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The European Parliament’s decision to include airline activities in the EU Emissions Trading Scheme (EU ETS) from 2012 will have a significant economic and operational impact on the aviation industry.

The controversial scheme is as a direct consequence of the 1997 Kyoto Protocol to the United Nations Framework Convention on Climate Control, which, for the first time, committed the international community to adopt binding targets and create tools to start tackling climate change. 

The bottom line for airlines is that they must realise a 20% reduction in CO₂ emissions relative to 1990 levels by 2020. 

And there is simply no way of getting out of it as the EU ETS directive will apply to all flights to, from and within Europe from 2012 onwards.

The EU announced its intentions to impose emissions trading in 2008, and most airlines have prepared for it by duly compiling and submitting two standard reports to the respective authorities. 

The first, the Emissions Report, describes how the airline plans to measure actual emissions as of 2012. The second, the Tonne-Kilometre Report, depicts how tonne-kilometres will be measured. 

Tonne-kilometres will be used to calculate the amount of free certificates issued to each airline. 

Collected by the authorities during the course of 2010, the reports and data within them must be verified by an independent contractor before any rulings are passed on individual airlines.

Current status of EU ETS

Most airlines have passed the first major milestone in the preparation for EU ETS by submitting their verified tonne-kilometre (TKM) data to the relevant authorities by the March 31, 2011 deadline.

Submission is a crucial step, since free allowances allocated to airlines by the EU are based on these reports. 

Indeed, the calculation of free allowances is a simple arithmetic. At EU level, all submitted TKMs are added and the share of each individual airline calculated. Based on the resulting percentage, a specific free allowance is calculated for each airline. 

The European Union will communicate information on the free allocation of certificates later this year.

Earlier this year, the EU revealed that airline CO₂ emissions averaged 219 million tonnes per annum between 2004 and 2006 and, based on these figures, the total allowance created for aviation in 2012 amounts to 213 million tonnes of CO₂ (cap at 97%). 

From 2013 onwards, this amount will decrease to 209 million tonnes (95% of the historic aviation emissions).

The cap and allocation mechanism

There will thus be 175 million certificates available for free allocation in 2012 and 171 million from 2013 onwards.

Between September and the end of the year, the EU will announce the total allocation of free emission allowances to each operator that submitted the monitoring plans on time (percentage share of TKM as described in the figure at the top opposite).

The effect of EU ETS

Lufthansa Consulting and its partner, First Climate, believes that the amount of free allowances received by airlines will be insufficient to cover total CO₂ emissions. 

We think that the shortfall will mean that airlines will have to purchase additional certificates for approximately 40% of their emissions, depending on their growth profile between the baseline period (2004–2006) and 2012. 

For every tonne of CO₂ emitted, one carbon certificate has to be surrendered. In case of default, a €100 penalty and carryover to the next compliance year are the result. 

Airlines will thus be faced with significant extra costs for EU ETS compliance – a financial burden they could have done without in today’s tough operating environment.

EUA (EU Allowance Unit) certificates are currently priced at approximately €20 per certificate. Prices are expected to rise drastically up to around €50 per certificate, should demand remain as high as currently expected.

Future challenges for airlines

The introduction of the EU ETS will limit airlines’ available funds for making investments while at the same time increasing the pressure to switch to modern, more efficient technologies in order to reduce emissions in an expanding market environment. 

This poses a major challenge for all decision-makers at airlines operating within the EU, as they will be required by EU ETS to minimise fuel consumption through operational improvements or technological innovation. 

In general, carriers will have to deal with fuel management in order to reduce one of their biggest cost drivers, which at the same time has a direct impact on the amount of certificates that need to be bought on the market.

In addition, EU ETS costs will have to be reflected in the 2012 budget, as the scheme imposes a significant impact on financials in the future. This implies that airlines will have to know and define their options beforehand – in other words, now! 

Concurrent costs should be included in the company’s strategy and development planning. This implies including EU ETS costs in route profitability calculations and profit forecasts. Also, existing network and fleet planning must be reviewed and re-evaluated to take account of EU ETS.

In terms of the adoption of the new rules, a well-defined carbon sourcing strategy must be developed to ensure compliance and keep EU ETS related costs to the minimum.

Given that all airlines flying to, from or within Europe will be faced with this cost factor, successful minimisation of these costs will create a significant competitive advantage. 

Airlines need to deal with the question of how to obtain missing certificates and how to reduce the cost for these certificates. 

They must address the question of where to buy the respective certificates, which types of certificates to buy and how to finance these transactions. 

Effects of a carbon strategy

Last but not least, EU ETS will also impact on airlines’ earnings, especially those of European airlines. 

Why? Because emission costs will have to be partially offset by increasing fares or levying a new surcharge. Particularly in price-sensitive market segments, a corresponding decline in demand seems quite likely.

Moreover, the EU ETS will turn out to be a market entry barrier to Europe, especially for small international airlines. 

Given the shift in international traffic to non-European hubs in the foreseeable future as well as competitive disadvantages for European hubs, market distortion is the likely outcome. 

Airlines might opt to counter the possible decline in demand by promoting their ‘green’ efforts or even transferring cost for them to their customers.

In order to develop an effective strategy for dealing with EU ETS, the market and its rules and regulations have to be thoroughly understood. 

This includes building up in-depth knowledge about the carbon market, developing a respective sourcing strategy and including carbon trading in the overall risk management strategy.