CORSIA AND THE INCLUSION OF AVIATION IN THE EU ETS

After a long wait (6+ years) and three years of intense negotiations, the International Civil Aviation Organization (ICAO) has committed to regulate emissions growth from international aviation from 2020 with CORSIA (the Carbon Offset and Reduction Scheme for International Aviation). CORSIA is ostensibly a market based mechanism that is designed to allow the aviation sector to offset the growth in carbon emissions. The European Commission’s response to CORSIA is due early 2017 and will address the continued inclusion, or not, of international and domestic aviation in the EU ETS. This article summarises both policies and explores how these will impact aircraft operators’ costs in the coming years.

ICAO & the EU Emissions Trading Scheme (EU-ETS)

The EU was the first to address aviation emissions by way of cap and trade back in 2012 when aircraft operators taking off and landing in the EU were included within the EU ETS. ‘Stop-the-clock’ derogation measures were introduced in late 2012 following an international backlash, particularly from the US and Russia. Stop the clock caused intercontinental flights to be excluded from the EU ETS for a period of one year (2012) and was later extended by another four years (2013-2016) to allow ICAO member states time to find a market friendly way to cap aircraft emissions.

In October 2016, just before the EU’s deadline, during the 39TH ICAO Assembly in Montreal, the main structure of CORSIA was put forward and agreed. CORSIA sets about achieving ICAO’S goal of Carbon Neutral growth from international aviation from 2020 onwards by making airlines purchase and surrender emission units generated by carbon offsetting projects for greenhouse gas emissions that are in excess of baseline emissions. In this case the baseline is the average of 2019-2020 emissions. However, between now and the start of the scheme in 2021 important details need to be clarified such as;

  • Offset criteria and eligibility (i.e. what counts as an offset)
  • Monitoring, Reporting and Verification of emissions
  • Baseline emissions
  • Regulatory frameworks to implement CORSIA nationally.

CORSIA has been divided into 3 phases, the first two  phases are voluntary and the last one is compulsory.

Pilot phase (2021-2023): only states that want to be part of the scheme will be included. Inclusion is on a member state level rather than individual aircraft operators. Aircraft operators from the states included in the pilot phase must offset emissions equal to the aviation sector’s average CO2 growth by the end of the phase multiplied by their own emissions in the phase. Aircraft operators must comply with their obligations under CORSIA every 3 years.

First phase (2024 to 2027):states not already participating may add themselves to the scheme but they are not obliged to do so.

Second phase 2027 to 2035: The second phase is the first mandatory one and will include all state signatories of ICAO except those least developed and small island countries accounting for less than 0.5% of global air traffic. Emissions reduction requirements will continue to be based on the average CO2 growth of the aviation industry. However, over time the obligations will be increasingly determined by an airline’s individual growth rate rather than the industry average. It will be 100% based on industry averages in 2021 through 2029, 80% in 2030, reducing each year to 30% by 2033.

CORSIA will apply to all international flights on routes between participating states. As of the 31st October 2016, 66 States, accounting for more than 80% of international aviation emissions, have stated that they will join the pilot phase (i.e. both of the voluntary phases). The total amount of emissions that CORSIA will need to offset between 2021-2035 is estimated to be around 2.7 billion tons of CO2 which, according to CE Delft, accounts for roughly 81% of aviation emissions growth from 2020 to 2035 or 21% of total aviation emissions. If this all becomes too burdensome, it will be possible for countries voluntarily participating to opt out of CORSIA if they give 6 months notice.

So what will happen to aircraft operators currently covered by the EU ETS?

Now that CORSIA has been agreed, the EU needs to define the inclusion of aviation in the EU ETS from 2017 onwards. The European Commission is committed to providing a report that considers the options for the coverage of aviation emissions in early 2017 and the continuation, or not, of the “Stop the clock” derogation. Much will depend on whether European lawmakers deem ICAO’s efforts to regulate aviation emissions to be adequate.

In a working document the EU sets out three potential policy options covering different geographical scopes and emissions coverage:

  • Full scope option – the EU ETS would return to its original design, all flights departing from or arriving at an airport in one of the EEA countries + CH (Switzerland).
  • 50/50 option – all intra EEA countries + CH flights covered and 50% of the emissions covered from flights between EEA + CH and a non EEA + CH countries,
  • Intra EEA+ CH scope – Similar to the “Stop the clock” derogation, all flights departing from an airport in one of the EEA + CH countries also arriving at an airport in one of the EEA + CH countries.

Aside from the European Commission’s deliberations on what emissions are included in the EU ETS, those aircraft operations that are already included (i.e. intra-EU flights) will be subject to additional change. The European Commission has proposed to amend the EU ETS Directive to align the current aviation cap with the 43% reduction trajectory other sectors in the EU ETS face over Phase IV (2021-2030). The ENVI proposal put forward in December 2016 also supports this measure making it likely the aviation emissions cap will be brought under the Linear Reduction Factor of 2.2% (or 2.4% if another ENVI proposal is adopted) that governs the yearly cap decrease. This means less free allocation to aircraft operators and may mean Phase IV starts with a 5-10% cap reduction at the start of Phase IV compared with Phase III (which itself is based on 95 % of 2004-2006 average aviation emissions). These two measures will cause the cap for aviation to be reduced by between 27% and 32% in the 10 years of phase IV. Auctioning and free allocation percentages, 15% and 82% respectively at present (the remaining 3% is set aside for new entrants), are also set to change with a 50/50 split in Phase IV currently supported.

The cost of compliance

Offset eligibility criteria for CORSIA has not been decided which makes it difficult to estimate compliance costs. However, it is widely expected that even if ICAO allow only Certified Emissions Reductions issued by the UN’s Clean Development Mechanism, they are so oversupplied, the cost is expected to be minimal.

However, the EU ETS is undergoing material change. For years the market has suffered from oversupply that has caused prices to be depressed and to languish in single figures. All of this seems set to change as EU politicians wake up to the reality that their flagship carbon reduction policy is not providing a signal for investments in low carbon technologies. Carbon market analysts, Energy Aspects, are predicting the price of an EUA to be as high as €24 by 2020 should the politicians review of Phase IV pass through the legislature.

Demand for offsets under CORSIA will be low, so when combined with expected low carbon offset prices the financial risk is also fairly low. However, in a carbon constrained world the low price can’t last forever and demand will pick up.  An interesting feature of CORSIA is that regardless of historic emissions, every airline will have to buy offsets even if their emissions drop after the baseline period.

Demand for carbon credits under the EU ETS looks set to grow due to policy changes reducing free allocations coupled with expected growth from the aviation sector.

Using current Clean Development Mechanism (CDM) prices, that are at a record low, leading carbon analyst Trevor Sikorski of Energy Aspects forecasts the cost of compliance for airlines in CORSIA during the two voluntary phases (2021-2027) will be around $100 million. It is important to note that the Paris agreement could result in an increase in demand for offsets which would have a positive effect on current prices meaning that this cost estimate can easily be raised to $500M or more.

A recent report by CE-Delft for the European Federation for Transport and Environment estimate the demand for EUAs by airlines under the Intra EEA + CH flights scenario, including the Commission’s proposal to align the cap to the LRF, is estimated to be about 535mt for the whole of Phase IV.  Energy Aspects average price forecast for Phase IV is between €30 and €36 per carbon credit. So at a total cost of €16 to €19 billion the EU ETS is easily the bigger risk.

Conclusion

The combination of CORSIA and the current scenarios for continued coverage of aviation by the EU ETS, itself subject to strengthening measures, will increase the financial risk that airlines face. The administrative burden will also increase. The scope of CORSIA is bigger than the EU ETS as it covers more routes and thus has a bigger potential requirement for emissions offsets. However, the EU ETS has a stricter cap that means more carbon will need to be purchased AND the cost of each carbon credit will be much higher than under CORSIA so will lead to a significantly higher cost of compliance.

Because final details on both CORSIA and the EU ETS need to be agreed by their respective governing bodies, fully evaluating the costs of environmental protection is a moving feast. Like most industries, the airline industry operates on thin margins so staying on top of this financial risk is crucial as greenhouse gas emissions rules tighten for everyone.

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