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The FuelEU Regulation will be effective as of 1 January 2025 and will, just as the EU ETS, significantly impact the cost structure and trading patterns of most ocean-going vessels in the EU. It will, as a consequence, impact most vessel related contracts including time charter parties. The regulation’s polluter pays-principle and the particular features of time charter parties entail some unique dilemmas for owners and charterers which can only be solved through carefully worded clauses.
We will in this newsletter describe how time charter party clauses for FuelEU could preferably be worded to protect owners’ exposures on FuelEU penalties and charterers’ interests – and to best align the purpose of the FuelEU Regulation with the commercial and operational realities of international shipping.
The FuelEU Regulation[1], EUs most recent regulation intented to decarbonise shipping, governs the greenhouse gas (GHG) intensity for the fuel used onboard vessels on voyages to and from EU ports. Specifically, it sets out targets for vessels to reduce the GHG intensity ratio on a yearly basis. Simply put, the less GHG the vessel emit compared to the amount of energy used onboard the vessels, the better.
Depending on whether the vessel’s total GHG intensity in each reporting period (i.e. calendar year) is below or above the target intensity ratio set out in the regulation, a vessel’s compliance balance will be positive (creating a surplus) or negative (creating a deficit). Crucially, if a vessel obtains a deficit for a reporting period, a FuelEU penalty (calculated based on a formula in the FuelEU Regulation) will be payable unless the vessel is pooled with other vessels carring a surplus[2].
The FuelEU Regulation sets out that a the vessel’s DoC holder, i.e. potentially external technical managers, are the responsible entity to ensure compliance with the regulation. It is thus unlike the EU ETS which (now) provides that the registered owner is responsible unless the registered owner mandates the DoC holder to assume this responsibility[3]. The same mandate mechanism is not – and should not be expected in the short-term – to be implemented for FuelEU[4].
For more background on the FuelEU, we refer to our newsletter of 11 March 2024 (link). Furthermore, we can recommend the FuelEU newsletters published by the Mærsk Mc-Kinney Møller Center for Zero Carbon Shipping, available on www.zerocarbonshipping.com.
In the time charter party context, while owners (or DoC holder) are the responsible entity from a regulatory perspective, the charterers will effectively – through the procurement of fuels and decisions to trade in the EU – control whether the vessel will be in a deficit or surplus. For the same reasons, the FuelEU Regulation acknowledges that time charterers constitute the “polluter” who ought to pay for the costs relating to ‘under-compliance’ (i.e. the FuelEU Penalty).
Nonetheless, the FuelEU Regulation provides for no mechanism for the charterers to bear the burden of the actual costs of FuelEU deficits under e.g. time charter party. Unless otherwise agreed: the owners are practically in the hands of the charterers and the owners will have to bear the costs. The solution to this predicament can only be provided by contract.
For completeness, owners may seek to rely on general indemnity provisions in charter parties requring charterers to cover voyage-related costs, including charges and taxes. Examples include BALTIME, Cl. 4, SHELLTIME, Cl. 7 and NYPE 2015, Cl. 40. However, as none of these clauses have been written with the FuelEU Regulation in mind, and due to the particular features of the FuelEU penalty, owners will often not be certain to be able to claim reimbursment for these costs. In any event, such clauses are unlikely to give owners a basis to claim reimbursment prior to the FuelEU penalty be determined by the authorities (long after the completion actual voyages causing the penalty)[5], leaving a significant expense for owners for a lengthy period.
If the parties wish to have a proper framework for handling the issues relating to the FuelEU Regulation, and avoiding unnecessary disputes there is no way around implementing a specific FuelEU clause.
The FuelEU Regulation includes a very explicit and clear GHG intensity target for the owners to meet in respect of vessels trading in the EU. This target will likely not be met for vessels which only use conventional fuels such as HFO and VLSFO.
On this basis, noting that charterers have full authority to choose between (lawful) fuels, it may seem as a necessary feature of FuelEU time charter party clauses to require the charterers to ensure that the vessel’s compliance balance is positive for each reporting period; i.e. that no deficit will accrue as the (owners’) vessel would otherwise be in ‘non-compliance’ with FuelEU.
Such approach would, however, reflect a gross misunderstanding. The FuelEU Regulation does not require the owners (DoC holder) to meet the GHG intensity target in respect of each voyage or even the whole reporting period for which the compliance balance is calculated. The FuelEU ‘merely’ require the responsible entity to ensure, e.g. through the payment of the FuelEU penalty, that the vessel become compliant. The FuelEU penalty does not, if paid, reflect any violation of the FuelEU Regulation but merely a means to comply. The FuelEU – and the FuelEU penalty – is rather to be viewed as a general financial incentive to use alternative fuels – however not for each vessel considered in isolation but for the fleet as whole. It may, depending on trading patters, the availability of biofuels and other alternative fuels and costs for the various fuels, both conventional and the greener alternatives, be more efficient to use (‘excessive’) amounts of green fuels on some vessels while allowing for other vessels to remain on ‘pollutive’ conventional fuels.
Importantly, this ‘permission to pollute’ is part of the reasoning for the FuelEU’s ingenious pooling mechanism. It is ‘okay’ to pollute and get a deficit if you pay the costs for purchasing a surplus from a third-party owner using greener fuels – if they are not simply pooling their own vessels[6].
Consequently, there seems to be no general persuasive basis for the FuelEU clause to require the charterers to use green fuels to meet the GHG intensity targets for a vessel on charter. It seems indeed impracticle if charterers – who may have used conventional fuels in the beginning of the year, resulting in a deficit – were then required to trade in the EU and then use green fuels in the last part of the year not for commerical reasons, but simply to offset the deficit with a surplus. The owners will also have no effective means to enforce such a requirement and it would if widely adopted likely negatively impact the effective allocation of vessels between EU and non-EU trades. Finally, any such requirement to avoid a deficit would not be needed to protect the owners as long as the owners have certainty of charterers’ full payment of the FuelEU penalty (see below).
The FuelEU Regulation includes a ‘compliance circle’ meaning that the responsible entity, need to ensure compliance with the regulation for each reporting period. Specifically, the decisions – on banking, pooling borrowing etc. – need to be effectuated in April of each verification period following the reporting period. In respect of the first reporting period, i.e. 2025, owners (or in principle the DoC holders) will need to effectuate the compliance decisions in April 2026.
The calendar year based regime may seem as a proper basis for the time charter party clause to also be structured around the calendar year. It could simply be agreed that the charterers were to reimburse the owners for all costs of a FuelEU penalty following the end of each calendar year (unless the vessel is redelivered earlier). For several reasons, this otherwise logical solution may though involve significant risks for the owners, mainly the build-up of large FuelEU penalty. There are, in our view, persuasive reasons for – more often than not – to agree on a monthly reconcilation, for vessels trading in the EU. The clause could provide that the charterers should pay a monthly surcharge (similar to a ETS surcharge) to owners based on the estimated FuelEU penalties while permitting the charterers to make hire deductions if these penalties are subsequently reduced due to monthly surpluses.
The case for a monthly adjustment of the FuelEU can be summarised as follows:
Based on the current practices on the monthly reconcillation under the EU ETS, the same should be feasible in respect of the FuelEU. It may thus fit most parties’ operating procedures for the ETS (as also provided for in BIMCOs ETS clause for time charter parties). Furthermore, monthly payments should be able to reasonable protect owners’ interests which would not be provided based on the yearly payments (unless the charterers provide alternative financial security). Monthly payments may also allow the owners to suspend performance under the contract if the charterers do not pay the surcharge (as most charter parties already provide in respect of hire payments). This may not be an effective remedy if the FuelEU penalty is only payable after delivery or at year end.
Naturally, this arrangement should only be agreed by the owners if they have comfort in being able to provide the data on a monthly basis – and if not verified, then based on owners’ best estimate. The wording in the contract should be aligned to cater the specific possibilities of the owners.
From a regulatory perspective, it is the DoC holder’s (and in the time charter party context, the owners’) sole responsibility and right to handle the compliance balance (surplus or deficit) for each reporting period. As the charterers procure the bunkers, it may though be argued that the charterers should also be in charge of handling the compliance balance on its own account. This may be done by agreeing contractually that owners should follow charterers’ instructions.
Such an arrangement would also allow the charterers to also obtain the (financial) benefit and risk of any surplus resulting from the charterers’ decisions to use alternative fuels.
Still, this may not work in all situations, in particular in short-term time charters where each charterer would not be able to control the compliance balance for the entire year. Furthermore, many charterers will simply not want to take this responsibility (even contractually) but merely pay the owners for the troubles. The owners may in some situations be better equipped to pool the vessels than the charterers, and in others, it will be the charterers. It will for instance in commercial pools be logical for the pool manager to fully control the compliance balance for all the pool vessels.
The exact, practical implementation of the pooling mechanism is not quite in place as it need to be effectuated through the FuelEU database which is not yet in place. In any event, it may be relevant to incorporate protections for the owners in the time charter clause even if the charterers are given the power to deal with the compliance balance for any given reporting period on behalf of owners. This is relevant as the compliance balance ‘sticks’ to the vessel. If the charterers fail to pool and then fail to pay the FuelEU penalty, the owners will be left with a non-compliant vessel.
The FuelEU is a complex regulation and this newsletter does in no way consider everything relating to time charter parties. The parties should consider other aspects, such as charterers’ obligations in respect of certification for the alternative fuels, potential reductions during off-hire periods, potential final adjustments of payments based on the final verified data (available in March in the verification period) and even an adjustment based on the final, actual costs – or proceeds – of pooling. These features should always be carefully considered on a contract-by-contract basis.
In conclusion, it is to be seen how the industry will handle the FuelEU Regulation respect of the time charter parties. Many unforseen developments have occurred in respect of the CII and the EU ETS. The FuelEU Regulation is – in our humble opinion – unlikely to be any different.
Gorrissen Federspiel is a knowledge partner with the Maersk Mc-Kinney Møller Center for Zero Carbon Shipping and actively assist owners, charterers and other stakeholders in preparing for the FuelEU and other decarbonisation regulations, both on the compliance and contractual issues.
[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 (the “FuelEU Regulation”).
[2] The responsible entity may subject to certain restrictions also decide to borrow an advance compliance surplus. See our newsletter of 11 March 2024, section “Compliance mechanisms”: FuelEU – introducing the new watershed regulation – Gorrissen Federspiel
[3] For the issues under ETS in respect of technical management agreements, see our newsletter of 27 June 2024: SHIPMAN and the ETS – a matter of agency? – Gorrissen Federspiel
[4] See our newsletter of 11 March 2024, section “Who is responsible? …” FuelEU – introducing the new watershed regulation – Gorrissen Federspiel
[5] The clauses will also not take any of the aspects of the FuelEU Regulation into account such as the new requirements for certification of marine fuels as provided under the FuelEU Regulation.
[6] The condition for pooling is that the total pool will be result in a surplus. See our newsletter of 11 March 2024, section “Compliance mechanisms”: FuelEU – introducing the new watershed regulation – Gorrissen Federspiel.