12. Prospective Costs for the Aviation Sector of the Emissions Trading Scheme

These projections assume a constant level of technological mitigation of emissions, see Air Transport Action Group 2010, Farries and Eyers (2008) and Lee et al. (2001). Lee et al. (2001), found 57 % of energy reduction came from engine efficiency, while aerodynamics efficiency accounted for 22 %. Farries and Eyers (2008) detail historical performance developments, and forecast fuel savings from engine and airframe improvements of 20–30 % and 20 % respectively, by 2025. Air Transport Action Group 2010 present updated material, accounting for the new European Air Traffic Management (ATM) initiatives and find similar conclusions. The rate of emissions reductions to date, however, is largely independent of the EU ETS principally due to weak anticipated EUA prices Zhang and Wei (2010).

The scheme has been instigated since 2005 as part of the EU agreement to cut worldwide emissions of carbon dioxide (CO₂) within the Kyoto Protocol. The scheme issues a restricted amount of emission allowances to firms on an annual basis. At the end of the year firms must hold the required amount of emission permits to meet their emissions of CO₂ over the previous year. The ETS allows firms to trade the amount of emission permits that they hold and as a result has applied a market value to this externality. In the EU ETS context the first phase of trading was 2005–2007 and the second one, which coincides with the first compliance period of the Kyoto Protocol, is 2008–2012. The third European trading phase has commenced in 2013. Now a single, EU-wide cap on emissions applies in place of the previous system of 27 national caps. In 2013 more than 40 % of allowances will be auctioned, and this share will rise progressively each year. For commercial airlines, the system covers CO2 emissions from flights within and between countries participating in the EU ETS (except Croatia, until 2014). The scheme’s application to non ETS countries was deferred in 2012 to allow time for agreement on a global framework for tackling aviation missions to be reached in autumn 2013.

To date, regulation allows airlines to use European Union Allowances (EUA) or European Union Aviation Allowances (EUAA). EUAs are used by both land based industries and airlines, while EUAAs can only be used by airlines. In Sect. 12.3, we show that the EUAA futures price changes are highly correlated with those of EUA futures price changes.

To elaborate, embedded in European Commission forecasts, with respect to emissions abatements, is an expectation that competition in the sector in combination with improved clean technologies will incentivize a reduction in emissions.

The APUs provide power for purposes other than propulsion, such as engine ignition and electrics.

The ICAO is a UN agency with responsibility for aviation. Its resolution 35–5 (2004) endorses emissions trading in principle.

Resolutions 37th ICAO Assembly 2010.

The EU as of 1-May-2004 (consisting of 25 countries).

EUAs are used by both stationary emitters and airlines while EUAAs can only be used by airlines.

Source: Bloomberg Terminal (Accessed 04-Jan-2013).

The pairwise correlation coefficient between EUAs and EUAAs is 0.98.

Nearly 40 % of orders were placed for a quantity of 1 (a 1,000 tonne contract), with 68 % comprising of combined order sizes of 1, 2, 5 and 10. At the other end of the scale, there were 75 orders for a quantity of 200 or more. The presence of the small trades indicates individual or small investors; while larger volumes are associated with larger investors (Barber et al. 2006).

The intercept is given an indicative (conservative) value of 20 Euro for three reasons. First, as previous studies have suggested prices of between 25 and 50 Euro per tonne (York Aviation, Carbon Trust and Bloomberg New Energy Finance). Second, due to the structural deficit anticipated between a carbon emissions cap of 221 million tonnes per year and the UN projection of 300 million tonnes by 2020. Finally, it is worthwhile to emphasize that the precise point estimate of the intercept is not of first order importance as the trend in simulated prices is our main point of concern.

Since the EUA price collapse in 2007 this instrument is bankable from year to year within the ETS phase II, and even between phase II and phase III of the ETS. The key issue is that intraphase banking has been allowed throughout (Phase 1, 2, 3); however interphase banking was not permitted between Phase 1 and 2. The Kyoto protocol only came into operation from 2008 onwards. The aim of Phase 1 was to get the market up and running.

There is an expectation, on the part of the European Commission, that competition in combination with improved clean technologies in the aviation sector will incentivate a reduction in emissions and complement any pass through of flight price increases to the customer due to the ETS extension to the sector.