Carbon Taxes in the Shipping Industry—Assessing Japan’s Proposal

There are growing calls for a carbon tax on shipping emissions. Jim Loftis, Ciara Ros and Tatiana Freeman of Vinson & Elkins look at the recent proposal from Japan for a global carbon tax, assess it in the context of the existing approaches in other jurisdictions and industries, and consider how those involved in the maritime industry need to prepare.

The shipping industry currently accounts for 3% of global emissions, and according to certain estimates, if unchecked, shipping could account for as much as 20% of global emissions by 2050. It is against this backdrop that there have been growing calls for the introduction of a tax on shipping emissions.

One of the first countries to put forward a landmark proposal for a carbon shipping tax was the Marshall and Solomon Islands, proposing a levy of $100 per tonne of carbon dioxide (CO₂) in early 2021. The proposal was met with a lukewarm response from other countries, and various tax proposals have been made since.

In May 2022, Japan proposed a financial incentive to decarbonise shipping. Japan called for a global carbon tax that would see the shipping industry pay $56 per tonne of CO₂ starting in 2025. If imposed, the tax is forecast to raise over $50 billion a year. The current proposal that Japan has put forward would see the tax increase every five years, to $135 per tonne of CO₂ in 2030, $324 per tonne in 2035, and as high as $637 per tonne by 2040 Japan’s proposal also suggests that the carbon tax for bunkers would be three times higher, given that each tonne of bunker fuel produces about three tonnes of CO₂.

We understand that the proposal was considered as part of a bucket of carbon reduction options at Marine Environment Protection Committee meeting 78, which took place between 6-10 June 2022. Decisions on the various proposals to reduce greenhouse gases, including carbon levies, are due to be taken at MEPC 80, in July 2023. Given Japan’s position as the second-largest ship-owning country in the world, any proposal will be taken seriously and seen as a guide by other jurisdictions on the parameters for any plans to reduce shipping emissions, whether in respect of carbon taxes or incentives for green ship owners. It is understood that Japan’s proposal would see money generated by the taxes utilised to subsidize zero-emission ships.

EU’s Approach to Shipping Carbon Taxes

Japan’s approach would see the proposal implemented on a global scale, but other jurisdictions have looked at region-specific approaches. For example, the EU has also sought to tackle the issue of carbon package which sets out a plan to reduce emissions in the bloc from 2023. The Fit for 55 plan proposes to introduce a carbon tax on shipping emissions.

When the measures in the package come into force, regardless of the flag they fly vessels will be required to purchase carbon allowances to cover all emissions produced during voyages within the EU, and half of the emissions generated by international voyages that start or finish at an EU port. In 2023, companies chartering large vessels will be required to purchase allowances for 20% of their emissions from ships that call at EU ports, increasing to 100% by 2026. It is worth noting that the proposal has been criticized for creating a risk of so-called carbon leakage. Indeed, one problem with the EU carbon tax package is that operators may look for shipping hubs outside the EU to lower their costs. It is possible, therefore, that operators may dock their large cargo ships outside of the EU, and then transfer their goods into Europe on smaller vessels, which have a lower carbon output.

In contrast, Japan’s proposal covers all global shipping emissions and is, therefore, more taxing (if you will pardon the pun) on the maritime industry at large. However, it may allow a more level playing field, as all companies will be treated the same and given the same chance to build up greener practices with the same lead time to start (or continue with) that transition. The utilization of taxes to subsidize zero-emission ships will also incentivize those that have started the transition early.

However, the question remains whether zero-emission ships are viable in this short period or whether it would be more beneficial to incentivize lower-emission ships in the transition period as technology is developed. This is a key consideration in view of the importance of the shipping industry in the supply chain, when the world is already facing significant disruption from supply chain issues, spiraling costs of living, the continued impact of Covid-19, and the Russia-Ukraine conflict.

Can the Aviation Industry Provide any Lessons for the Maritime Industry?

While different in many ways, as key transport industries with similar emission statistics, there may be lessons that the maritime industry can learn from the taxation that already applies in aviation. Carbon taxes in the aviation industry have been controversial, with strong opposition from carriers to taxes introduced by countries such as the UK, Australia, and Sweden. For example, the Aviation Intelligence Unit has argued that carbon taxes have not necessarily led to lower CO₂ emissions. The UK introduced air passenger duty in 1994, but carbon emissions have continued to increase. However, the impact may be more meaningful in the context of commercial transport compared to consumer travel.

The EU Fit for 55 package proposes that polluting aviation fuels, especially kerosene, will no longer be exempt from energy taxation on intra-EU flights. The tax, applicable to both private and commercial flights, will be introduced gradually from 2023 before being enacted in full in 2033.

The response from the aviation industry as well as environmentalists may prove valuable for the shipping industry. For example, environmentalists have criticized the 10-year implementation time frame as being too slow. To maximize its efficiency in reducing emissions, a carbon tax on the maritime industry may require a shorter implementation period. The EU scheme has also been heavily criticized by airlines like Lufthansa, and Frankfurt and Munich airports, who have argued this policy provides an unjust advantage for competitors outside the bloc. This criticism can also be levied in respect of policies applying to EU shippers, and may adversely impact the price of goods within the EU as shipping costs increase. This highlights the benefit of a global approach to any taxes on the shipping industry, which, in turn, may also reduce the possibility of carbon leakage.

Thinking Ahead

The increasing calls for a carbon tax on shipping, packages like the EU Fit for 55, and Japan’s call for a global carbon tax, may serve to increase the momentum and accelerate plans for shipping to be included in other jurisdictions’ taxes. At present, it is important to note that the EU package only applies to ships inside the EU, so shipping operators can plan around this, but the Japanese proposal would not permit geographical planning.

It will be key for those in the maritime industry to start planning for the allocation of these costs and consider who will take the risk of increased emissions if there is any delay or disruption to a journey. The allocation of tax costs and risks of increased emissions should be built into charter parties. In addition, if charterers take on these costs, they will need to consider how the costs can be absorbed or passed on, and whether any risks as a result of cargo issues can be passed on to the end customer.

Ahead of carbon taxes on shipping being implemented, companies will need to consider not only investing in ships with greener technologies and fuels, but also preparing for how they can utilise any tax incentives for low or zero-emission vessels. Shippers may also wish to consider diversifying their fleets, to allow for greater use of smaller, lower emission producing vessels.

It is encouraging to see this trend is taking place already. For example, Maersk decarbonisation plans to power new container ships on carbon-neutral methanol. In the first quarter of 2024, Maersk will introduce the first in a ground-breaking series of eight large ocean-going container vessels capable of being operated on carbon-neutral methanol. The series will replace older vessels, generating annual CO₂ emissions savings of around one million tonnes. If Japan’s proposal is adopted, this would save Maersk $56 million per year (between 2025–2030) in taxes.

It is clear from the response to the aviation industry’s carbon tax in the EU, the risks of carbon leakages, geographic planning, and the risk of unfair competition in siloed jurisdictional proposals, that a global approach would likely be more effective at tackling emissions, with less impact on supply.

Japan’s carbon policy proposal is global and, if adopted, would therefore enable a more cohesive approach to the issue of tackling emissions in the maritime industry. However, it remains to be seen whether this is considered a broad enough proposal by the industry at large, and whether it is practicable to create a true global proposal that will be accepted by both governments and industry players. The implementation and legal framework for an endeavour of this size will be a significant but worthy challenge if it can make a true environmental impact without crippling such a key industry.

Previously published by Bloomberg Tax on June 26, 2022. Reproduced with permission from Copyright 2022 The Bureau of National Affairs, Inc. (800-372-1033) www.bloombergindustry.com.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.