EEXI and CII enter into force
January 1st, 2023 marked the first day of implementation of the IMO short term mandatory measures adopted in MEPC 76 in 2021, namely the Energy Efficiency Existing Ship Index (EEXI) and the Carbon Intensity Indicator (CII). These short-term measures are implemented in support of the intermediate target set out in the context of IMO’s Initial GHG strategy back in 2018, aiming at a 40% reduction in vessels’ carbon intensity per transport work by 2030 vs 2008.
The EEXI is a technical measure addressing the technical design of an existing vessel by imposing retroactively energy efficiency requirements equivalent to the Energy Efficiency Design Index (EEDI) of new buildings. EEXI is a one-off certification taking place at the first annual, intermediate or renewal survey of IAPP Certificate on or after 1st January 2023. Its implementation is expected by market participants to be relatively straightforward with some engine derating involved or installation of energy saving devices that reduce standardized CO2 emissions related to the installed engine power, capacity of the vessel and speed for the least efficient ships in the fleet.
However, the implications of the CII enforcement are more complex. The CII is an operational efficiency measure calculated as grams of CO2 emitted per dwt nautical mile on an annual basis. CII calls for a 2% annual CO2 carbon intensity reduction between 2023 and 2026 or an 11% cumulative improvement by 2026 vs a 2019 reference level. Future reduction rates for 2027-2030 are yet to be determined and will be decided as part of the review to be concluded by January 2026.
Vessels will be given an annual rating ranging from A to E, where A and B are related to major superior and minor superior performance respectively, and D and E to minor inferior and inferior performance, respectively. The ratings will derive from the attained CII calculated on an annual basis, which will be compared with the required CII against the 2019 reference line. The attained CII will be calculated based on the Annual Energy Efficiency ratio (AER) formula, which is a supply-based metric.
Currently there are no penalties for the most carbon-intensive ships. Speed reduction is being discussed as the primary tool to reduce ships’ fuel consumption and emissions in order for them to comply with the CII. I
At the same time, the market has voiced concern over potential market distortions driven by the AER metric. For example, the most fuel inefficient vessels might increase ballast legs in order to inflate the annual distance travelled to improve their CII rating.
Furthermore, there is no regulated penalty in place that will help bridge the gap between the potential earnings loss incurred by having to steam at optimal speeds dictated by commercial factors vs optimal speeds dictated by efficiency criteria, while increasing the ballasting distances in order to achieve CII compliance.
The above could lead to divergent freight market impact across maritime sectors, as dry bulk, tankers and containers (together accounting for ~80% of global bunker consumption) do not stand at the same point in the shipping cycle. Meanwhile, the technological profile of the existing fleet is diverse which means that the operational and commercial chartering strategy selection criteria will differ substantially within each fleet. Eco and non eco vessels without scrubbers are more likely to have an optimal speed closer to the speed required to satisfy the minimum CII required in the scenario where VLSFO prices move higher in the next years.
On the other hand, the higher scrubber penetration in the larger sizes of the fleet makes speed as a commercial and operational tool more complicated to use and is likely to reshape the chartering strategy mixture between voyage and period charters. This suggests that the bargaining power between shipowners and charterers in each trade and vessel segment differs and will ultimately dictate the optimal mix of strategies in each sector in relation to operational performance.
In anticipation of the CII enforcement, the market has stipulated that modern lower emitting vessels (eco) may be and gain a structural earnings premium, while trade flows could potentially shift due to higher voyage costs. This means that even though there is no regulated penalty in place, an endogenous market penalty will arrive in the form of a multi-tier freight market with modern eco vessels enjoying premiums particularly in the West, where the EU is further increasing the voyage cost burden via the ETS (due to be introduced in 12 months time). In addition, lower speeds particularly of the vessels rated ‘D’ would increase inefficiencies and thereby tighten effective fleet supply. However, this development is likely not to be uniform across regions. If achieving the required CII is prioritized in commercial decision making, then a scenario where the AER metric entails the risk of reducing inefficient vessels’ speeds and utilization, and thereby increasing speeds of efficient vessels should not be excluded. Accordingly, there is no one scenario on how the above might be reflected in fleet repositioning decisions between the West and East and the impact on the freight market.
Finally, although we suggest that freight market tiers related to CII performance will emerge in 2024 when 2023 performance reporting will take place, an impact on nominal supply fundamentals will likely not be seen immediately, but in 2 to 3 years from now. This reflects the timeframe in which ships rated ‘E’ or ‘D’ will have to implement their reported carbon intensity correction plan.
If these vessels are not able to comply in time, they will naturally have be squeezed out of the market, accelerating scrapping and incentivizing part of the fleet renewal required for the sector’s decarbonization transition.