Regulating Aviation Emissions: CORSIA and EU ETS

After years of negotiation, the International Civil Aviation Organisation (ICAO) has committed to regulating emissions growth from international aviation starting in 2020 with CORSIA (Carbon Offset and Reduction Scheme for International Aviation). CORSIA is a market-based mechanism designed to offset carbon emissions growth in the aviation sector. The European Commission is due to respond to CORSIA early in 2017 and decide whether to include international and domestic aviation in the EU Emissions Trading Scheme (EU ETS). This article provides an overview of both policies and explores their impact on aircraft operators’ costs in the coming years.

ICAO and the EU Emissions Trading Scheme (EU ETS):

The EU was the first to address aviation emissions through cap and trade when it included aircraft operators within the EU ETS in 2012. However, “stop-the-clock” derogation measures were later introduced following international objections, temporarily exempting intercontinental flights from the EU ETS. These measures were extended until 2016 to allow ICAO member states time to develop a market-friendly approach to cap aircraft emissions.

In October 2016, during the 39th ICAO Assembly in Montreal, CORSIA’s main structure was agreed upon. CORSIA aims to achieve carbon-neutral growth in international aviation from 2020 by requiring airlines to purchase and surrender emission units generated by carbon offsetting projects. The baseline for CORSIA is the average of 2019-2020 emissions. However, several important details, such as offset criteria and eligibility, monitoring and reporting of emissions, baseline emissions, and regulatory frameworks, need clarification before the scheme’s implementation in 2021.

CORSIA is divided into three phases:

Pilot phase (2021-2023): Only states that voluntarily choose to participate will be included. Aircraft operators from participating states must offset emissions equivalent to the aviation sector’s average CO2 growth multiplied by their own emissions during the phase. Compliance with CORSIA obligations is required every three years.

First phase (2024-2027): Non-participating states may choose to join the scheme but are not obliged to do so.

Second phase (2027-2035): The second phase is mandatory for all ICAO member states, except for the least developed and small island countries accounting for less than 0.5% of global air traffic. Emissions reduction requirements will initially be based on the industry average, but over time, obligations will increasingly depend on an airline’s individual growth rate. The reduction will be 100% based on industry averages from 2021 to 2029, gradually decreasing to 30% by 2033.

CORSIA will apply to all international flights between participating states. As of October 31, 2016, 66 states, accounting for over 80% of international aviation emissions, have committed to participating in the pilot phase. The estimated total emissions CORSIA needs to offset between 2021 and 2035 is around 2.7 billion tons of CO2, accounting for approximately 81% of aviation emissions growth from 2020 to 2035 or 21% of total aviation emissions. Participating countries can voluntarily opt out of CORSIA with a six-month notice period.

What will happen to aircraft operators already covered by the EU ETS?

With CORSIA now agreed upon, the EU must decide how to include aviation in the EU ETS from 2017 onwards. The European Commission will provide a report in early 2017 addressing the coverage options for aviation emissions and whether to continue or discontinue the “stop-the-clock” derogation. The decision will depend on whether European lawmakers deem ICAO’s efforts sufficient in regulating aviation emissions.

The EU has outlined three potential policy options for the EU ETS:

Full scope option: All flights departing from or arriving at airports in European Economic Area (EEA) countries and Switzerland would be covered.
50/50 option: All intra-EEA flights would be covered, along with 50% of emissions from flights between EEA countries and non-EEA countries.
Intra EEA+ CH scope: Similar to the “stop-the-clock” derogation, only flights departing from and arriving at airports in EEA countries and Switzerland would be covered.
For aircraft operators already covered by the EU ETS (e.g., intra-EU flights), additional changes are expected. The European Commission proposed amending the EU ETS Directive to align the aviation cap with the 43% reduction trajectory faced by other sectors in Phase IV (2021-2030). The Environmental Committee (ENVI) also supports this measure, meaning the aviation emissions cap will align with the yearly cap decrease of 2.2% (or 2.4% if another ENVI proposal is adopted). This will result in reduced free allocations to aircraft operators, potentially starting Phase IV with a 5-10% cap reduction compared to Phase III (based on 95% of average 2004-2006 aviation emissions). Auctioning and free allocation percentages, currently 15% and 82% respectively, are also likely to change, with a 50/50 split supported for Phase IV.

The Cost of Compliance:

The cost of compliance for CORSIA is difficult to estimate as offset eligibility criteria have yet to be decided. However, even if only Certified Emissions Reductions issued by the UN’s Clean Development Mechanism are allowed, oversupply is expected to keep costs minimal.

Meanwhile, the EU ETS is undergoing significant changes. Oversupply has depressed prices for years, but recent recognition that the policy lacks investment signals for low-carbon technologies is expected to drive up prices. Carbon market analysts predict that the price of an EU Allowance (EUA) could reach €24 by 2020 if Phase IV reforms are implemented.

Demand for offsets under CORSIA is likely to be low initially, resulting in low carbon offset prices and a relatively low financial risk. However, in a carbon-constrained world, prices are expected to increase as demand grows. Notably, regardless of historic emissions, all airlines will be required to purchase offsets under CORSIA, even if their emissions decrease after the baseline period.

Demand for carbon credits under the EU ETS is projected to grow due to policy changes reducing free allocations and expected aviation sector growth. Energy Aspects, a carbon market analyst, forecasts compliance costs for airlines during the voluntary phases of CORSIA (2021-2027) to be around $100 million based on current low CDM prices. However, increased demand resulting from the Paris Agreement could raise this estimate to $500 million or more.

A recent report by CE Delft estimates that the demand for EUAs by airlines under the intra-EEA + CH flights scenario, considering the Commission’s proposal to align the cap with the linear reduction factor, will be approximately 535 Mt for the entire Phase IV. Energy Aspects predicts an average price range of €30-€36 per carbon credit during Phase IV. This implies a total cost of €16-€19 billion, making the EU ETS the greater financial risk.

Conclusion:

The combination of CORSIA and the continued coverage of aviation by the EU ETS, subject to strengthening measures, will increase the financial risk for airlines. Additionally, the administrative burden will grow. While CORSIA covers more routes and potentially requires more emissions offsets, the EU ETS has a stricter cap and higher carbon credit prices, resulting in significantly higher compliance costs.

The final details of both CORSIA and the EU ETS still need to be agreed upon by their respective governing bodies. Evaluating the costs of environmental protection is an ongoing process. Given the airline industry’s thin margins, staying informed about financial risks is crucial as greenhouse gas emissions regulations become more stringent for everyone

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