Winners and losers as airline industry is forced to spend 23-35 billion euros on EU ETS allowances, finds report
Thu 10 Dec 2009 – A new report by the Carbon Trust underlines the uncertainty faced by airlines over the impact of the EU Emissions Trading Scheme (EU ETS) on their profits. With the likelihood that the industry will be required to purchase €23-35 billion ($34-$52bn)) of additional allowances over the period 2012-2020, there will be winners and losers. The report finds those airlines that improve fuel efficiency have the potential to benefit significantly from the EU ETS, and could increase profitability by 20-40% compared to average airlines, assuming carbon costs between €25-50/tCO2 ($37-74/tCO2), whereas the least fuel efficient airlines could see profits drop by as much as 40%.
The Carbon Trust is an independent company set up in 2001 with the support of the UK Government and has a mission to help accelerate the transition to a low carbon economy. The report aims to give mainstream institutional investors and their advisors a briefing on the potential consequences of climate change regulation on the financial performance of the airline industry. It focuses in particular on the sensitivity of airline industry profits on entry to a cap-and-trade scheme, and uses example scenarios that could apply when aircraft operators (including large airlines) enter the EU ETS.
The authors of the report say the ultimate impact of a cap-and-trade scheme on an individual airline’s performance is critically determined by four key factors:
·the prevailing cost of carbon;
·the number of carbon allowances allocated for free to airlines;
·the rate of ‘price pass-through’ to customers; and
·how airlines manage their cost structure in response to a potential change in demand from customers due to increased ticket prices.
Airlines operating more competitive short-haul leisure flights are likely to be more exposed due to the greater price sensitivity of their customers, states the report. Meanwhile, operators of long-haul business flights are likely to be less exposed and could even gain in profitability in the short term.
“Aviation is one of the fastest growing sources of carbon emissions, so entry of the sector into the EU ETS is an important step forward in tackling climate change,” says Bruce Duguid, Head of Investor Engagement at the Carbon Trust. “However, the full impact this will have on the airlines is still uncertain.”
Duguid warns that the aviation industry must achieve a significant breakthrough in energy efficiency or low carbon biofuels otherwise additional policies beyond the EU ETS may need to follow, including further taxation to boost R&D spend and measures to limit new runway capacity.
The report also points out that aircraft operators are eventually likely to have to internalize the cost of their non-CO2 warming effects, as science outlining the environmental impacts becomes better understood. “This is a significant risk hanging over aircraft operators, given that scientists suggest the non-CO2 damage could be as large as two to four times the level of the CO2 damage,” it says.
It points out a number of carbon markets already factor in the CO2 equivalent impact of other Kyoto-agreed greenhouse gaspollutants. The Kyoto Protocol supports non-CO2 greenhouse gas emissions reduction and in time it is likely that the non-CO2 impacts of aircraft operators will be incorporated into any regime to tackle aviation emissions, forecasts the report, including the EU ETS.
The report questions whether joining the EU ETS will greatly increase the industry’s energy efficiency. “One concern about relying on energy efficiency gains to reduce aircraft operator emissions within the EU ETS is that airlines already are heavily incentivized to reduce their energy use due to the high proportion – often 30-40% – of an airline’s cost base that kerosene represents. Adding the recent low cost of carbon in 2009 to kerosene prices does not provide much additional incentive for energy efficiency.”
It suggests that adding a cost of carbon will be less effective than the high kerosene prices airlines faced in 2008. “It appears likely that it will make little difference in the short term, although it should create an important signal that in future the effective cost of kerosene will be higher and therefore greater efforts to improve energy efficiency will be rewarded,” the report’s authors believe.
“The addition of a cost of carbon adds an additional volatility, or ‘turbo boost’, to the price of kerosene which will increase further the case for fuel efficiency for airlines,” they add.