EU Emission Trading System og konsekvenser for dansk luftfart
3 English summary
The EU Commission has decided to launch initiatives aimed at reducing GHG emissions from aviation. To this end, the Commission wishes to bring aviation into the existing EU Emissions Trading Scheme. In recent years, the Commission has therefore commissioned a number of review and studies in this particular field, and intends to submit a legislative directive in a couple of months. The inclusion of aviation in the emissions trading scheme would take effect already from 2011.
In developing an emissions trading scheme for aviation, a number of key questions defining the exact scope and role of the scheme the must be addressed, including:
• Which requirements are necessary to ensure proper coordination of the proposed scheme with the Kyoto Protocol, given the fact that signatories to the Protocol are under no obligation to reduce emissions from international aviation and shipping?
• Flights to be covered; intra-EU flights only or all flights departing from EU airports to anywhere in the world?
• Types of emissions to be included, including how can provisions be made for the fact that the climate impact of aviation emissions is greater than the impact of the same emissions made on ground?
• How should allowances be distributed to airline operators and should they be granted free of charge or issued against payment?
The outcome of these decisions will affect to the economic impact on the aviation sector in case aviation is incorporated in the emissions trading system. Depending on the design of the emissions trading system, Danish aviation operators may either look forward to a net benefit or face financial losses.
Based on theoretical and empirical data, the study assesses how the inclusion of aviation in the emissions trading scheme may affect Danish aviation.
Issuing allowances will increase production costs of the "commodity" (in this case a flight on a given route) corresponding to the allowance price multiplied by the CO2 emitted during production of the said "commodity".
Such additional costs must be borne either by the consumer or by the producer (the airline operator). The degree to which airline operators will be able to pass on additional costs to their consumers largely depends on the competitive situation. A decisive factor in this respect is the number of competitors operating the route in question and the degree of equal treatment of operators under the allowance scheme.
Analyses made by means of market models[2] indicate that factors such as the allowance price, the level of marginal costs and the price elasticity of demand are of limited importance to the cost pass-through decision of airline operators. By contrast, other factors are decisive, such as particularly competition from non-EU carriers, the number of competitors in the market and competition intensity among airlines. Making general observations of the impact of the proposed allowance scheme require insight into the competitive market situation.
Generally, market modelling results indicate that there is a positive correlation between competition and the pass-through of costs in the sense that the stronger the competition, the higher the degree of pass-through of costs. This finding is universal in all models, despite varying underlying assumptions, and it results from the fact that competing companies "can afford less". In other words, companies are forced to raise prices to avoid loosing money and closing down over the longer term. The opposite is the case for monopolies and companies operating in a weak competitive market. Such companies can “afford” to absorb part of the cost increase. Accordingly, the scheme will imply that the most well-established companies pay a higher share of costs.
Stylized modelling results indicate that monopolies may even experience a negative cost pass-through situation, the reason being that cost increases trigger rising airfares, which, in turn, result in weakening demand and eventually in falling sales. Thus, the monopolist is unable to cover additional costs by increasing sales. The reverse situation prevails in the rare event of perfect competition. If companies are in perfectly competitive markets, they are able to pass on in full the costs of participating in the scheme to their customers. This is true because prices in the event of perfect competition are equal to marginal costs, and when every company faces the same increase in marginal costs, prices will increase by the same amount.
Likewise, if there are several non-EU companies outside the allowance scheme on the market, EU companies may be faced with a negative cost pass-through situation as non-EU carriers will capture market shares from EU carriers included in the allowance scheme.
The impact of the allowance scheme on airlines’ financial performance is quite another matter. The financial performance depends on three factors, i.e. the degree of pass-through of costs, the total quantity of free allowances and allowance prices.
If the bulk of allowances are granted free of charge to airline operators, it would be perceived as a state subsidy measure since airline operators need not buy allowances on the market. It is important to note that, in theory, free allocation would not influence airline decisions on production activities. In the event of free allocations, price decisions and the quantity of flights offered by airline operators would depend exclusively on marginal costs.
In terms on the economic impact on airline operators, free allocation will constitute a net profit. The degree to which this will exceed production costs is conditional on the ability of airline operators to pass on additional costs to consumers. The combination of a large quantity of free allowances and fierce competition in the market tend towards a net profit for the airline operator.
It is important to point out that models have been established on the presumption that the individual airline operator acts rationally from a financial point of view by fixing prices and number of flights in a way that optimises profits generated from operating routes. It is uncertain whether airline operators operate along these lines in the short term. However, in the longer term, market competition is bound to compel airline operators to aim for economic optimisation to survive. Further, there is some uncertainty regarding central data relating to the individual flight routes, including actual prices, costs and competition. Therefore, results are subject to uncertainty, and findings of pass-through of costs established must be considered indicative rather than unambiguous.
The degree of pass-through of costs for 14 selected flight routes were analysed, representing typical routes covered by Danish aviation. As mentioned above, the analysis assumes that airline operators act optimally from a theoretical viewpoint and that market adaptation for the entire sector takes place all at once. In practice and in the short term, lower degrees of pass-through could be observed as airline operators might need time to adapt to new, increased marginal costs incurred by the allowance scheme.
Considering the uncertainties inherent in such analyses, it can be inferred that the economic impact on Danish aviation of introducing an allowance scheme will depend on the ability to pass on allowance costs to consumers and the total quantity of free allowances.
In an allowance scheme covering intra-EU aviation, the break-even point to the airline companies of a scheme is reached at 70 % free allowances. In a scheme covering all flights departing from EU airports (the line "all routes" in the figure below) the break-even point is reached at 60 % free allowances.
Introducing an allowance scheme without free allowances would incur losses on Danish aviation in the order of DKK 130 to 180 million annually depending on the geographical scope of the scheme. At 50 % of free allocations, the estimated loss sustained by Danish aviation will be DKK 30 to 40 million/year.
The loss turns to a profit at the above-mentioned break-even points when the amount of free allowances reaches 60 % and 70 % respectively. In the event that all allocations are granted for free (100 %), the profit brought to airline operators is estimated to DKK 55 million annually in the scheme covering intra-EU flights and DKK 120 million in the scheme covering EU departing flights.
Correlation between the share of free allowances allocated and the economic impact on Danish aviation (MDKK/year)
Assuming higher allowance prices, both curves become steeper in the sense that the relative loss and profit both become higher. However, it is beyond the scope of the present study to analyse further the correlation between allowance prices and the economic impact on aviation.
Expanding the scheme to include both intra-EU flights and all flights into and out of the EU (as considered by the EU Commission) would imply increases in aviation activities and emissions that are not considered above. However, this would not influence the findings relating to the individual one-way trip, but would imply that the costs of aviation operators without free allocation would reach a level of DKK 228 million. Setting the number of allowances allocated free of charge to 50 % would incur losses on the aviation sector in the range of DKK 25 million whereas free allocation in full would lead to a profit of DKK 178 million. In this model, the break-even point in terms of free allocation is reached at 56 %.
The potentials of airline operators to bring down emissions were not included in the present analyses, but is not assumed to alter overall results. However, the potential for reducing emissions over time is expected to be significant through the application of more efficient aircraft, enhanced air traffic and route management, improved procedures and flight traffic control.
On the issue of impacts on consumers, it is tentatively estimated that allowance costs will amount to 1 to 4 % of marginal costs. The share of the allowance costs passed on to consumers are expected to amount to up to around 2 % of the airfares, and loss of passengers up to 3 % at the most.
Fodnoter
[2] A market model is a tool used to assess the expected impact of changing market conditions, including costs. The method is based on economic theory and is applied by Danish and European competition authorities.
Version 1.0 Februar 2007, © Miljøstyrelsen.