Incentive distortions in FuelEU Maritime: Reforming the GHG intensity penalty structure

The FuelEU Maritime Regulation introduces a greenhouse gas (GHG) intensity standard for maritime transport, enforced through financial penalties for non-compliance. While intended to promote cost-effective decarbonization, this paper demonstrates that the current formulation creates a declining penalty per unit of non-compliance as emissions increase, weakening marginal abatement incentives for higher-emitting vessels and encouraging strategic behaviour. For a heterogeneous fleet with a fixed aggregate non-compliance balance, the total penalty depends on how non-compliance is distributed across vessels: it is maximized when GHG intensities are equalised and minimized at a boundary solution with at most one vessel taking an interior value between the target and baseline intensities. This feature introduces distortions that are inconsistent with efficient and equitable policy outcomes. To address these issues, we propose a reformed penalty structure and provide analytical results supported by numerical examples. The revised design restores constant marginal incentives, improves fairness and transparency, and eliminates strategic distortions in compliance markets. The results highlight the importance of functional form in policy design for maritime decarbonization.