EU ETS in aviation - Trade war or damp squib?

I had earlier blogged about the EU ETS ruling of the European Court of Justice. Whether the contours of the dispute would take the contending parties to the doorsteps of another international body, the WTO's Dispute Settlement Body, is debatable.

Reports in the new year indicate that different parties are taking divergent viewpoints. The NYT reported that the European Commission was serious in imposing the EU ETS Scheme,

"The European Commission said on Thursday that airlines that did not follow a new European law requiring them to account for their emissions of greenhouse gases could face being banned from European airports.

The warning was the latest stage in an escalating war of words between the European Union and countries like China, which have expressed fierce opposition to a law that represents the European Union’s boldest move to date to protect the climate.The initiative went into effect at the start of the year and involves folding aviation into the European Union’s six-year-old Emissions Trading System, in which polluters can buy and sell a limited quantity of permits, each representing a ton of carbon dioxide."

Some Airlines seem to have fallen in line and are in a mood to comply with the "environmental friendly" order. This report indicated that US Airways and United-Continental were complying with the provisions of the scheme, albeit by passing the burden onto the customer.

"United-Continental and US Airways have joined Delta in adding a $3 surcharge to one-way tickets to Europe, days after the European Union started requiring airlines to pay for carbon emissions.

Spokesmen for all three airlines would not discuss the reasons for the surcharges.

But industry analysts call the surcharge a clear sign that consumers could bear the brunt of a European law that the U.S. airline industry has estimated would cost it $3.1 billion from now through 2020.

The new surcharge also happens as consumers are already paying surcharges for higher fuel costs on international flights.

“This is a new fee, so it’s going to go straight to the bottom line, and that means consumers will be paying,” says Charles Leocha, director of the Consumer Travel Alliance. “This is one more fee on top of all the other ones, so it adds up.”

One Airline Association appears to be sticking to a confrontationist stand. China Air Transport Association. As reported here,

"China, of course, will not cooperate with the European Union on the ETS (emissions trading scheme)," said Chai Haibo, deputy secretary-general of the China Air Transport Association, which represents the country's airlines.

"The CATA, on behalf of Chinese airlines, is strongly against the EU's improper practice of unilaterally forcing international airlines into its ETS," Chai said from Beijing, where the group is based."

Whether this would result in an all out trade war having ramification across sectors is too early to judge. A negotiated settlement could also be on the cards. Further, passing on the burden to the paying customer is always an option. 

A recent interesting report by an aviation industry intelligence association (OAG) is found here. It essentially forecasts two fall outs of the ETS regime on the airline industry:

"In consequence, the EU ETS will create two possible scenarios. The first one will generate higher air fares due to the carbon tax at an additional average cost of approximately 3% per passenger. The second scenario will  see airlines  use non-EU points  as intermediate stops to avoid the additional costs. The impact of introducing this new carbon tax will be visible not only in carriers’ capacity and frequency, but also in European airports and airports outside the area affected by carbon regulation."

The report concludes,

" In the longer term, an aircraft operator's ability to pass on the additional carbon cost will  be a key differentiator and will vary from operator to operator although it is likely that such costs will be passed on to the passenger. The degree to which an individual airline is able to pass on this cost will be influenced by the efficiency of its route network, market pricing and price elasticity of the route. Those airlines with a higher proportion of premium revenues may find it easier to pass on carbon costs to passengers, as these costs will be a proportionately lower percentage of the ticket price than for  lower priced economy passengers. Low-cost and short-haul airlines that have lower premium revenues, and particularly those with older aircraft fleets,  will be more affected by ETS scheme across their business.

The decision made by the EU to include aviation in the EU ETS has already proven to be controversial. A group of US airlines  are  pursuing a case on this issue at the European Court of Justice.  26 countries, including China, Russia, India, and the United States, publicly voiced their opposition to the initiative. Adding to confusion on the issue, the US House of Representatives on 24th October  2011  passed a bill  prohibiting US airlines to participate in the controversial EU scheme. 

The inclusion of aviation into the EU ETS, in long term, will have not only a direct impact on ticket prices to/from and within Europe but also on regional aviation demand. It is forecasted that air fares will  increase  approximately  about 3% due to carriers’ additional carbon tax that may lead to demand suppression on certain markets."

Trade, environment and markets are in interesting confluence here.