What will FuelEU mean for the LNG sector?

FuelEU¹ will take effect from 1 January 2025. The compliance implications will be significant for many key stakeholders who consume conventional liquid fossil fuel, because how a fuel is produced will now be just as important as the type of fuel a ship consumes. Stakeholders will need to decide on compliance pathways and strategies, both to minimise the impact FuelEU will have on operational costs and business and also to maximise the potential opportunities it will create. 

This article explains FuelEU, assesses the important role LNG could play in the shipping sector’s compliance choices in the coming years and offers some commercial and contractual considerations.

What is FuelEU?

FuelEU will regulate the greenhouse gas (GHG) intensity of the energy and fuels used on board ships above 5,000 GT which call at EEA ports from 1 January 2025, irrespective of flag. 

It sets maximum limits for the yearly average GHG intensity on a well-to-wake (WtW) basis (GHG Intensity Limit).  The GHG Intensity Limit will apply in 5 year periods, mandating a 2% reduction from 2025, 6% from 2030 and more acute percentage reductions from 2035 through to 2050.

From 2026 onwards, ships will be assigned a compliance balance, which will either be in surplus or in deficit depending on whether the GHG Intensity Limit has been exceeded. 

A ship’s annual GHG intensity performance will be monitored during a calendar year and reported to an accredited verifier in the following year.  Once verified, either a Document of Compliance will be issued or a Euro fiscal amount (FuelEU Penalty) will be payable. 

The designated compliance entity (Company) responsible for meeting the GHG Intensity Limit (including any FuelEU Penalty) will be the ISM document of compliance holder² which, in most cases, will be the technical shipmanager. 

In addition to the mandatory GHG Intensity Limit, FuelEU will introduce a requirement for zero emissions at EU berths from 2030³ and a potential renewable fuels of non-biological origin (RFNBO) sub-target from 2034.⁴

What compliance tools and pathways are available?

Due to the WtW GHG intensity of VLSFO and MGO, ships using these fuels exclusively will almost certainly generate a deficit compliance balance and incur a corresponding FuelEU Penalty.

Companies should therefore reflect carefully on the compliance pathway(s) that best suit their operations, fleet profile and commercial objectives to achieve compliance.  These could include:

• Paying the FuelEU Penalty: The simplest compliance option, this is unlikely to be sustainable long term due to the accelerated percentage reductions in the GHG Intensity Limit. It may also be more expensive than other options.
• Borrowing/Banking: Companies can bank a compliance surplus to future reporting periods.  Under limited conditions, they can also borrow against a future reporting period (at a 10% premium).
• Pooling: Compliance balances can be pooled with other ships, spreading the risk and cost of compliance, but also creating the opportunity to monetise FuelEU.  However, pooling must comply with FuelEU and pooling choices (eg with whom and on what basis) should be considered carefully, together with the associated risks and benefits.
• Using less GHG intensive maritime fuels⁵: Options here include LNG, biofuels, LPG and RFNBOs.  Substantial investment may be required in new technologies and retrofits to deploy these at scale.  It may also increase the operational risk or fuel cost. 

What role does LNG have to play?

It has been suggested that that the shipping sector will need to reduce 2.4 million tonnes of CO2eq to meet the 2025 FuelEU compliance target and that the existing fuel mix of low GHG intensive fossil fuels (LNG and biofuels) may be able to make up a significant amount of this reduction.⁶ This is because, depending on the combustion system and provision for methane slip⁷, it is expected that ships consuming LNG⁸ will not only meet the GHG Intensity Limit(s) but will actually create significant compliance balance surplus into the 2030s.  If so, LNG occupies an important space in the shipping sector’s compliance possibilities through pooling of compliance balances, at least until alternatives (such as RFNBOs) are readily available (and accessible) at scale for the sector. 

Commercial and contractual considerations

Using LNG to achieve compliance will be a more intricate process than simply amending bilateral contracts (eg time charters) on an individual ship basis because the implications of FuelEU are more complex than other shipping emissions-related regulations such as EEXI, CII and EU ETS. Key considerations include the following:

• Time charters: These will need to be amended to account for FuelEU.  The traditional approach of passing down responsibility for compliance risk and cost may need to be modified, especially where the prospect of a compliance balance could be a benefit (surplus) rather than a burden (deficit) in the short term.  Negotiations are likely to centre around orders as to fuel consumption and boil-off gas and entitlement to any surplus, given that charterers are responsible for fuel supply.  Where a charterer is looking to receive the FuelEU benefit of a ship, it will need to ensure it has access to the surplus and the right to direct and control the Company (with which there will be no direct contractual privity).  This applies equally where there is a deficit and pooling could attract a lower cost than a FuelEU Penalty.  However, the longer the charter duration, the increased risk that a FuelEU Penalty may still materialise in the medium to long term even where LNG is used.  BIMCO have also recently published their BIMCO FuelEU Maritime Clause for Time Charter Parties 2024.⁹

• Pooling: This presents the opportunity for stakeholders to either manage their exposure to the compliance cost on a fleet basis or to monetise over-compliance.  Provided there is an available market and the pooling cost is less than the FuelEU Penalty, a surplus may be sold to ships which have a deficit.  There is no standard format for this.  Multi-party negotiations are likely to be required, depending on the commercial objectives and this will influence the contractual structure and framework to be used.  Stakeholders should consider this option carefully in light of their FuelEU strategy (see below) as it will impact the approach taken in time charters.

• FuelEU Strategy: The use of pooling will depend on the stakeholder’s approach to FuelEU as well as operational, commercial and counterparty risk related factors.  This will come down to whether FuelEU is to be viewed as a compliance burden or a risk management exercise (which can have an upside).  For shipowners and operators, it may depend on the size and diversity of a fleet (including any newbuild/retrofit programmes), fuel choices and whether it involves owned and chartered tonnage operating in different sectors.  For charterers, it may depend on the risk and responsibility allocated under contracts which, again, may be used to minimise exposure to a FuelEU Penalty. Charterers may also be better placed to take advantage of the unique opportunities created by FuelEU by trading and pooling compliance balances. 

• LNG bunkering: With the 2023 orderbook indicating that the largest share of alternative fuelled orders remains LNG dual-fuel ships¹⁰ and an increase in demand for LNG fuel as a compliance pathway, LNG bunkering will become increasingly important.  Please see our article on LNG bunkering for more information.

HFW Comment

HFW is working with clients across the sectors to navigate FuelEU and is advising on compliance strategies, pathways and contractual solutions to achieve not only compliance, but also commercial goals. Please contact us if you would like to learn more.

Research undertaken by Valerio Carlini, Trainee Solicitor.

Footnotes

1. Regulation (EU) 2023/1805 of the European Parliament and of the Council of 13 September 2023 on the use of renewable and low-carbon fuels in maritime transport, and amending Directive 2009/16/EC.
2. Defined as the shipowner or any other entity (such as the manager or bareboat charterer) that has assumed responsibility for the operation of the ship and agreed to undertake the duties and responsibilities imposed by the ISM Code.
3. This applies to containership and passenger ferries – where onshore power supply or zero-emission technology will be mandatory – requiring compliant port calls to be made.
4. In circumstances where there has been less than a 1% uptake of RFNBOs, also known as e-fuels, by the sector by 2031, Fuel EU Maritime will also introduce a 2% sub-target for use of RFNBOs on board ships from 2034.
5. Making use of onshore power and wind-assisted propulsion will also contribute towards zero-emissions and Fuel EU Maritime compliance.
6. FuelEU Explainer: Is the industry ready for 2025? | Mærsk Mc-Kinney Møller Center for Zero Carbon Shipping
7. Annex II, Fuel EU Maritime and including the type and amount of pilot fuel used.
8. LNG carriers and LNG dual fuel ships.
9. https://www.bimco.org/contracts-and-clauses/bimco-clauses/current/fueleu-maritime-clause-for-time-charter-parties-2024
10. https://www.tradewindsnews.com/insight/clarksons-hails-hugely-significant-year-for-shipping-industry-decarbonisation/2-1-1578209