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VIII
III List of Abbreviations
AAU/s Assigned
Amount
Unit/s
A-CDM Airport
Collaborative
Decision
Making
art.
Article
ATC
Air
Traffic
Control
ATK/s
Available Ton Kilometer/s
ATM
Air Traffic Management
CDM
Clean Development Mechanism
CER/s
Certified Emission Reduction/s
CO
2
Carbon
dioxide
EC
European
Commission
EEA
European Economic Area
EEX
European Energy Exchange
ERU/s
Emission Reduction Unit/s
ETS/s
Emission Trading Scheme/s
EU
European
Union
EUA/s European
Emission
Allowance/s
EU-ETS
European Union Emission Trading Scheme
GHG/s Greenhouse
gas/es
IATA
International Air Transport Association
ICAO
International Civil Aviation Organization
IET
International Emission Trading
IPCC
Intergovernmental Panel on Climate Change
JI Joint
Implementation
KP
Kyoto
Protocol
IX
LCC/s
Low-cost carrier/s
NAP/s National
Allocation
Plan/s
NWC/s Network
carrier/s
par.
Paragraph
R&D
Research and development
RTK/s
Revenue Ton Kilometer/s
SESAR
Single European Sky ATM Research
UN
United
Nations
UNFCCC
United Nations Framework Convention on Climate Change
1
1 Introduction
1.1 Background
Climate change has been a major concern in climate policy and has therefore regularly
been on politicians agenda for a long time. For this reason, several scientific studies in
climate research were conducted to detect main causes of this disturbing environmental
development. It was determined that anthropogenic (i.e., human-induced) greenhouse
gases (GHGs), such as nitrous oxide (N
2
O), methane (CH
4
), and carbon dioxide (CO
2
),
have been major contributors of global warming.
1
In particular, atmospheric CO
2
con-
centration, which is caused by the combustion of carbon based fuels, has been declared
as one of the major drivers of the greenhouse effect. Beyond that, records show a
significant increase of atmospheric CO
2
concentration compared to pre-industrial levels.
2
In order to address these climate change challenges and mitigate global warming,
international environmental treaties, such as the United Nations Framework Convention
on Climate Change (UNFCCC) and later the Kyoto Protocol (KP), were established to
enforce limitations on GHG emissions.
3
As a result, the overall GHG emissions within
the European Union (EU) were decreased by 5.5% between 1993 and 2003.
4
Moreover,
additional actions were taken through the creation of the European Union Emission
Trading Scheme (EU-ETS) in 2003. This cap-and-trade scheme operates through the
allocation and trade of emission allowances to reduce GHG emissions in a cost effective
manner. Its original scope required only selected industries, such as energy, iron, and
oil, to comply with the emission trading scheme (ETS).
5
Aviation, as an industry whose
CO
2
emissions have risen in the EU by 95% since 1990, accounts nowadays for about
3.3% of the EU's total CO
2
emissions. However, it had never been subject to the KP nor
included in the EU-ETS.
6
In 2008, the European Commission (EC) proposed the inclu-
sion of aviation in the EU-ETS as a response to the continuous air traffic growth which
caused a constant increase of CO
2
emissions from aviation. As a result, Directive
1
See Grubb (2003), p. 147.
2
See Intergovernmental Panel on Climate Change (2007); Kiehl and Trenberth (1997).
3
See United Nations (1992); United Nations (1997).
4
See Wit et al. (2005), p. 1.
5
See European Commission (2003), Annex I.
6
See European Environment Agency (2012), pp. 293-294.
2
2008/101/EC (henceforth Aviation Directive), an amendment of the original EU-ETS
legislation, was ratified and came into force in January 2012. Since then, all flights
departing from and arriving at an airport located in the European Economic Area (EEA)
have been subject to the EU-ETS.
7
Figure 1 illustrates the long-term evolution of global
air traffic between 1980 and 2007, including major events leading to some temporary
variations of activity:
Figure 1: Evolution of world air traffic (1980-2007) expressed in RTK (billions)
8
A significant volume of literature already exists concerning the inclusion of aviation in the
EU-ETS. Most of the research laid its focus on specific industry levels such as the
individual airline, the aviation industry in general or macroeconomic aspects
.
In this
context, these studies tried to anticipate market reactions triggered by the EU-ETS by
analyzing specific issues such as the financial impact on airlines, changes in competitive
behavior or implications for the overall industry development.
9
As a consequence, the
existing studies took only a limited market view and made assumptions about expected
developments in specific fields of the aviation industry. However, at the time of writing
this thesis, conclusions about the scope of impact could hardly be drawn from existing
impact assessments because of the wide range of issues that exceeded the scope of
most impact studies.
Hence, a broader research approach is needed which takes
7
See European Commission (2008), preamble, par. 16; The EEA consists of the EU, Iceland,
Liechtenstein, and Norway.
8
See Chèze et al. (2011), p. 5.
9
See Anger (2010); Lowe et al. (2007); Scheelhaase and Grimme (2007).
3
different analytical perspectives to describe the scope of impact of the EU-ETS and
depict potential effects for the aviation industry.
1.2 Objective and limitations
The main objective of this thesis is to describe the scope of impact of the EU-ETS on
aviation and to develop a detailed understanding of the effects for the aviation industry
through its inclusion in the EU-ETS.
Facilitated by the following remarks, including a comprehensive impact analysis, this
thesis will also help to understand:
the potential chances and risks for airlines through the recent incorporation in the
EU-ETS,
the expected market development of the aviation industry in the future due to the
imposition of an ETS for GHG emissions,
the international legal framework for climate change and emission trading, and
the distinct industry characteristics, including interrelations and dependencies
between the legislation and the aviation industry.
Due to the complexity of the research topic, the presented analysis in this thesis is
conducted under scope limitations. The focus of the analysis is to examine the impact of
the EU-ETS on passenger airlines, excluding cargo airlines and other market partici-
pants such as airport operators, ground handlers or other service providers.
10
Also,
adjacent industries such as tourism and the oil industry are not subjects of the analysis.
1.3 Structure
This master thesis is structured into six main sections. After the introduction, section two
provides the reader with an overview of the legal framework for climate policy in order to
describe the legal scope of major climate policy treaties and explain how the EU-ETS is
embedded in this legal environment. At first, international and national law is conceptual-
ized by distinguishing between different environmental treaties. Later remarks refer to
10
In this thesis, the terms "aviation industry" and "airline industry" are used interchangeably.
4
major climate change treaties such as the UNFCCC and the KP. Eventually, a detailed
description of the EU-ETS, including its objectives, scope, and mechanisms, is given.
Based on the preceding part, section three delves further into the EU-ETS by focusing
on the aviation industry and its incorporation in the EU-ETS. In the beginning, a brief
overview of key characteristics of the aviation industry is provided to achieve a sufficient
understanding of the market players, the competitive situation, and major industry
trends. Subsequently, the section elaborates on environmental policies in international
aviation ending with a detailed description of the Aviation Directive including its objec-
tives, design parameters, and latest amendments. Section four encompasses a com-
prehensive analysis of EU-ETS describing the scope of impact for the aviation industry.
Different industry parameters that are potentially impacted through the inclusion in the
EU-ETS are identified. Moreover, expected effects for the industry are highlighted and
potential market reactions of airlines are discussed to provide support for future predic-
tions on industry developments. In order to achieve an overall understanding of the
scope of impact, the impact assessment takes three distinct analysis perspectives. The
individual perspective focuses on the impact of the EU-ETS on airline profitability.
Subsequently, the intra-industry perspective takes a broader view on the impact on
competition between market players. Eventually, the collective industry perspective
focuses on potential changes in market performance and development, and thereby
examines effects for the overall aviation industry. Thereafter, section five outlines main
results from the impact analysis, including main drivers of impact for aviation. Later,
management implications for airlines to cope with the EU-ETS regulatory are discussed.
Finally, section six concludes this thesis by recapitulating the key aspects of the re-
search topic and providing a future outlook for potential developments regarding the EU-
ETS and the aviation industry.
5
2 Legal framework for climate change and emission trading
2.1 Demarcation of international and EU law for climate change
In order to understand the legal framework for climate change and the embeddedness of
the EU-ETS in this system, it is important to differentiate between international and EU
treaties. Furthermore, it helps to clarify the legal scope of the respective treaties at the
international and EU level.
The UNFCCC is an international environmental convention on climate change. It was
negotiated at the United Nations Conference on Environment and Development in 1992
and has been effective since March 1994.
11
At that time, GHGs were declared as a
major driver of climate change which raised the awareness of the fact that human-
induced emissions cause global warming. However, the UNFCCC did not contain any
legal obligations for climate change prevention. Instead, as a multilateral environmental
convention it provided the framework for negotiations about further, more specific,
multilateral agreements to protect the climate system.
12
In later years, the UN adopted the KP, which has become the most prominent treaty
established under the umbrella of the UNFCCC. As a multilateral treaty against climate
change, it specifies the original objectives of the UNFCCC and sets legally binding and
quantified emission targets. As to date, the UNFCCC has been ratified by 195 parties,
including major economies such as the EU and the United States of America (USA).
13
Article (art.) 4 of the KP entitles the EU member states to fulfill their KP emission targets
collectively.
14
Under this rule, which is often called the "EU Bubble", the EU takes on a
distinct role under the KP legislation since it allows for regional legal enforcements of
emission mitigation measures within the community.
As a result, the EU-ETS was launched as part of the European Climate Change Pro-
gram in October 2003. With the introduction of the EU-ETS, the EU decided to jointly
11
See United Nations Framework Convention on Climate Change (2013); United Nations (1992),
art. 23 (1).
12
See United Nations (1992).
13
See United Nations Framework on Climate Change (2012b); In addition to each EU member state,
the EU signed the KP collectively as a community of states; The last ratifying country was Andorra
on 2 March 2011.
14
See United Nations (1997), art. 4.
6
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7
between developed (Annex I parties) and developing countries (non-Annex parties)
regarding expected initiatives to combat climate change.
19
Furthermore, the UNFCCC
explicitly states to ensure equity between its parties and therefore applies "the principal
of common but differentiated responsibilities" which imposes all parties to protect the
climate system; however, developed countries ought to take the lead in implementing
precautionary measures against climate change. Also, industrialized nations are re-
quired to support developing countries that bear a disproportional burden under the
UNFCCC.
20
2.3 Kyoto Protocol
The KP is an international environmental agreement based on the UNFCCC which
specifies the objective of preventing climate change by setting quantitative limitations on
GHG emissions.
21
Although the KP was originally adopted in December 1997, it did not
enter into force until February 2005 because of the USA's withdrawal from the protocol
in 2000. In order to become effective, art. 25 KP requires the signing of not less than 55
countries, whose overall CO
2
emissions total at least 55% of the global CO
2
emissions
for 1990.
22
Since the USA withdrew from the protocol in 2000, the remaining KP parties
had not fulfilled this requirement until Russia's ratification in late 2004. Since then, 192
parties have been obliged to comply with the Kyoto emission targets.
23
The KP follows a
sequential timeline consisting of distinct commitment periods for which specific emission
targets are set. The first commitment period ran from 2008 to 2012 whereas the second
commitment period will span from 2013 to 2020 as recently decided at the UN Climate
Change Conference in Doha. However, amendments concerning emission targets made
on this conference are yet to be approved by the parties.
24
For the first period, it was
agreed to reduce overall GHG emissions by at least 5% compared to the base year.
25
19
Annex I parties are developed countries and countries that are undergoing the process of transition
to a market economy. Non-annex countries include all developing countries that have signed and
ratified the KP.
20
See United Nations (1992), art. 3.
21
GHGs covered by the KP include CO
2
, CH
4
, N
2
O, HFC
s
, PFC
s
and SF
6
.
22
See United Nations (1997), art. 25; Freestone (2005), p. 9.
23
See United Nations Framework on Climate Change (2012a); United Nations Climate Change
Secretariat (2004).
24
See United Nations Framework on Climate Change (2012c).
25
See United Nations (1997), art. 3 (1); The base year for most parties is 1990 except Bulgaria (1988),
8
During these negotiations the EU was committed to a mutual emission reduction target
of 8% which is known as the Burden Sharing Agreement.
26
Similar to the UNFCCC, the KP also acknowledges the different industrialized levels of
its parties and therefore only requires developed nations listed in Annex I of the
UNFCCC to comply with its quantified emission targets.
27
In order to regulate emission
levels, each Annex I party initially obtains so called Assigned Amount Units (AAUs)
which are calculated by applying the party's emission reduction target to the GHG
emissions in the base year.
28
If a KP party fails to meet the predetermined reduction
targets, a penalty of 30% for each excess emission unit (hereinafter Kyoto unit) is
enforced. This means that for each ton of GHG emissions, which exceeds the reduction
target, 1.3 Kyoto units will be deducted from its AAUs for the subsequent commitment
period.
29
In order to increase the flexibility of the KP and increase cost efficiency to meet
reduction targets, KP parties are allowed to add or subtract Kyoto units from their AAUs
through the use of flexible mechanisms.
30
The KP provides three flexible mechanisms
which are widely known as Kyoto mechanisms. These are, Joint Implementation (JI), the
Clean Development Mechanism (CDM), and International Emission Trading (IET).
31
JI is a project-based mechanism in which an Annex I party invests in an emission
reduction project in another Annex I party.
32
As a result, the investing party receives
Emission Reduction Units (ERUs) in addition to its AAUs while deducting the same
amount of Kyoto units from the beneficiary's account. In this way, the total amount of
Kyoto units does not increase but Kyoto units are only redistributed.
33
The CDM constitutes another project-based mechanism which enables KP parties to
acquire additional Kyoto units. In contrast to JI projects, a CDM rewards Annex I parties
after investing in emission reduction projects conducted in developing countries.
34
In
Hungary (average of 1985-1987), Poland (1988), Romania (1989), and Slovenia (1986).
26
See European Council (2002a).
27
See United Nations (1997), art. 3 (1).
28
See United Nations (1997), art. 3 (7).
29
See United Nations Framework on Climate Change (2008), p. 29.
30
See United Nations (1997), art. 3 (10-12).
31
Further EUAs can be acquired through land use, land use change, and forestry activities (LULUCF)
which are not discussed in this thesis due to its low significance for the aviation industry.
32
See United Nations (1997), art. 6.
33
See United Nations Framework on Climate Change (2008), p. 17.
34
See United Nations (1997), art. 12.
9
those projects, the funding party receives so called Certified Emission Reductions
(CERs) which can be converted into Kyoto units. Since emissions from non-Annex
parties are not subject to the KP, CDM projects increase the total amount of Kyoto units,
and thereby allow for increased GHG emissions under the KP.
35
Unlike the preceding Kyoto mechanism, IET represents a market-based mechanism
which creates the framework for international trade of Kyoto units between the KP
parties.
36
The IET gives KP parties, whose projected GHG emissions exceed the AAUs,
the opportunity to acquire additional Kyoto units through trading activities on the carbon
market. In turn, it enables KP parties, whose GHG emissions are lower than their AAUs,
to gain profits through the sale of unused Kyoto units to high-emitting parties. Moreover,
the trading opportunity of unused Kyoto units encourages KP parties to take domestic
actions, and thereby reduce GHG emissions. To prevent future compliance issues with
emission targets resulting from intensive trading of Kyoto units, KP parties are obliged to
retain a certain number of Kyoto units to maintain a so called commitment period
reserve.
37
However, the IET does not prescribe any domestic or regional ETSs it rather
constitutes the foundation on which other ETS can be established. Yet, all trading
activities carried out under sub-ETSs are subject to the KP and need to comply with the
KP emission targets.
38
In the following, the EU-ETS as the most prominent regional sub-
ETS of the KP is described.
2.4 European Union Emission Trading Scheme
2.4.1 Motivation and objectives
The EU had always been an advocate for the battle against climate change. According-
ly, the EU urged to take policy measures to prevent global warming. It was predicted
that an increase of the global annual mean surface temperature by more than 2ÛC above
pre-industrial levels would cause irreversible catastrophic events.
39
Also, it was obvious
35
See United Nations Framework on Climate Change (2008), p. 18.
36
See United Nations Framework on Climate Change (2012d); United Nations (1997), art.17; ERUs
and CERs obtained through emission reduction projects are tradable emission units on the carbon
market.
37
See United Nations Framework on Climate Change (2008), p. 58.
38
See United Nations Framework on Climate Change (2008), p. 16.
39
See European Commission (2005).
10
that the 8% decrease in CO
2
emissions confirmed under the Burden Sharing Agreement
would not be sufficient to achieve this target. Scientific findings by the Intergovernmental
Panel on Climate Change (IPCC) had indicated that a sustainable global CO
2
emission
reduction of at least 50% below 1990 levels must be achieved by 2050 to avoid severe
climate change events.
40
For this reason, additional mitigation measures were needed to
further curtail CO
2
emissions. This led to the creation of the EU-ETS in October 2003.
Since its launch in January 2005, it has been a cornerstone of European climate policy
and presents the central instrument of the EU Climate and Energy Package from
December 2008. Under this initiative, the EU pursues a 20% GHG emission reduction
compared to 1990 emission levels by the year 2020.
41
2.4.2 Scope and extensions
As to date, the EU-ETS has been introduced in 31 countries including the 27 EU mem-
ber states as well as neighboring countries such as Norway, Liechtenstein, Iceland, and
Croatia. As an entity-based ETS, the EU-ETS covers some 11,000 installations across
several high-emitting industries, including energy, oil, coke, metal ore, and steel.
42
In its
entirety the EU-ETS accounts for around half of the CO
2
emissions released in the EU.
43
This makes the EU-ETS the largest multinational ETS against climate change.
44
Since its launch, the EU-ETS has experienced several scope extensions as for instance
the incorporation of N
2
O which results from the production of nitric acid.
45
Also, exten-
sions of the legal scope to non-EU countries such as Iceland, Liechtenstein, and Norway
were accomplished.
46
In addition, the international civil aviation industry, as the first
segment of the transportation industry, was incorporated by adopting the Aviation
Directive. Besides sectoral and GHG-specific extension plans, the EU pursues further
geographical scope extension by promoting the EU-ETS beyond community borders.
This also emphasizes the EU's overall vision of developing an international network of
40
See Intergovernmental Panel on Climate Change (2007).
41
See European Council (2008).
42
Within an entity-based ETS emission allowances are traded between companies.
43
See European Commission (2013a).
44
See European Commission (2009b), p. 5.
45
See European Commission (2009b), p. 13.
46
Croatia joined the EU-ETS in January 2013 leading to 31 member states covered by the EU-ETS.
11
ETSs and creating a global carbon market.
47
Art. 25 of the EU-ETS explicitly states the
openness to other compatible mandatory GHG ETSs. In this regard, officials from the
EU and the Australian government recently reached an agreement on linking the
schemes by 2018.
48
2.4.3 Allocation and cap system
The EU-ETS operates as a cap-and-trade scheme. This means that it sets a limit on the
total amount of GHGs that are allowed to be released by the members under the
scheme.
49
The cap determines the total amount of emission allowances, so called EU
Emission Allowances (EUAs), which the members receive to cover their emissions. If
emissions from business operations exceed the amount of EUAs, members need to
engage in trading activities to buy or sell EUAs on the carbon market. Also, as a sub-
trading system of the KP, the EU-ETS entitles members to use Kyoto credits to cover
emissions as agreed under the Linking Directive.
50
EUAs are allocated using a combination of auctioning and free allocation whereas the
majority of EUAs are allocated free of cost by applying a benchmarking scheme. The
quantity of EUAs that are freely allocated depends on the specific industry and its
competitive situation on the global market to ensure competitiveness of the European
economy. However, in order to achieve the ambitious emission reduction targets and
generate revenues for EU mitigation measures, the EU intends to steadily increase the
share of EUAs allocated under auctioning.
51
The free allocation of EUAs to stationary
installations, such as industrial plants, follows a product benchmark. This benchmark
represents the 10% most efficient installations whose performance is compared to
eligible installations to determine the number of free EUAs allocated to the members.
52
At the end of every year, each member must surrender EUAs equivalent to the respec-
47
See European Commission (2003), art. 25.
48
See European Commission (2013e).
49
See European Commission (2013a).
50
See European Commission (2004).
51
See European Commission (2013a).
52
See European Commission (2011a).
12
tive emission level of the year. If emissions exceed the quantity of EUAs, financial
penalties are imposed by the regulatory authorities of the member states.
53
2.4.4 Trading and price mechanisms
As mentioned earlier, the EU-ETS is an entity-based ETS. As such, individual compa-
nies perform emission trading on a common carbon market.
54
On the contrary, IET
under the KP solely takes place between KP parties at a national level.
55
It should be
noted that emission trading refers to the trade of emission rights as opposed to trading
of emissions themselves. In this context, an emission right is the permission to release a
certain amount of CO
2
within a specific period of time.
56
Besides trading with EUAs, the
EU decided to link the Kyoto project-based mechanisms to the EU-ETS. Since then, EU-
ETS members are allowed to use a limited number of Kyoto credits to cover emissions
under the EU-ETS and trade international credits (JI and CDM) on the carbon market.
57
Beyond the general trade of EUAs, the EU-ETS legislation allows for inter-temporal
trading which involves banking and borrowing of EUAs. Banking enables EU-ETS
members to carry EUAs to future years whereas borrowing describes the use of future
emission allowances to cover emissions from current operations. The inter-temporal
trade gives members more flexibility to use EUAs under dynamic emission levels.
However, to avoid compliance issues in future periods, the EU-ETS does not allow inter-
period borrowing across compliance periods.
58
In order to achieve emission reductions
and stimulate emission mitigation actions, the EU imposes an emission cap based on
historical emission levels which are lower than emissions released under current eco-
nomic activities. This results in EUA scarcity and creates value for the emission allow-
ances so that a market price can be established.
59
Also emitters are encouraged to
manage business operations more effectively and lower carbon emissions in order to
ease the cost burden of emission charges.
53
See European Commission (2003), art. 16.
54
In the following the terms "companies" and "members" are used interchangeably.
55
See United Nations (1997), art. 3, 17.
56
See De Witt Wijnen (2005), p. 403; European Commission (2003), art. 3; Under the EU-ETS, an
EUA represents the right to emit one metric ton of CO
2
within a given year.
57
See European Commission (2004); For further details see also: Jepma (2003).
58
See Chevallier (2012), pp. 157-158.
59
See Faber and Brinke (2011), p. 3.
13
2.4.5 Timeline and structural changes
The EU-ETS is periodically divided into consecutive trading phases. The first trading
phase commenced in 2005 and spun over three years ending in 2007. It is often called
the trial period as it was primarily pursued to gain experience in the operation of a
multinational ETS, to establish an effective carbon price, and to provide seamless free
trade of EUAs across the EU. Simultaneously, the implementation of a functioning
infrastructure to perform reliable monitoring, reporting, and verification of emission data
was a main objectives during the initial phase. Hence, significant CO
2
emission reduc-
tions were not expected during this time period.
60
Phase two ran from 2008 to 2012
coinciding with the first Kyoto commitment period. During this period, various changes of
the community scheme were made to solve teething problems and ensure a more
effective ETS against climate change. In this regard, allocation rules were changed,
geographical scope extensions were conducted, and the Kyoto mechanisms were linked
to the community scheme.
61
As it can be seen, the EU-ETS as the largest multinational
ETS requires constant revision by the policymakers to maintain an effective instrument
against climate change. Especially, the size and complexity of the scheme has caused
problems to implement a resilient scheme which does not require continuous modifica-
tions to achieve its objectives. Since its introduction, the EU-ETS has required various
structural changes to improve its effectiveness and achieve its environmental goals. The
EU-ETS has recently ended its second trading period. The EC proposes further struc-
tural changes for the current period which runs from 2013 to 2020. In the following,
current developments regarding structural reforms of the EU-ETS are addressed.
In order to increase transparency and lower the complexity of several autonomous
National Allocation Plans (NAPs), the EC decided to introduce a harmonized allocation
methodology at EU level. Since 2013, EUAs have been centrally allocated applying a
community-wide emission cap. This initiative promises to prevent member states from
applying discriminatory measures, as they will no longer be able to favor their national
industries under the NAPs.
62
Moreover, the third period will experience a significant shift
from free allocation to auctioning. In this regard, it is proposed to assign at least 50% of
60
See Elleman and Joskow (2008), p. iii.
61
See European Commission (2013b).
62
See European Commission (2011a).
14
all EUAs through auctioning. In addition, a more stringent cap will be enforced which will
decrease annually by 1.74%, reaching a 21% emission decrease compared to 2005
levels at the end of the period.
63
To raise environmental awareness outside the EEA and increase the international reach
of its ETS, the EU has promoted the EU-ETS outside the EEA and has tried to establish
links to other national or regional ETSs. As a first step towards a global network of
carbon ETSs, officials from the EU and Australia recently announced to link their ETSs.
Both countries agreed on establishing a full link between the two systems by 1 July
2018. This means that the free trade of emission allowances between Australian and
European businesses will be possible. In addition, there are ongoing negotiations about
linking the EU-ETS with the Swiss ETS. The merger of ETSs can potentially decrease
system costs, increase market liquidity, and create a more stable carbon market.
64
There are currently debates about measures to ensure price stability on the carbon
market. During the first and second trading period there have been system flaws that led
to critical price falls on the carbon market. For instance, the former high level of decen-
tralization made individual member states responsible to allocate EUAs to their national
businesses. Under NAPs, large companies lobbied for a fair allocation of EUAs to
prevent disadvantages in global competition. As a result, EUAs were distributed too
generously at the national level which led to an oversupply of EUAs within the EU.
65
In
addition, companies were not allowed to bank excess EUAs for further use in future
trading periods.
66
As a consequence, the carbon price plummeted sharply in May 2006
reaching its low in 2007 at almost 0/t CO
2
. The price recovered at the beginning of
phase two, reaching its peak in August 2008 at 28/t CO
2
before falling again shortly
after.
67
This price collapse was predominantly indebted by the economic downturn
during this period which led to a decline in demand for EUAs. Since mid 2009, the EUA
price had been fairly stable at around 15 /t CO
2
before dropping again below 10 /t in
the second half of 2011 as outlined in figure 3:
63
See European Commission (2009b), p. 12.
64
See European Commission (2013c).
65
See Egenhofer et al. (2011), p. ii.
66
See European Commission (2003), art. 13.
67
See European Energy Exchange (2013a).
Fig
As a re
up a hu
2013.
69
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carbon
implem
allocatio
the third
period.
EUAs a
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68
See Eu
69
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70
See Eu
71
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ure 3: Carbon
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9
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70
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012b), p. 5.
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011a).
012a).
front-year fu
over previo
s projected
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ed from th
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EC plans to
deferral of
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over the in
C propose
and regain
to 30% in 2
e three per
eduction fa
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, and
tures contrac
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d to reach
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out a rang
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he EU lev
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ndividual y
es the follo
price stab
2020,
manently,
actor of 1.7
sectors,
cts with deliv
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the impact
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on of EUA
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ad some 90
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d to gradu
years of th
owing mea
ility in the c
4% before
ery in Decem
s were able
to 2 billion
of the EUA
ures to sta
As under N
vent a furt
00 million
e end of th
ually decre
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sures to s
carbon ma
2020,
15
mber)
68
e to build
n EUAs in
A surplus
abilize the
NAPs and
her over-
EUAs for
he trading
ease and
period.
71
ustain an
rket:
16
establishing discretionary price management mechanisms such as a carbon price
floor or an allowance reserve.
72
However, each of these proposed measures are still under debate and have yet to be
passed by the EU legislative in order to be enforced.
72
See European Commission (2012b).
17
3 International aviation and climate change
3.1 International aviation industry and airline economics
In order to understand the implications of emission charges for airlines, it is important to
have general knowledge about specific characteristics of the aviation industry. This also
helps to comprehend distorting effects on different airlines and to make projections for
future industry developments. The following remarks highlight industry-specific parame-
ters describing the overall industry, including the past evolution, current competitive
situation, market players, and major industry trends, to provide relevant information for
the later impact analysis.
3.1.1 Market evolution and competition
The aviation industry has experienced a dynamic development for a long time. In
particular, several liberalization and deregulation measures have turned the aviation
market from a formerly highly regulated industry into a truly globalized market. The
Airline Deregulation Act which was passed by the US congress in 1978 is frequently
mentioned as a pioneer for deregulation which triggered a move towards an open
aviation market. The treaty phased out governmental regulations over air fares, flight
routes, and barriers to enter the US aviation market for foreign airlines.
73
Following this
trend, similar efforts were made throughout the world, e.g. in Canada (1984), New
Zealand (1986), Australia (1990) and Europe (1992-1997).
74
The deregulation instigated a reorganization and strategic realignment of airline busi-
ness models which was supposed to meet global industry demand more effectively. As
a result, the renowned hub-and-spoke system became widely the preferred network
configuration since it enabled airlines to increase aircraft utilization while providing a
larger route network for passengers.
75
In contrast to the widespread hub-and-spoke
model, Southwest Airlines has been a prominent exemption by following its low-cost
strategy since its foundation in 1967. Today, Southwest Airlines is seen as the pioneer
73
See United States Congress (1978).
74
See Gillen (2006), p. 367.
75
See Gillen (2006), p. 368.
18
of the low-cost business model which offers passengers low-fare tickets by cutting down
on services as for instance on-board meals, hub connectivity, and baggage transfer
handling.
76
Following Southwest Airlines, a large number of low-cost carriers (LCCs)
were founded around the globe such as AirTran, jetBlue, Ryanair, and easyJet.
77
Numerous market entries of LCCs intensified market competition and influenced price
policies of many airlines. Air fares had to be decreased in order to stay competitive so
that many airlines struggled to survive in the market.
78
Also, an unprecedented trend of
market consolidation was experienced in the industry.
79
In recent years, network carriers (NWCs), which traditionally provide passengers with
comprehensive customer service, have more and more integrated the competitive low-
cost business model in order to participate in this prospering market segment. NWCs
have started to acquire existing LCCs (e.g. Lufthansa's acquisition of Germanwings in
2009), or established own low-cost subsidiaries (e.g. BMI's spin-off leading to the
formation of bmibaby).
80
A similar strategic convergence can be observed in the low-
cost segment where LCCs increasingly provide passengers with improved service
quality. Because of various market entries in the low-cost segment, competition has
picked up and the market has become fairly saturated. As a result, formerly pure differ-
entiators started to offer complementary services on flights. Also new aircraft layouts
including business class seating is nowadays apparent.
81
Correspondingly, the term
"hybrid airlines", which describes airlines whose strategy combines aspects from tradi-
tional and low-cost business models, can often be found in recent scientific literature.
82
In the course of increasing competition and intensifying price wars, the aviation industry
has experienced a huge shift towards inter-organizational collaboration. This becomes
evident in the fact that a large number of airlines have entered strategic alliances during
the past decade. Today, members of the three airline alliances, namely Star Alliance,
oneworld, and Sky Team, capture around 80% of the total market share.
83
The trend
76
See Flenskow (2005), p. 102.
77
In May 2011 AirTran was acquired by Southwest Airlines.
78
See Goolsbee and Syverson (2008); Tan (2011).
79
See Gillen (2006), p. 368; Bermig (2005), p. 20; Delfmann et al. (2005), pp. 4-5.
80
bmibaby terminated its service in September 2012 after BMI's takeover by IAG.
81
See Daraban (2012), p. 38; Klaas and Klein (2005), p. 138.
82
See Ehmer et al. (2008), p. 13; Bieger and Agosti (2005), p. 41.
83
See International Air Transport Association (2011), p. 1.
19
towards the creation of alliance constellations can be seen as a response to increasing
market dynamics caused by previous deregulation of the global aviation sector. In order
to counter rising market volatility, lower uncertainty, and reduce reaction time for com-
petitive moves, leading airlines engaged in strategic alliances, and thereby decreased
their own vulnerability to unexpected market developments.
84
Airline alliances often
show a high degree of integration with alliance partners, including route coordination,
revenue sharing, joint pricing, and marketing.
85
3.1.2 Market players
The aviation industry encompasses several market participants. Analyzing the value
chain reveals major market players, such as aircraft manufacturers, airlines, ground
handlers, airport operators, and air traffic control (ATC), that contribute to the air trans-
portation service. Given the complexity of the aviation industry this thesis limits its scope
to the airline market. In the following, traditional types of airlines including their tradition-
al business models are described.
NWCs are characterized by a large route network which is operated by a hub-and-spoke
system to serve a wide range of destinations. As to date, NWCs constitute the leading
type of airline capturing the largest market share in the aviation industry.
86
Within a hub-
and-spoke network, airports at central locations (hubs) are strategically vital in order to
collect traffic through so called feeder flights from various origins (spokes). In this way,
passengers are accumulated at central locations so that larger airplanes can be used for
long-haul flights to transfer passengers to the respective destinations.
87
In order to
operate hub-and-spoke networks, NWCs are required to keep diverse fleet compositions
consisting of various types of aircraft to operate short- and long-haul flights. Typically,
airlines benefit from this network configuration through scale effects such as network
extensions, increased utilization of airplanes, and a more efficient use of ground staff
and equipment.
88
Moreover, NWCs are distinguished by the comprehensive customer
service. In this regard, NWCs generally offer different passenger classes, including
84
See Agusdinata and de Klein (2002), pp. 202-204.
85
See Bermig (2005), p. 28.
86
See Boeing (2012).
87
See Gillen (2006), p. 369.
88
See Auerbach and Delfmann (2005), pp. 76-79; Jäggi (2000).
20
economy, business, and first class. These passenger classes provide different service
levels as for instance on-board service, in-flight entertainment, ticketing service, and
passenger lounges at airports. Consequently, air fares are regularly in the upper price
range claiming a premium price whereas most profits are generated from business- and
long-haul travel.
89
In contrast, LCCs usually operate a point-to-point network between smaller airports.
These airports are often less congested which enables LCCs to reduce ground times
and minimize holding patterns resulting in an improved on-time performance.
90
In order
to provide low fares, LCCs inevitably need costs at a low level. Hence, LCCs normally
charge passengers for in-flight service. Further cost savings result from the homoge-
nous fleet composition. As LCCs predominantly operate short- and medium-haul flights
in a point-to-point network, they are able to support their operations with only a limited
number of different types of aircraft. In doing this, LCCs can reduce costs for mainte-
nance, staff, and other overheads. In addition, a generally high seat density of airplanes
enables LCCs to achieve high utilization rates and generate economies of scale.
91
Similar to the low-cost business model, charter airlines follow a low-cost strategy by
operating homogenous fleets with high density seating in a point-to-point network. In
contrast, to LCCs, charter airlines usually provide some complementary on-board
services such as meals, newspapers, and in-flight entertainment. Originally, charter
airlines sold flights via tour operators as part of holiday packages and were therefore
mainly focused on the tourism industry. For this reason, flight schedules usually change
over the year due to seasonal demand, and temporary surcharges at peak travel times
are common. Moreover, leisure travelers have been found to be more tolerant for longer
distances to the departure airport which allows charter airlines to save costs by operat-
ing flights from selected airports.
92
Today, many charter airlines have been acquired by
large tour operators and are fully integrated in their value chains.
93
89
See Gillen (2006), p. 369.
90
See Bieger and Agosti (2005), p. 53.
91
See Ehmer et al. (2008), p. 8.
92
See Ehmer et al. (2008), p. 11.
93
See Bieger and Agosti (2005), p. 54.
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