Emissions trading: What does it mean? January 2006

It seems highly likely that the air transport industry will be included in the European Emission Trading Scheme (ETS) although at the moment the means, methods and methodology has yet to be determined.

The European Commission commissioned a consultative report in the Summer of 2005, (The Delft Report), aims to take soundings and produce further indications of the approach by early Spring or Summer 2006, and produce legislation by end 2006 or early 2007.

Implementation is unlikely before 2008 and more likely to be delayed to 2012 — after the first Kyoto Protocol period. It is likely that the industry will have to buy European Union Allowance units (EUAs) on the basis of tonnes of CO2 required.

In addition there may be side charges (through airport charges) to account for other greenhouse emissions and impacts. It is unlikely that individual carriers would be granted grandfather rights — as has been allowed in other industries. It is possible that the carriers would have to acquire through auction all their requirements. It is more likely that there will be a political compromise providing a benchmarked allowance, excesses to which EUAs would have to be traded.

The impact on individual carriers will then depend on the fleet age, fleet structure, usage, flight plans, flight routing and other efficiencies of the operator concerned. In the current European aircraft fleet operations the average emissions appear to work out at between 1.0 grammes and 1.6 grammes of CO2 per ASK flown depending on the fleet and network structure concerned. The greatest adverse impact will be on the LCCs.

Problems ahead

As always in the aviation industry this subject is creating international political problems. The US in particular is not a signatory to the Kyoto Agreement and does not seem to accept the suggestion that Air Transport emissions are necessarily contributory to global warming. It is concerned that one region could decide operating parameters that it believes should be more properly decided by the inter–govennmental International Civil Aviation Organisation (ICAO). ICAO has already decided that the subject should be discussed — but the Europeans feel that the time that would be taken by ICAO to reach any decision would be years away.

Including aviation into the ETS will internalise an external cost for the first time for many operators and effectively introduce an aviation fuel tax on international aviation.

The EC–commissioned report suggests that the impact on ticket prices will be less than 1% and that therefore the impact on demand will be less than 2% over time. However, this depends on the potential purchase rate within the ETS when it comes into effect (the EU commissioned report estimates an effective rate of between €10 and €30 per tonne of CO2). Current trading on the ETS puts the price of a tonne of CO2 at some €25/tonne (€30/tonne was reached briefly last summer).

It is more than likely that the trading value in 2013 will be higher than this and the EU assumptions are likely to be a significant underestimate.

The airline industry is still set to grow at around 5% a year over the next fifteen years. Barring a major technological breakthrough it will have less control over emissions than many other elements of industry and is therefore likely to be a net buyer over time. Furthermore, without a renegotiation of the Kyoto Protocol, the industry will be acquiring EUAs from a pool of emission units that exclude aviation’s existing emission levels — and so the more the industry needs to buy the higher the effective price is likely to be. The industry’s emission requirements are bound to grow as a proportion of total EU greenhouse gas emissions.

The worst hit are likely to be the pure intra–European operators no matter which charging scenario is chosen, those with the oldest fleets and those who want to grow faster than the average. The beneficiaries are likely to be those who operate profitable and efficient flights out of the EU — they would not dare say so but they would be able to provide effective economic subsidy to their internal EU flights — those who decide to limit growth, and those with the youngest fleets.The proposed guidelines are still subject to much discussion.

Background and proposals

There are more side effects from air transport operations in relation to pollution than for many other industries that stay on the ground. In addition there are major questions of how the pollution effect is measured and over what area of control it should be considered.

The main pollutive effects are:

• CO2 emissions from burning fuel
• NOx emissions at altitude are estimated to have a greater impact on ozone depletion on the order of 2–4 times that of CO2 emissions — although the science of measuring this is immature.
• Vapour trails (contrails) are suspected of providing seeding for cloud cover that may be a further contributor to global warming.
• Ironically the more efficient engines for fuel consumption may at high altitudes provide a greater impact on pollution in respect of these two points than the efficiency gain.
• Equally ironically, noise abatement measures designed to alleviate ground noise pollution may have an additional effect.

Measurements: There appears to be currently only a hypothetical method of measuring NOx emissions and their effects. CO2 emissions on the other hand are fairly easily equated with fuel consumption. It appears likely that the proposals that will prevail will base measurement of green house gas emission on the intake of jet kerosene — which is already a measurable and file–able international requirement for all aviation — along with side charges to take into effect the impact of NOx emissions.

Chargeability: The Delft Report considered various methods of any proposed ETS. Its principal and sole recommended proposal is to make the airline operators trade their CO2 emissions and provide for additional charges through the airports for the effects of NOx emissions. No guidelines for NOx charges have yet been proposed.

Scope: The report proposed various possibilities for the potential scope that European emission trading in aviation may cover. These are:

• Intra–EU flights
• Intra–EU flights and 50% of emissions on routes to and from EU Airports
• Emissions of all flights departing EU airports
• All emissions within EU Airspace
• Emissions of all flights departing from EU airports plus remaining emissions in EU airspace.
• Intra–EU and routes to and from third countries that have ratified the Kyoto Protocol There are problems in interpretation, control and data gathering and measurement for each of these options. One of the biggest problems concerns flights that touch countries outside EU control — in that there can be no definitive answer to the ratio of fuel consumed (and therefore the green house gas pollution) for a specific proportion of a flight (Note that the consumption of fuel on a flight bears no linear relation to the distance flown — a greater proportion of fuel is consumed on take off and landing than in cruise) . In addition, the industry would automatically react by loading more fuel in areas where the ETS did not operate and argue subsequently over the effective usage. In addition it is practically impossible to measure emissions purely in EU airspace — the regulatory authorities can only go on tracking air lane usage which equally can only be a rough estimate of emissions.

The most likely outcome would be to use the actual fuel usage — which is a mandatory part of all civil flight rules.

Additionally there would be a substantial difference between the different scopes proposed as to the level of existing emissions — which would have a significant impact on the proportion of CO2 allocated units that would be included in any ETS (see table, above).

Kyoto Protocol issues

The Kyoto Protocol specifically excludes international aviation (as distinct from domestic aviation) from the greenhouse gas measures — and consequently it is not subject to the Assigned Amount Units (AAUs) of greenhouse gas emissions under the protocol — at least not during the initial 2008–2012 period. In addition the non CO2 climate effects (not related to fuel burn) of both domestic and international aviation are not covered by the protocol. Including international aviation into the ETS may create some distinct accounting problems — equivalent to attempting to include the black market economy into official economic data. There are again various options being considered:

• Extend the Kyoto Protocol to include international aviation — (impractical)
• "Borrow" AAUs from other sectors
• The aviation sector should "buy" all its allowance from other sectors
• Obligation to buy AAUs above a baseline
• Semi–open trading: the industry is allocated allowances and can buy additional units from other sectors but cannot sell surplus units
• Trade restricted: the industry is allocated allowances and can buy additional allowances from other sectors but can only sell to other sectors from the stock of allowances it has bought from other sectors.

Allocation method: grandfathered rights vs benchmarking

Other industries have been granted grandfather rights to emissions, excess to which they would have to acquire through the ETS. For aviation it is considered that this approach would severely disadvantage new entrants into the industry, Consequently it appears that the EU will propose either auctioning of all allocation units or introduce a benchmarked year for existing operators and at some time may work out how to include new operators.

Auctioning appears to be the most attractive option for allocation. From an economic angle it is to be considered the most efficient option. Other important advantages are the achievement of simplicity regarding the equal treatment of new entrants compared with existing operators and crediting for early action, and the lower administrative burden associated with data requirements. There is also a significant degree of flexibility regarding the extent to which auction revenues are recycled. A second–best option would be to start off with benchmarked initial allocation.

In general, it is felt that benchmarking is to be preferred over a grandfathering approach, the latter being less favourable to new entrants and those companies that already operated relatively energy–efficient aircraft in the baseline year.

Impact on Industry

Airports: Minimal impact except for a potential slowdown in growth rates • Will be required to add elements to airport charges that take into account NOx emissions (as LHR and others already do to a certain degree)

Airlines: • Improve relative economics for network and international hub operators • Benefit further those with modern economic fleets

• Squeeze the economics of operating LCC and other point–to–point regional operators
• On a point–to–point basis will have very little competitive impact — except as determined by the type of aircraft operated.
• Will effectively be a tax on fuel, the rate of which will be determined by the rate that the industry as a whole decides to grow combined with the rate that other industries regulated by the Kyoto protocol are able to reduce emissions.

Economic estimates

The following tables present an illustration of the theoretical potential full total economic impact of ETS as a proportion of current revenues on various European airlines. These attempt to show the level by which unit revenues (income per ASK) would have to increase from today’s levels in order to recoup the full cost of acquiring EUAs by the time that ETS comes into force — even though the cost of acquiring EUAs may well only be at the margin. The bold columns represent a guess at the likeliest range for the value of EUAs depending on the various scenarios. This is equivalent to the likely excess marginal cost per seat kilometre that would apply from the date of introduction of the ETS for aviation.