New regulations aimed at reducing the maritime shipping industry's greenhouse gas (GHG) emissions will have a substantial impact on day-to-day operations in the maritime sphere.

Background

The Energy Efficiency Design Index (the EEDI) - the first set of mandatory measures to improve energy efficiency of new build vessels adopted in 2011 - and the Ship Energy Efficiency Management Plan for all ships (adopted by the MARPOL Annex VI Parties) were seen as "fundamentally changing the baseline for the performance of the incoming global fleet in terms of the emission reductions".

New regulations, the Energy Efficiency Index for Existing Ships (EEXI) and the Carbon Intensity Indicator (CII) (the Regulations), adopted earlier this year apply to:

  • all ships over 400gt to calculate their EEXI; and
  • all ships over 5,000gt to initiate the collection of data for reporting their annual operational CII.

The Regulations will result in ships being given a rating for their energy efficiency and it is thought that over time, certain actors in the market (port authorities, governments and other stakeholders) will provide incentives to those who have achieved the highest rating for their vessels.

What is EEXI?

EEXI sits alongside the EEDI but they have their differences; EEDI applies to new build vessels whereas the EEXI applies to existing vessels.

EEXI is based on design parameters, such that a minimum standard for existing ships should be established and that only those designed for efficient low carbon emitting vessels should be allowed to continue trading. EEXI is a one-off classification of the energy efficiency of a vessel's design, construction and technical features.

Taken together, the EEDI and the EEXI aim to improve the global fleets' energy efficiency. There is a maximum threshold level that the relevant indices must fall below; and that threshold level has been steadily lowering every 5 years.

It is no great surprise then that in order for existing fleets to meet these thresholds they must become more and more energy efficient, which will not always be financially viable and hence the real impact will likely come from the new EEXI requirements and their application to existing vessels.

What is CII?

The CII determines the annual reduction factor needed to ensure continuous improvement of a ship's operational carbon intensity within a specific rating level. The actual annual operational CII achieved must then be documented and verified against the required annual operational CII. This enables the operational carbon intensity rating to be determined. Based on a vessel's CII, a vessel's carbon intensity will (from 2024) be rated A, B, C, D, or E (A being the highest rating). The rating awarded to a vessel signifies a major superior, a minor superior, moderate, minor inferior or inferior performance level.

Impact of compliance for owners/operators

EEXI compliance

In order to comply with EEXI, a vessel will have been installed with either an engine power limitation device or with energy saving devices by way of technological refits which will increase the efficiency of the vessel:

(i) Technological retrofits – since EEXI relates to the design of the vessel, the retrofit of "clean" technologies was seen by many as the only realistic and "fail safe" way of achieving compliance with EEXI. This was of course not always financially feasible (often dependent on the age of the existing vessel in question) for either shipowners or operators (both of which bore the costs of this in some form) and often, where compliance proved to be too onerous, owners elected for the scrap yard.

(ii) Engine Power Limitation –. in some ways, the adoption of engine power limitation devices (which, in effect, reduce the speed of a vessel) have been the most cost-effective solution for owners and have not imposed particular or significant disruption to the operation of the vessel (at least in the short term). But owners will be wary of the impact on future charter agreements of adopting these devices; reduction of speed will invariably put owners of such vessels at a disadvantage when negotiating the hire rates they are able to demand from their charterers.

CII compliance

The CII framework, unlike EEXI (which is essentially a one-time certification regime), imposes ongoing obligations on owners on the actual carbon emissions of a vessel. A vessel's CII is to be calculated and reported annually using a formula prescribed by the International Maritime Organisation. A vessel will then be awarded its rating (as before, ranging from A to E). Those vessels that continuously receive subpar CII ratings (e.g., D for three consecutive years or E for any length of time), are required to submit corrective action plans setting out the steps that the owners will take to reach the required index level of C or above. Given the ongoing nature of CII compliance, the compliance burden could, therefore, arguably be higher than that of EEXI compliance.

Certainly, compliance with CII has the capacity to impact directly the rights and obligations of owners and charterers more than compliance with EEXI. In a time charter, for example, the charterer's orders could result negatively in a vessel's CII rating, while slow steaming or the choice of different and longer routes might result in the vessel attaining a higher CII rating, these actions may be deemed breaches of an owner's obligation to proceed with utmost dispatch.

Impact of compliance for financiers

The carbon intensity of a vessel is obviously aligned to responsible environmental behaviours of owners which is not something that is new to the market; banks and financial institutions have been focused on this for several years.

The Poseidon Principles are one example of recent measures taken by banks and financial institutions as a response to the need for a global framework for responsible ship finance. The Poseidon Principles, signed up to by certain members of the financing community and which impose measures on their shipowner customers to reduce carbon emissions of the vessels that the banks were financing, are, however, a voluntary set of principles.

The measures imposed by the Regulations, however, add another limb to a vessel's bankability; lower ratings, for example, or lagging technological improvements to lower carbon emissions will likely impact pricing on ship finance loan facilities and the collateral value that the banks give those vessels.

Not only will the financing of vessel purchases potentially be impacted by the introduction of the Regulations. So too may the financing of upgrades to vessels. Some owners may be wary of banks' response to the "bankability" of improvements and upgrades when the measures that are often the impetus to these are continuously shifting in an upward trajectory of ever greater efficiency for CO2 emissions. However, banks will likely recognise that these measures are by necessity in a state of flux and are now part of the lending landscape as part of the global effort to reduce the industries' carbon footprint and fit with the aim of most funders' operating in this sphere of providing support for these types of initiatives and measures.

The impact which the Regulations will, or might potentially, have on owners, operators and lenders, highlights, perhaps, that a more "joined up" approach between the new efficiency Regulations and certain internal measures to which the banks and financial institutions operating in the market are subject (such as the Poseidon Principles) would give greater clarity and consistency for owners charters and banks trying to navigate the myriad of measures aimed at reducing GHG.

Contributors

Hannah Sinclair

Senior Associate

Bruce Stephen

Head of Banking and Financial Services & Partner