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Decarbonisation and contracts in the world of international maritime trade

There is so much discussion about the regulatory side of maritime decarbonisation. And there is so much complaining about uncertainty and about the need for clarity and certainty. As if the future can be known and all that is needed is to have it laid out on a map – neatly organised, defined and preordained by this government or that international organisation. One wonders how much certainty there was when steam started replacing sails, and fuel oil started replacing coal.

Unlike other regulatory areas (pollution, safety), decarbonisation is a journey on an uncertain course and with an unclear destination: percentage reduction or net zero? And what does net zero actually mean by reference to “well to wake”? And how do we get there? What is the course? It is also an effort with unknown tools, possibly tools that have not been invented yet.

If, conceptually speaking, we seek the impossible; and if, practically speaking, we seek the unattainable, what’s left? Do we need a decarbonisation prophet or an oracle to guide us?

Moving away from the philosophical, the point of this article is to provoke a different thought process, so that we take a step back from decarbonisation as a regulatory issue, and reflect on whether a regulatory approach misses the wood for the trees. Behind the seemingly innocuous technical jargon of “operational carbon intensity requires a linear reduction in the in-service carbon intensity of ships between 2023 and 2030”, looms a contractual tsunami.

Cargo ships, especially in the wet and dry bulk trades, are not purely “operational” and “in service”, by and for the benefit of the shipowner. Cargo ships do not carry their shipowners’ cargoes. A vessel’s voyage represents contractual relationships: charterparties, bills of lading, sale contracts, letters of credit. Alterations to the way in which cargo ships are operated have contractual repercussions. This feature differentiates bulk cargo shipping from heavy industry, manufacturing, aviation or, indeed, passenger shipping. If one now adds the spot nature of much of bulk shipping, a far more dynamic contractual landscape emerges, which also differentiates bulk from container shipping.

Those contracts that make up international maritime trade have their genesis in the age of sail, were refined for steamships, and adapted for contemporary ships. It might surprise the uninitiated that the cornerstones of maritime law have remained fundamentally unaltered since the age of steam: the Hague Rules date back to the 1920s and the York-Antwerp Rules to the 1890s.

We need to reflect on whether the contractual structures on which the edifice of international maritime trade has been built over 150 years will be fit for purpose for the decarbonisation journey.

Let’s start with the two main types of contracts for the employment of ships: time and voyage charterparties. The big question surrounding EEXI and CIIs is operational optimisation: are the orders given by a time charterer optimised so as to reduce fuel consumption and emissions? This is not simply about the obvious question of choice of speed, but also the choice of routes and ballast voyages. Currently, time charterparties give charterers complete flexibility and the right to issue any employment orders required by their commercial considerations. But what if those considerations collide with the need to reduce emissions? Until now, the only exception to a charterer’s right to issue employment orders was safety and the navigational prerogative of the ship’s master. Is that dichotomy (commercial employment vs navigational safety) still fit for purpose? Or do we now need a contractual mechanism to introduce emissions’ reduction as a parameter in charterparties?

Turning now to voyage charters, the risk of delay is on the shipowner, who receives the same amount of freight regardless of the length of the voyage, and the shipowner pays for bunkers. Depending on the state of the market, there is a fine balancing act that determines profit or loss: speed vs consumption vs voyage length vs arrival time. And, of course, a shipowner’s best friend: demurrage. Lawyers define it as “liquidated damages for the vessel’s detention at the port beyond the agreed laytime”. Often, demurrage represents a large part of a shipowner’s profit. This encourages the universal practice of “sail fast, then wait”: all bulk cargo ships under voyage charter steam towards the port of destination without regard for local conditions, so that they arrive as soon as they can, tender Notice of Readiness, so as to get the laytime clock running. And when laytime expires, demurrage becomes payable. Now, take a step back and think: is that universal practice sustainable in today’s world? Or is it an anachronism that was born in an age where ships sailed into the sunset with little communication.

Demurrage is also a common feature of the sale contracts for the commodities that are carried by cargo ships, and the same consideration applies for the traders too: demurrage is often a profit centre for traders, who may pay less demurrage to shipowners than they receive from their contractual counterparties under the sale contract. And the same question arises: is demurrage consistent with the Era of Decarbonisation, or should we now consign it to the history of the Era of Sail, the Era of Steam and the Era of Fuel Oil.

There is a common thread running through charterparties and sale contracts: fundamentally, they all prioritise safety, followed by commercial considerations. Depending on the bargain, the commercial considerations of one or other party prevail. No such contracts provide for the third factor: emissions’ abatement. And this is not a question of regulations, but a question of contractual autonomy.

Clearly, regulations and, in particular, Carbon Intensity Indicators, will provide a framework for contractual provisions. However, it is important to remember that the maritime industry has always served as a paradigm example of contractual laissez-faire and shipping and trading are areas of commercial activity of almost complete contractual autonomy. This enabled the transition through the earlier Eras, and there is no reason why it cannot also apply in the Decarbonisation Era. It is certain that charterparties and commodities sale contracts will be re-thought and re-modelled to become fit for purpose on the decarbonisation journey. It is inevitable that the bi-polar world of navigational safety vs commercial reality will be replaced by a triangle that will now feature emissions’ reduction. But to start making the necessary changes, one needs to stop thinking in the narrow terms of regulatory compliance, and let shipping do what it has always done: adapt to an ever-changing world through the continuous evolution of commercial contracts.
Source: Stephenson Harwood LLP. by Haris Zografakis

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