Aviation and Emissions Trading, onwards and upwards
Carbon is well and truly back on the agenda for the aviation sector in 2015. Airlines should prepare for the risk that the price of emission allowances could lift significantly in coming years, argue Louis Redshaw, Director of Redshaw Advisors and Julien Dufour, VERIFAVIA CEO.
In Europe, after a 2-year absence, aircraft operators need to re-establish their carbon emissions verification and trading activities. The market for carbon has also moved on, the low prices of the last 2 years can no longer be taken for granted. Meanwhile, on the international stage, ICAO must come up with a global mechanism to cover aviation emissions by 2016 otherwise the industry may be left behind by the USA and China who, jointly, recently announced targets and cooperation agreements to tackle climate change. It is unlikely that these two super-powers will allow aviation emissions to go on unabated. We summarise both legislative and market developments and explore how these will impact aircraft operators’ costs in the coming years.
Aviation & the EU Emissions Trading Scheme (EU-ETS)
'Stop-the-clock' – last minute legislation by the European Commission in late 2012 - proposed that intercontinental flights should be excluded from the EU ETS for a period of one year (2012). The EC was responding to tremendous pressure from several countries, particularly the US and China. ‘Stop-the-clock’ was finally extended for another four years (2013-2016). The compromise kept pressure on ICAO to find a market based mechanism to cap aircraft emissions while essentially giving in to the threats of trade sanctions made by some countries.
If ICAO doesn’t come up with something, the EU is threatening to go ahead with requiring intercontinental flights to account for their emissions from 2017. This is no longer an idle threat, support is coming from a most unexpected place, China’s domestic emissions trading system (see below).
In the meantime, back in Europe, to give aircraft operators time to get used to all the legislative turmoil, the deadline for the reporting and surrendering of 2013 emissions was pushed back to 31 March and 30 April 2015 respectively. This has created a one-off two-year compliance cycle which may have caused some companies to take their eyes off the carbon trading ball, here is the state of play:
- Non-commercial operators: only those with more than 1,000 tonnes of emissions (considering all flights to, from and between EEA airports) are now covered. This dramatically reduces the burden of monitoring and reporting costs for some 90% of companies that were originally covered.
- Commercial operators: the exemption of 10,000 tonnes still exists however these companies need to watch out, if they have only 1 flight in Europe and their emissions are more than 10,000 tonnes (considering all flights to, from and between EEA airports), they are still captured by the EU ETS (for their intra-European flight emissions)
- Finally, there were changes to the way operators could balance their positions. Back in 2012 each aircraft operator was entitled to use cheaper international offsets (CERs and ERUs) for up to 15% of their total requirement. This has been scaled back dramatically such that the limit is now 1.5 % during phase 3 (2013 to 2020). Some of the previous offset allowances may be carried forward however.
European carbon markets are being manipulated to achieve higher prices
Europe has seen major legislative changes and proposed changes in the last 12 months that are primarily designed to boost carbon prices. Higher prices are apparently desirable so that polluters’ investment decisions are properly incentivised and so that larger, longer term emissions cuts don’t hit the EU economy disproportionately hard. The low EU Allowance (EUA) carbon prices of the last few years (around €5 on average) are a thing of the past. The legislative changes can be summarised as follows:
- As a short-term measure, the European Commission is postponing the auctioning of 900 million allowances until 2019-20 to allow demand to pick up (so-called ‘backloading’).
- Europe’s 2030 emissions reduction target was agreed in October 2014 and is set at 40% below 1990’s emissions levels. This translates into a 2.2% per year reduction in free allocations from 2020, up from the current 1.74%.
- The Market Stability Reserve (MSR). To tighten supply further the Commission has proposed withdrawing, from 2021, 100Mt per year of the allowance glut until there is only 400Mt. Subsequent amendments to this proposal include:
- moving the 900Mt backloaded volume directly into the reserve so that it doesn’t return as currently planned in 2019
- starting the MSR in 2016 instead of 2021
So what does this mean for aircraft operators?
Compliance just got more expensive and will get more expensive still. The carbon currency set up for the aviation industry, EU Aviation Allowance (EUAA), is linked to EUA prices because the former are in short supply (there are free allocations and auctions of EUAAs but the total is insufficient to meet demand) and the latter can be used in their place.
So far EUAA auctions have been at a small discount of around €0.25 to EUAs. This will likely narrow to zero over time as supply is bought up, the aviation sector is forecast to be short by 17.5Mt (possibly as much as 20Mt) in 2015 (source: Energy Aspects) and the auctions will only supply 16.4Mt.
Oil and jet fuel prices have been falling off a cliff over the past few months with crude oil prices more than halving however the carbon market is headed in the opposite direction. The reason for this anomaly is that carbon simply isn’t like other commodities in one vital respect: most politicians want fuel prices to be low, so they promote policies to achieve this whereas they have a stated ambition to get carbon prices higher and for supply to be increasingly constrained. These facts are hard to ignore and a prudent risk manager, in an industry where carbon emissions are expected to climb, might well include spending some of the savings from reduced fuel prices and a weaker Euro on a strategic carbon reserve.
ICAO saves the day?
On Friday 4 October 2013, at the close of its 38th Assembly, ICAO adopted a resolution that called for a Market Based Mechanism (MBM) to tackle emissions from international aviation to be decided at the 39th Assembly in 2016 for global implementation by 2020. If a deal is struck, then it would be the world’s first truly global MBM for carbon emissions mitigation.
A deal is far from certain. ICAO has narrowed down the MBM options to an off-setting scheme without revenue generation but there is still a lot of room for flexibility and changes:
- Targets would take into account the difference between an individual operator’s annual emissions and its historical emissions over the 2018-2020 period but also the growth of aviation emissions as a whole during the same period.
- Only carbon offsets that respect the (to be specified) criteria would be eligible.
- There would be separate provisions for new entrants, fast-growing operators and early movers, as well as exemption thresholds for smaller aircraft and lower emitting operators.
- In order to take into account the Special Circumstances and Respective Capabilities (SCRC) of developing states - also known as Common, But Differentiated Responsibilities (CBDR), - there is a consideration of special route-based adjustments, although this is a highly sensitive political issue.
- There is a call by some parties for a cap on the price of offsets: if the price of offsets exceeds a pre-defined threshold, the offsetting obligations would be reduced accordingly. This is obviously a highly controversial idea that goes against the basic market principle of supply and demand.
In the meantime the world has apparently moved on. In China confidential reports indicate that they may suspend the CAAC Directive which bans Chinese airlines from complying with the EU ETS. This is likely to be because China has already implemented seven ETS pilot programmes, they will implement a nationwide ETS by 2016 (which would become the largest ETS in the world) and the Shanghai ETS already includes domestic Aviation. President Obama, most recently in his state of the union address, highlighted his personal ambition to get the US to take on man-made climate change and it seems that the majority of the American people agree. This positivity reached a peak on 12th November 2014 when China and the US jointly announced agreement on new emissions reduction goals.
One of two outcomes is a serious reality; ICAO’s hand is forced or the major economies go ahead without them. Either way, aviation looks set to be dragged into a global carbon mitigation effort and the cost that goes with it.
Carbon prices currently look low when compared to politicians’ ambitions and analysts’ forecasts. When combined with the prospect of a global and potentially complex mechanism from ICAO, ever decreasing free allocations in the EU, potential inclusion in China’s National ETS and, in aviation’s case, a high probability of emissions growth, aviators are going to have to commit increasing resource to understanding and managing their carbon price risks.
Louis Redshaw is founder and Director of Redshaw Advisors Ltd. Redshaw Advisors is a leading carbon finance and trading company that specialises in helping companies to; buy carbon for compliance with carbon emissions trading systems, manage their future risks and optimise their carbon allocations. (http://www.redshawadvisors.com/)
Julien Dufour is founder and CEO of VERIFAVIA a worldwide independent accredited environmental verification, certification and auditing body for aviation (airlines and business jets), airports and maritime transport (shipping). VERIFAVIA also provides technical assistance, training and capacity building for Market-Based Measures / Aviation MRV and ICAO 'State Action Plans' to governments and aviation regulatory authorities. (http://www.verifavia.com/)
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