Our partner, FCC Aviation, a multilingual team of regulatory compliance specialists with more than 10 years of experience in compliance with aviation tax and emission regulations.
How emissions trading really works?
When aviation was included in the European Union’s Emissions Trading System (ETS) in 2012 one of the questions most people asked was how emissions trading actually works. The EU ETS works on the ‘cap and trade’ principle which means that the volume of greenhouse gases that can be emitted each year is limited by a cap and that emission allowances bought at auction or distributed for free are later exchanged (or traded) between regulated companies.
So what is an emission allowance?
An emission allowance gives its holder the right to emit one metric ton of carbon dioxide. If you don’t have enough allowances to cover your emissions, then you have to purchase them. This is important because you have to surrender emission allowances equivalent to the number of metric tons of CO2 emitted during the previous year by 30 April. Flight departments who are short of emission allowances get their allowances from carbon trading firms or from aggregators, such as FCC Aviation, who bulk buy allowances to later distribute them among their clients. Allowances are mainly bought at the (secondary) carbon market from companies with an allowance surplus.
Like with any other market, the price you pay for a European Union Allowance (EUA) or European Union Aviation Allowance (EUAA) fluctuates. Prices tend to go up as demand for emission allowances increases or supply decreases, and vice versa. In addition, the price signals sellers not only when to sell allowances, but also how much to sell, which brings us to the fundamental idea behind an emissions trading system, like EU ETS.
Thanks to the price signal, emissions are reduced where this can be done at lower costs because, generally, you would not reduce your emissions if the costs of doing so is higher than buying emission allowances. Not so much in aviation, but EU ETS regulates industries where companies are better off investing in abatement measures and selling unused allowances on the carbon market. So ultimately, it is the carbon market (and more precisely the carbon price) and the abatement cost structure of each regulated company that determines where emissions are reduced.
What’s the main difference between EU ETS and CORSIA?
The first main difference is that under EU ETS you have to surrender emission allowances to cover 100 percent of the emissions you produce during a qualifying flight, whereas under CORSIA you only offset a fraction of your emissions. The size of the fraction depends on how much industry emissions have grown since 2019 and how much emissions you reported.
Another difference is that under CORSIA eligible carbon credits cannot be obtained from an exchange where standardized contracts (spot or futures) are traded like under EU ETS. CORSIA eligible credits must be bought from emission reductions project managers, subject to their own terms and conditions. But, most likely, you won’t even notice because your carbon trader or broker will act as an intermediary. Nonetheless, obtaining small quantities of carbon credits for CORSIA compliance might be more challenging due to the non-existence of a carbon market.
Lastly, the total quantity of emission allowances that is available for free or against payment is limited under EU ETS because of the system-wide emissions cap set by the regulator. By contrast, there is no upper limit to the number of carbon credits that can be produced by emission reductions projects
Why is EU ETS likely to become increasingly expensive for flight departments?
Flight departments are expected to dig deeper into their pockets in the years to come mainly because of the EU’s growing ambitions to tackle climate change and the increase of aviation emissions over time.
Let’s start with the EU and its target of net zero emissions by 2050. To meet this goal, the EU has set the emission reduction target for 2030 to 40 percent of 1990 emissions.
The 40 percent emission reductions target translates into an annual decrease of the emissions cap by 2.2 percent which means that a decreasing number of emission allowances are auctioned or distributed free of charge. This creates scarcity and affects the carbon market because the number of allowances in circulation goes down. Sellers of allowances have fewer allowances to sell and buyers, such as most airlines and business jet operators, must compensate for the reduction in free allowances by buying an increasing number of allowances on the carbon market. Lower supply and higher demand for allowances must ultimately lead to an increase of the carbon price, all other factors being equal.
According to the EU, higher carbon prices are also desirable because they encourage investments in low-carbon technologies and without those investments, emission reductions are less likely to take place where this can be done at lower costs.
In addition, the EU has given itself a powerful tool, the so-called Market Stability Reserve, to manipulate carbon prices, for instance, in situations where the market faces an oversupply of allowances.
Looking at the demand for allowances, aviation emissions will most likely continue to increase as traffic increases and technology improvements are not sufficient. At least not for the next 10 or 20 years. For example, carbon emissions from flights within the European Economic Area have increased from 53.5 million tonnes in 2013 to 64.2 million tonnes in 2017.
This trend will most likely continue and increase the budget that growing aircraft operators have to set aside to meet their CO2 obligations.
What is the Impact of Covid-19 on CORSIA?
It is fair to
say that the COVID-19 pandemic had an impact on everybody’s private and
professional life. This is even more true for the Carbon Offsetting and Reduction
Scheme for International Aviation, CORSIA, mainly for the following two
First, CORSIA aims at offsetting all future emissions growth. The
starting point or baseline, against which future emissions are compared to, was
supposed to be an average of 2019 and 2020 emissions from international
flights. But then COVID-19 hit in early 2020 and air traffic, along with
emissions, fell sharply to levels from 20 years ago. Holding on to 2020
emissions would have reduced the baseline and, as a consequence, significantly
increased future offsetting requirements. To not put an overly high financial
burden on aircraft operators, ICAO decided to only consider 2019 emissions for
the calculation of the baseline.
2) Secondly, it will take time for the industry, as a whole, to recover so we may not reach 2019 traffic and emissions levels for several years. This means that you won’t have any offsetting requirements for the years to come even if your individual emissions from, e.g. 2021 or 2022, are above your 2019 emissions. What counts is the sum of emissions from international flights carried out by all participating aircraft operators and as long as those emissions don’t exceed 2019 levels you won’t have any offsetting requirements, meaning that you won’t be required to purchase and cancel eligible carbon credits.
What’s the difference between emissions trading systems and environmental taxes?
Emissions trading systems and environmental taxes are both policy measures that seek to reduce emissions. In addition, they have in common that they put a price on emissions to make the polluter pay for the damage it causes.
The damage to the environment is reduced in two ways. First, higher ticket prices lead to a reduction in demand for air travel, traffic and ultimately emissions (at least for airlines) and, secondly, in the case of a truly environmental regulation, the proceeds are used for investments in green technologies or for mitigating the negative effect that greenhouse gas emissions have on our society and on our planet.
As for the difference, a carbon tax has a fixed rate. In practise, policy makers determine the tax rate more or less arbitrarily. Another difference is that the amount of emissions reduction is uncertain because predicting how a carbon tax affects traffic is one of the more difficult tasks.
By contrast, an emissions trading system, such as EU ETS, has an emissions cap and, provided that ETS does not lead to more emissions elsewhere (so called carbon leakage), we know already at the start how much emissions will be reduced. What’s variable, however, is the carbon price. It is determined on the carbon market which means that it moves up or down depending on the supply and demand for emission allowances.
Bigger emitters, such as airlines, usually protect themselves from price fluctuations by buying forwards or futures. This strategy is much less common in general aviation. Most business jet operators buy their allowances on the spot market just before the surrendering deadline. Consequently, they are more exposed to carbon price hikes. This risk can be reduced by buying allowances e.g. every three months and when market conditions are favorable.
Tobias Konik, Chief Executive, FCC Aviation
To Learn More: https://www.fccaviation.com/