuous overview and monitoring. Let us know if you are interested in learning more about how software solutions can help you with your CII and EU ETS compliance requirements.