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Market News

 September 12, 2011
Carbon trading for aviation struggles to take off

 The inclusion of aviation in the European Union Emissions Trading System (EU ETS) is under increasing pressure from North American, Russian, and Chinese lobby groups, airlines, and governments. Launched in response to the anticipated additional costs to airlines, the extent and level of these challenges is considerable. The US airlines estimate an additional cost burden on industry of $1bn by 2020, while Emirates estimates between $500m to $1bn by 2020.

The Chinese Airline Association, China Air Transport Association (CATA) and Air Transport Association of America are all asking for the withdrawal or suspension of the deadline for inclusion of aviation in the region at the start of next year. Chai Haibo, vice president of CATA, has called the plan "unreasonable and illegal", arguing that increased air fares may dampen European growth, deter Chinese tourists from visiting the region, and could lead to retaliatory border taxes.

The US airlines -- Continental and American Airlines -- are enacting more direct measures by filing a civil law suit, with the assistance of the National Airlines Council of Canada (NACC) and the International Air Transport Association (IATA), against the European Commission (EC), arguing that inclusion violates international aviation agreements.

In parallel to civil actions brought against the EC, the US Congress is also attempting to pass a bill that bans American companies from complying with EU legislation, with the support of the US State Department. The US is adamant it will not be coerced into partaking in the upcoming caps on aviation emissions. US officials made their position very clear at a US-EU aviation discussion in Oslo recently: the US State Department said it had "strong concerns" about Europe's plans to include all flights in and out of the region subject to emissions trading.

The inclusion of aviation in the system is already set in law, so changes to it are unlikely. It does, however, contain a provision that countries may be exempted from the scheme if they impose "equivalent measures". So far, however, the US has not submitted any proposals for what could be considered an equivalent measure.

China is also seeking exemption from the system and has mooted a proposal of a 22 per cent reduction on baseline emissions, currently being assessed by the EU to determine its suitability as an equivalent measure. Challenges to the legislation are not only from outside the EU. The Association of European Airlines (AEA) said in a letter to the Commission on 24 May that legal challenges may result if American and Chinese airlines are exempt from the system. The AEA said the legislation should be applied to "all or none".

The AEA is right to point out that the legislation should be applied to all or none, and it is right to be concerned by the moves in the US. However, the suitability of equivalent measures and the ability of the EU to ensure compliance with the ETS under a scenario where the bill passes the US Congress both remain unknown.

The AEA also expressed concern over the additional costs for airlines, stating that roundtrip air fares within Europe may rise between €1.80-9.00 as a result of the new restrictions, while a roundtrip flight from Brussels to New York at current carbon prices of about €15 could cost an additional €12.

Carbon cap

These challenges are being mounted in spite of what we consider to be generous cost-containment features offered to the aviation industry; namely, a late base year and ample free allocations. The cap will begin at 97 per cent of 2004-2006 emissions and fall to 95 per cent of those "historical" emissions starting in 2013. Furthermore, 82 per cent of the emission allowances making up the airline industry's cap will be allocated for free; only 15 per cent will be auctioned.

The remaining three per cent will be put into a special reserve for later distribution to fast-growing airlines and new entrants to the system. The EC will decide by 30 September on the number of EUAs to be auctioned, to be distributed for free and to be allocated to the special reserve. Moreover, EUA allocations for aviation will be determined based on the efficiency of carriers in 2010, a year when fuel prices surged, Icelandic volcano ash reduced air travel, and freezing weather and labour strikes disrupted travel.

According to the EC, the inclusion of aviation into the EU ETS will reduce emissions by 183 million tonnes by 2020, a 46 per cent reduction compared with business as usual. Ensuring regulatory integrity is crucial, particularly since aviation will become the second-largest sector in the EU ETS after the power generators.

At this stage in the negotiations, it is difficult to see the outcome as having the regulatory strength hoped for. The enforcement of the legislation resides in a legal quagmire and will inevitably result in decade-long legal battles if the EC does not provide some sort of compromise for the countries currently dragging their feet.

China is likely to work with the EC and enact an equivalent measure. But the US is likely to oppose any action or under-deliver on whatever equivalent measures it promises to implement, judging by the co-ordination of attacks by government and business, and the visceral reaction of US lawmakers.

The EC appears to be handling the objections well, but as the legal challenges gather pace in the US, it remains to be seen whether the EC will have the fortitude to ensure compromises do not result in the unfair treatment of airlines in and outside the EU.

Matthew Gray is an analyst at carbon market research firm IDEAcarbon