We estimate the economic impacts on US airlines that may arise from the inclusion of aviation in the European Union Emissions Trading Scheme from 2012 to 2020. We find that the Scheme would only have a small impact on US airlines and emissions, and that aviation operations would continue to grow. If carriers pass on all additional costs, including the opportunity costs associated with free allowances, to consumers, profits for US carriers will increase. Windfall gains from free allowances may be substantial because, under current allocation rules, airlines would only have to purchase about a third of the required allowances. However, an increase in the proportion of allowances auctioned would reduce windfall gains and profits for US airlines may decline.
In 2005, the European Union (EU) implemented an emissions trading scheme (ETS) for certain industries and installations to partially fulfill its obligations under the Kyoto framework to reduce greenhouse gas emissions (European Union, 2003). The EU-ETS is in its second phase (2008–2012) and a third phase will operate from 2013 to 2020. The EU will develop post-2020 climate policies according to future international policy developments and progress in the understanding of the science of global climate change.
The EU-ETS sets progressively lower caps on annual greenhouse gas emissions and 2020 limits are set at 79% of 2005 emissions covering all EU states plus Iceland, Liechtenstein and Norway. It covers carbon dioxide (CO2) emissions and nitrous oxide emissions from installations in the energy sector such as power stations, combustion plants and oil refineries, and emissions from most other industrial installations.
In 2008, the European Commission adopted directive 2008/101/EC, to include aviation in the EU-ETS from the beginning of 2012. All flights to or from airports in ETS countries, irrespective of carrier nationality, will have to acquire allowances to cover CO2 emissions. While the International Civil Aviation Organization (ICAO) and International Air Transport Association (IATA) generally support market-based policies to abate aviation emissions, the inclusion of aviation in the EU-ETS has been challenged. Some foreign governments and airlines argue that the EU-ETS in its current form is both unjustly harmful to airlines and contravenes international treaties, such as the Chicago Convention. In this connection, the US government has requested an exemption from the EU-ETS for US carriers. Additionally, some US airlines and their trade body, Airlines for America (A4A), have filed a case in the European Court of Justice. Other countries, such as China, are also calling for exemptions (Flottau et al., 2011). Under current EU legislation, an exemption may be granted for airlines from countries that implement measures “equivalent” to those in the EU to reduce GHG emissions.
In extending the EU-ETS to aviation, the European Commission will allocate aviation allowances for 97% of average annual emissions from 2004 to 2006 in 2012, and 95% of the same historical average from 2013 to 2020. However, aviation emissions may exceed the quantity of aviation emissions allowances if aviation buys allowances from other sectors covered by the EU-ETS and/or purchases emissions credits from certain clean energy projects. Under current regulations, 85% of aviation emissions allowances will be granted for free (grandfathered) each year based on each carrier's market share in 2010, and 15% of allowances will be auctioned. However, EU legislation allows policy makers to revise the number of allowances grandfathered from 2015 onwards.
We forecast the potential impact of the EU-ETS on US airlines from 2012 to 2020. Reflecting current market behavior, we modeled an emissions price of €15/tCO2 in 2010 that increased by 4% per year. We considered three cost pass-through assumptions. In our modeling framework, CO2 emissions from US airlines between 2011 and 2020 increased by 35% in the reference scenario and 32% under the EU-ETS when there is full cost pass-through. The small reduction in aviation emissions reflects high abatement costs in aviation relative to abatement costs in other industries. When there is full cost pass-through, airlines received windfall gains of $2.6 billion from the grandfathering of allowances.
