The Fallout of EU Aviation Carbon Emission Quotas

By XUE YANPING

THE EU will expand its carbon emissions quotas system to the aviation industry from January 1, 2012. Regulations issued by the European Commission in 2008 stipulated that all domestic and international flights that arrive at or depart from an airport in the EU will be included in the EU quotas system, and furthermore, carbon emissions throughout the whole voyage, not just EU territory, will be subject to the new regulation.

The Chinese aviation administration made a clear statement against EU's one-sided restrictive measures last March.

The stricter standards are expected to affect over 2,000 of the world's carriers, among which are 33 Chinese airlines, including the country's top three international carriers – Air China, China Eastern and China Southern. Last March China's aviation administration responded with a denouncement of what it termed as the EU's one-sided restrictions. Two months later, it sent representatives for preliminary talks with its counterpart in the EU, but the EU adamantly refused to amend the law. In early August, some Chinese airlines, together with carriers based in the U.S., Japan and Singapore, published a joint statement threatening to boycott the EU aviation quotas. No conciliatory response has been received from the EU thus far, and as the deadline for compliance looms the problem becomes more acute.

EU Aviation Quotas Backstory

The EU aviation emission quotas are the result of the expansion of the EU ETS (European Union Emission Trading Scheme), commonly known as the EU carbon market. Officially launched in January 2005, the EU ETS is the largest of its kind in the world. It operates in 30 European countries, made up of the 27 EU member states plus Norway, Iceland and Liechtenstein. Today 12,000 companies are involved, representing the energy industry (power stations and heat supply companies) and the manufacturing industry (steel and building material factories).

The EU ETS is an exchange system, with institutional members that include the Paris Carbon Exchange (Bluenext), the Dutch Climate Exchange (Climex), the Austrian Energy Exchange (EXXA), the European Climate Exchange (ECX), the European Energy Exchange (EEX), the Italian Power Exchange (IPEX), the Nordic Power Exchange (Nordpool) and the London Energy Brokers Association (LEBA). The EU ETS is one of the three largest emission trading schemes in the world; the other two are the Chicago Climate Exchange (CCX) and the NSW Greenhouse Gas Abatement Scheme in Australia. In 2008 the ETS recorded its turnover at US $91.9 billion and a trading volume of 3.1 billion tons of carbon dioxide, which respectively accounted for 71 percent and 64 percent of the world's total.

The ETS works on the principle of "cap and trade." This means the European Commission issued a "cap," or limit, on the total amount of certain greenhouse gases that can be emitted. Each member state can apply for its allotment according to its emission situation. Member states can adjust quotas among each other within the cap, as companies receive emission allowances that they can buy from or sell to one another as needed. The absolute limit on allowances available ensures that they retain their value. For extra greenhouse gas emissions members need to purchase quotas in the market.

The ETS sets its goal in three phases. During Phase I (2005 - 2007) and Phase II (2008 - 2012), it provides emission allowances for free. By Phase III (2013 - 2020), granting of such allowances will be subject to more competitive conditions, till they are completely replaced by auction. Before 2012, certain high-emission industries are subject to caps, namely power stations, steel works, non-ferrous metal smelting, the chemical industry, and the cement, glass and paper-making industries. The start of 2012 will see airlines joining the scheme, which means the ETS will cover 55 percent of all carbon emitted in the EU. Under the ETS system, the annual allowance decreases year by year: 2.1 billion tons from 2008 to 2012. Starting from 2013, the annual allowance will be reduced by 1.74 percent until it reaches 1.7 billion tons in 2020.

Implementation Mechanism

Flights are not the main source of carbon emissions in the EU. In 2007, for example, emissions from aviation accounted for about 12 percent of the total for transportation. It is expected that air transportation emissions will reach 170 million tons in 2012, with international flights responsible for 147 million tons – far below highway transportation. However air transportation is among the fastest-growth industries. According to EU statistics, in 2012 air transportation will see an increase of 150 percent over 1990 traffic, which means rising fuel consumption and of course, growing carbon emissions. In this regard, it makes sense for the EU to enforce the cap, but how will EU control aviation emission through quotas?

Distribution of emission quotas are based on historical data, just as practiced in other industries. According to the EU, the allocations for airlines in 2012 amount to 97 percent of historical emissions, referring to average annual emissions of airlines from 2004 to 2006, or about 2.195 billion tons according to EU statistics released in March 2011.

As to the distribution of permits, both free allocation and paid auction will be used. In 2012, only 15 percent of allowances will be auctioned, and the rest will be distributed free of charge. In 2013, the auction proportion will remain the same, while free allocations will drop to 82 percent, with the remaining three percent left for those experiencing rapid business growth. From this we can roughly calculate that the cap of aviation emission in 2012 will be 213 million tons, of which 181 tons are free allocations. In 2013 the cap will be set at 208.5 million tons, and from 2013 to 2020, annual free allocations will be 171 million tons.

Regarding penalties for excessive emissions, the EU stipulates that starting in 2013, before April 30 every year carriers must surrender enough of their allowance to cover all its emissions in the previous year. If an airline's actual emissions exceeds its quota, it will have to purchase the extra allowance from the international carbon market to offset the exceeded part. If the submitted quota is lower than the actual emissions, the airline will face a fine. It also must pay the owed quota in the following year. The EU aviation carbon emission quotas apply not only to the EU domestic airlines but also foreign airlines. If fines don't work, even more stringent punitive measures are ready to be brought down, including prohibiting the carrier's business in the EU, or even detaining its aircraft.

The Impact on China's Aviation Industry

The new regulation has triggered strong responses from the international aviation industry, with the most vocal and open opposition coming from airlines in China, the U.S. and Japan. Two years ago, American airlines even filed a lawsuit in a British court against related EU institutions.

In contrast to the airlines of developed countries where the industry is in a state of saturated competition with little room for growth, Chinese air transportation is experiencing rapid growth, with an annual rate of increase six to seven times that of the EU. The expansion of their market share is vital for Chinese airlines, but obviously, the room it needs will not be available after EU expanded carbon emission quotas to the aviation industry.

Considering that carbon trading is a well-developed market in the EU, Chinese airlines will definitely pay huge fees for the permits. The exact loss is hard to calculate, but rough estimates are possible. If the international carbon price increases to EUR 30 per ton between 2012 and 2013, Chinese carriers operating on European routes will pay extra fees as high as EUR two billion from 2012 to 2020, which means about EUR 300 million per year. The average fuel consumption of a one-way flight from China to the EU is 100 tons, which will, according to the carbon emission factor for fuel, produce about 300 tons of carbon dioxide.

EU aviation quotas will increase carrier costs significantly, but the most severely affected will be air cargo businesses. Now over 20 percent of all cargoes between China and the EU, and 60 percent of IT parts and products are transported by air. Chinese carriers are very sensitive to price changes as the cargoes are low value-added products. In the last decade, Chinese cargo airlines have been losing their share of international routes. Considering the extra fees for emissions and high operation costs, they will probably have to give up their EU markets. Therefore, EU aviation quotas are not just a matter of profit reduction for Chinese carriers, but also a loss of international market share and a cause of arrested development.

The Intention of the EU

Aviation emission allowances are an important part of the EU ETS, which is itself key to the EU's commitment to the Kyoto Protocol and has been integrated into the EU's legal system. As this scheme controls a large part of market-based carbon trading, any policy adjustment will influence the carbon price and also the formulation and amendment of international rules. Nowadays, it is the rule makers who have grasped the initiative, and the EU ETS is therefore an important instrument for the EU to promote its concept and system for carbon emission control in the world.

Bringing in airlines to the ETS system indicates that the EU is trying to expand its international influence. The action is probably an experiment. Carbon tariffs adopted by one zone can control the carbon emissions of foreign companies, but as a border adjustment tax this system is comparatively rigid and accompanied by a high degree of political and economic risk, often prompting retaliation from trading partners. While carbon emission quotas are more flexible, they put a brake on the rapid development of competitors, improve the market situation of European airlines, and also promote the region's own solution. Cloaked in the feel-good "slowing down global warming" rationale, it will easily win people's approval, which is what the EU intends.

------------------------------

XUE YANPING is a research fellow at the Institute of European Studies, the Chinese Academy of Social Sciences.