ETS: trade diversion risk?

ETS IN A NUTSHELL
Under the extended ETS legislation¹, shipping companies need to surrender allowances for CO₂ emitted by commercial cargo and passenger ships of 5000 gross tonnage (GT) and above. A gradual phase-in will apply between 2024-2026. By 2026 the European Commission will review whether ships between 400 and 5000 GT will also be included in the EU ETS. In addition to CO₂ emissions, the legislative bodies agreed to include methane and N₂ O in the EU ETS from 2026 onwards.

As further details are still awaited, this Business Briefing focusses on CO₂ emissions. Box 1 explains how the ETS allowance system will work in practice.

The proposed ETS obligation differs between CO₂ emitted on intra-EU voyages (100 per cent allowances) and extra-EU voyages (50 per cent allowances). An intra-EU voyage is defined as a voyage where both the origin and destination of the voyage are within the EU. If either the origin or the destination is outside the EU, the voyage is defined as extra-EU. The distinction is relevant as it can create a financial incentive for shipping companies to reduce intra-EU voyages².

POTENTIAL IMPACT
Generally speaking, the lower the geographical distance towards an alternative non-EU transshipment port, the larger the risk of shifting trade routes. The risk that container shipping companies will try to avoid the ETS obligation will depend on different variables including the ETS price, (alternative) fuel prices and the existence of alternative shipping routes using ports outside the EU. Figure 1 provides an overview of large EU container ports and geographically nearby non-EU ports. RHDHV notes that the risk of shifting trade routes towards ports outside Europe is particularly relevant for transshipment activities; import/export cargo is less likely to be rerouted. 

COST BENEFIT ANALYSIS
The RoyalHaskoningDHV has setup a financial cost-benefit analysis to assess the financial impact on shipping companies and the risk of shifting trade routes. The building blocks of the financial cost-benefit analysis are fuel costs, charter costs and the expected costs as a result of the obligation to surrender ETS allowances, referred to as “ETS costs”. On the one hand, a shift of a trade route towards a port outside Europe is expected to lead to lower or zero ETS allowance costs. On the other hand, a shift is expected to lead to higher charter costs and fuel costs. RoyalHaskoningDHV has developed its own regression models to estimate charter and fuel costs for different vessel types based on historical data of, among others, Seaweb and Clarksons. The financial cost-benefit analysis is set up for two cases:

1. Eastbound (Asia-Europe): 20k TEU ship from Suez to Algeciras (2002 nm)
2. Westbound (Transatlantic):10k TEU ship from New York to Rotterdam (3383 nm)

For the sake of simplicity, this study uses the following assumptions:

• The analysis is based on container transshipment;
• The analysis is based on ETS allowance costs after the gradual phase-in period;
• The analysis assumes similar port costs in EU port and non-EU port;
• The analysis takes into account a specific leg of a larger container routing. The effects on the total routing (e.g. Asia – Europe) are not part of this analysis.

RISK OF EVASION
The risk that container shipping companies will try to evade the ETS obligation will depend on different variables including the ETS price, (alternative) fuel prices and the existence of alternative shipping routes outside the EU. Generally speaking, the lower the geographical distance towards an alternative non-EU port of call, the larger the risk of shifting trade routes. RHDHV has estimated the ‘tipping point’ where the avoided ETS allowance costs outweigh the increased charter and fuel costs.

On the Eastbound case (FIgure 2), the tipping point is estimated at a geographical distance of around 400 nautical miles from the original EU port of call. Beyond that point, the additional fuel and charter costs are likely to outweigh the avoided ETS costs.

On the Westbound case (Figure 3), the tipping point is around 650 nautical miles.

The difference between the Eastbound and Westbound case is due to multiple factors including the distance of the original trade route and ship size assumptions. As expected, the risk of ETS evasion will be higher if the original trade route (e.g. New York to Rotterdam) is longer and the geographical distance towards an alternative non-EU port is lower. A sensitivity analysis (Figure 4) shows that the ‘tipping point’ can decline to around 300 nm (Eastbound) and 500 nm (Westbound) in case of higher fuel prices.

STAKEHOLDER IMPACT
At this stage it is hard to predict to what extent the additional ETS costs will be transferred to customers (i.e. higher cost per TEU) and to what extent shipping companies will intensify their efforts towards clean fuels as a result of the ETS regulation. RHDHV notes that reliable access to alternative fuels will help making the shift, which underpins the importance of initiatives like the Green Corridor between Singapore and Rotterdam. An important takeaway from this analysis is that European regulators should closely monitor potential evasive behaviour to make sure the desired decarbonisation efforts of the maritime sector are to be achieved. 

_{[1] As the legislative text has not been published yet in the EU Official Journal, this Business Briefing is based on the publicly available information about the agreement.}

_{[2] To avoid evasive behaviour, the new legislation includes a specific clause for container ships calling at non-EU transshipment ports (which have >65 per cent transshipment activity) which are located less than 300 nautical miles from an EU port. Although the leg from origin to the transshipment port technically can be considered a voyage between a non-EU port and another non-EU port, still 50% of the ETS allowances are required for this voyage.}