European Union: Aviation And The EU ETS: What's Next?

The European Union Emissions Trading System ("EU ETS") faced serious international opposition in 2012 for seeking to include carbon emissions from flights into and out of the EU under the ETS regulatory umbrella. While the EU retreated from full enforcement at the 11th hour of 2012, EU officials have made clear that the EU intends for aviation emissions associated with European Union travel and transport to be regulated under some scheme by the end of 2013. This intent to regulate emissions outside the EU, coupled with volatile carbon prices, will prove 2013 to be a year of significant EU ETS developments for the aviation community as well as the global community. This article briefly outlines recent aviation-related developments with the EU ETS and then highlights areas to watch in 2013.

EU ETS Legal Framework

On November 19, 2008, EU Directive 2008/101/CE amended the Directive 2003/87/EC on the EU ETS to incorporate greenhouse gas emissions from aircraft. The Directive applies to flights by passenger or cargo aircraft to, from, or within the EU with maximum takeoff weights of more than 5,700 kg, but excludes military, police, customs and rescue flights; flights on state and government business; and training or testing flights. The Directive, published in the European Official Journal on January 13, 2009, requires allowances to be submitted by April 2013 for 2012 aircraft emissions.

Looking Back on 2012

International Opposition. The inclusion of foreign carriers into the EU ETS encountered tremendous resistance in the international community. In February of 2012, China ordered its carriers to not participate in the EU ETS. In addition, China went a step further and ordered its carriers to cease purchases of new Airbus aircraft. The Chinese government-ordered freeze temporarily suspended the purchase of at least 45 new A330 aircraft worth approximately €10 billion.1 Similarly, India-flagged carriers refused to report verified 2011 carbon emissions to the EU in March 2012 as required by the EU ETS in accordance with direction from the Indian government.

In the United States, the first piece of legislation debated after the November 2012 election was the European Union Emissions Trading Scheme Prohibition Act of 2011, which potentially prohibits any operators of civil aircraft in the United States from participating in the EU ETS.2 Other countries, including Russia, heavily criticized the unilateral imposition of an emissions trading scheme as contrary to the mandates and restrictions of ICAO through the Chicago Convention and other international treaties.

On November 9, 2012, the ICAO Council announced that it was forming a high-level group to provide near-term recommendations to develop a global market-based mechanism to address greenhouse gas emissions from aircraft (the "MBM Group"). The MBM Group will be composed of senior policymakers and government officials from various member countries, determined by taking into account geographic representation and levels of international civil aviation activities. The MBM Group is expected to propose a market-based mechanism Framework and Feasibility Report for consideration at the next triennial ICAO Assembly in October 2013.

EU Stops the Clock. The EU quickly welcomed the ICAO Council announcement. On November 12, 2012, EU Climate Commissioner Connie Hedegaard proposed that the EU "stop the clock" on enforcement of the EU ETS for flights to and from the EU. In exchange for return of freely allocated allowances, aircraft operators would not be required to submit allowances to offset 2012 emissions in April 2013. Aircraft operators can still report 2012 emissions to the EU, but they will not be fined for failure to do so. The reprieve applies only to flights to and from the EU; flights within the EU remain fully obligated to comply with the ETS. Both Ms. Hedegaard and the European Parliament rapporteur German MEP Dr. Peter Liese have clearly stated that the "stop the clock" provision is intended to provide an opportunity for an international consensus on the issue at the October ICAO Assembly, and should the international community fail to take adequate steps, the EU will fully reinstate the ETS.

Economic Impacts. In 2012, airlines with business in Europe may have made €1.36 billion in profit from charging passengers fees for carbon emissions. A study by Dutch consulting group CE Delft found that airlines profited from both the 2012 "stop the clock" action and the structure of the ETS.3 First, airlines raised revenues on intercontinental flights into and out of Europe in anticipation of the ETS requirement to buy allowances to cover flight emissions. For the "stop the clock" period, these airlines no longer need to purchase allowances, resulting in what CE Delft estimates to be unexpected profits of €243 million to €486 million depending on the assumed pass-through rate. European airlines are estimated to be the primary beneficiaries (55 percent) of the regulation change followed by U.S. airlines (13 percent). In early 2012, some airlines explicitly adopted passenger surcharges and fuel charges to pay for anticipated allowance costs.

The second source of profits arises from the freely allocated allowances. The ETS structure grants airlines a certain portion of free allowances, but the raised revenues for 2012 do not appear to account for the free allowances. CE Delft believes that some airlines passed on the cost of purchasing allowances as if a portion of the allowance were not free. The consulting group estimates a 2012 windfall of a €436 million to €872 million for airlines that took advantage of the opportunity to charge carbon fees on freely allocated allowances.

EU ETS: What's Next in 2013?

EU ETS Reform. The challenges faced by the global aviation community as it attempted to navigate the EU ETS in 2012 are not unique to the aviation sector. Moving into 2013, the EU ETS faces serious hurdles. The EU ETS structure operates on a cap-and-trade principle in which a progressive declining cap creates scarcity of allowances, which then forces reductions of greenhouse gases as capped companies adjust operations to decrease their allowance costs.

The EU ETS was developed on the assumption that economic growth would outpace the supply of allowances and international compliance credits. Regulators assumed a year-to-year increase in productivity would lead to increased demand for the right to emit carbon within the European Union. In reality, the number of allowances and international credits available was greater than the verified emissions for 2009, 2010, and 2011. The result of this imbalance in demand and supply is a current oversupply of two billion allowances. In 2008, carbon prices hovered near €30 per metric ton. In January 2013, the market saw multiple record-lows as prices dropped 40 percent in a single day to €2.81 per metric ton.

Solutions to ameliorating the carbon price are not immediately obvious. Created by EU legislation, the scheme cannot be abandoned until 2020 even if carbon prices drop to zero. As early as 2011, the environmental committee of the European Parliament sought permanent withdrawal of 1.4 billion allowances in a "set-aside." Opposition to the measure led to a diluted "backloading" plan in which the Commission recommended a freeze on the auction of 900 million allowances between 2013 and 2015. While some EU members like Britain support freezing auction of allowances and even more drastic structural reform, countries like coal-dependent Poland adamantly oppose measures that would increase carbon prices. Even if the backloading plan is settled and implemented in 2013, the plan will still leave the ETS scheme in need of modification as the eventual return of the frozen allowances to the market in 2017 and 2018 will undermine the progressive declining cap.

ICAO Meetings. Two significant ICAO meetings are scheduled for 2013. The first is the Symposium on Aviation and Climate Change, "Destination Green," planned for May 14–16 in Montreal, Canada. The development of the Framework and Feasibility Report, due in October 2013, will draw significant attention from symposium attendees. While the symposium will not immediately result in an action plan or report, it will provide an opportunity for meeting and discussion among prominent parties and provide an opportunity for policymakers to float thoughts and ideas that are still under development.

The 38th Assembly of ICAO, scheduled for September 24–October 4 also in Montreal, is more significant. At the autumn meeting, the MBM Group is expected to deliver its proposal for a market-based mechanism Framework and Feasibility Report. Stakeholders have many questions about the report: Will the report be sufficiently substantive to convince the EU to continue holding off or entirely abandon its efforts to enforce emissions trading for flights outside of the EU? Will a framework that is acceptable to non-EU parties, such as Russia, China, India, and the United States, that opposed international inclusion in the EU ETS even emerge? Will a compromise solution provided by the MBM Group be more palatable to non-EU countries than continued battle with the EU? While the framework presented by the MBM Group will affect the future of the EU ETS, it is unclear if the report will lead to development of a global emissions scheme or if it will reignite the controversy over the application of the EU ETS to flights outside the EU.

U.S. Prohibition Law. Another significant ETS event that may occur in 2013 is the issuance of an order by the United States Secretary of Transportation prohibiting operators of U.S. registered aircraft from participating in the EU ETS. Shortly after the EU announced that it was "stopping the clock" on international obligations under the EU ETS, President Obama signed the European Union Emissions Trading Scheme Prohibition Act of 2011 in November 2012. The law does not immediately prohibit U.S. registered aircraft from participating in the EU ETS. Instead, it orders the Secretary of Transportation to make determinations regarding the effect of the EU ETS on U.S. interests, and if he determines U.S. interests are harmed, he must issue a prohibition order. The potential order would prohibit all U.S. registered aircraft, including air carriers and privately owned aircraft, from participating in the EU ETS.

Largely due to the EU's action in stopping the clock, the Secretary has not yet issued a prohibition order. However, if the EU reinstates the full EU ETS based on unfavorable developments at the October ICAO Assembly, the Secretary is likely to issue a prohibition order. In that case, the United States would join China and India in prohibiting its registered aircraft from participating in the trading scheme.

Private Aircraft Owners Stuck Between a Rock and a Hard Place. The EU's actions in stopping the clock have delayed most, but not all, of the international controversy regarding the EU ETS. Since the scheme remains in full effect for flights within the EU, international operators flying between European countries will still be subject to the EU ETS requirements. This does not significantly affect international air carriers because most of their intra-European flights are operated by European code share or other alliance partners. In contrast, the corporate business jet community still faces ETS burdens. International corporate jet operators planning to fly point to point in the EU are currently required to register with the EU ETS, report emissions for flights within the EU, and submit allowances for these flights.

Continued ETS requirements will cause corporate jet owners substantial compliance costs and potentially place them in a position of violating the laws of their home country. Even if most aircraft registered outside of the EU make only a few intra-EU flights per year, they will incur significant expense in complying with the EU ETS. Aircraft owners will need to study and understand the EU ETS requirements. They will need to register with EU ETS, collect emissions data regarding their flights, and develop an accounting system to buy and submit allowances. All of these transaction costs will likely dwarf the actual cost of allowances incurred by many internationally registered private jet owners.

Beyond these costs of compliance, international jet owners may find themselves forced to violate one law in order to comply with another. India and China have both prohibited their national airlines from participating in the EU ETS. As the U.S. prohibition does not go into effect until the Secretary of Transportation issues a prohibition order, U.S. registered aircraft are not yet violating U.S. law by participating in the EU ETS. However, if the Secretary issues an order, business jet owners will quickly find themselves deciding whether to violate the law of their home country or of the EU. The U.S. Department of Transportation is actively holding discussions with the U.S. National Business Aviation Association and other private aircraft stakeholders to determine the full impact of this scenario.

Liability concerns over noncompliance with either the EU ETS or a home country's regulations could cause aircraft lessors to amend leasing contracts with airlines. Noncompliance with regulatory schemes may lead to fines or asset impoundment. Leasing and financing companies may seek provisions that the lessees or sublessors will operate the aircraft in compliance with specific regulations. Additionally, financers may seek amendments that ensure that noncompliance liability from the EU ETS or other clashing regulation cannot be shifted to the owner, lessor, or financer of aircraft.4

Other Expected 2013 Developments. In addition to international expansion through ICAO, 2013 may see the EU ETS begin to merge with other similar schemes. Australia and the European Council may take formal steps to establish a full two-way link between the EU ETS and the 2015 Australian emissions trading scheme. On January 24, 2013, the European Commission submitted to the Council a recommendation to open negotiations on linking the systems. If the systems are linked, companies would be able to use carbon units from either system for compliance purpose. Additional progress may also be made in linking Switzerland to the EU ETS.

In April, European airlines still obligated for intra-continental flights will undergo their first allowance surrender. The EU will publish finalized National Implementation Measures figures, which will determine the number of free allowances capped entities can expect to receive in the Phase III implementation. Favorable allocations may lead some companies to sell off surplus allowances, further decreasing carbon prices. The Climate Change Committee may also clarify the banking rules related to aviation allowances. Amendments proposed in January 2013 would carry over 2012 aviation allowances to Phase III without changing their aviation designation.5

Conclusion

The year 2013 is ripe for continued regulatory development. As governments across the globe attempt to reconcile divergent views about emissions regulation, airlines and other industries may continue to find themselves in the cross hairs. Careful planning and an integrated understanding of the emerging legal framework will be essential to those seeking to navigate the least burdensome path through uncertainty in the coming years.

Footnotes

1. Tim Hepher, "China Halts 10 More Airbus Orders: Source," REUTERS (Mar. 15, 2012).

2. European Union Emissions Trading Scheme Prohibition Act of 2011, Pub. L. No. 112-200 (2012).

3. Dagmar Nelissen and Jasper Faber, "Cost and Benefits of Stopping the Clock," CE Delft (Dec 2012).

4. Hannah Meltzer, "Aircraft Lessors Seek to Safeguard Against Controversial EU ETS Laws," LEASINGLIFE (Aug 20, 2012).

5. "Proposal to Update EU ETS Registry Rules Submitted to Climate Change Committee," EUROPEAN COMMISSION (Jan. 10, 2013).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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