Flying free of the ETS: EU won't include international flights in its ETS (for now)

The EU Commission announced on 12 November that it would put on hold its plans to include international flights from outside the EU in its scheme, to give the International Civil Aviation Organisation (ICAO) time to forge a proposal for a global deal in time for the 38th ICAO General Assembly in September/October 2013.

The EU ETS will continue to apply to all flights within and between the 30 European countries in the EU ETS, but some commentators are expecting a backlash from budget carriers whose business is biased towards short haul flights.

How the EU plan was supposed to work

From the time that the EU passed legislation for CO₂-e emissions from aviation to be included in the EU ETS to the time this legislation commenced was four years. The scheme, to the extent that it applies to flights in and out of the EU did not last a quarter of that.

Rather than impose the point of obligation for CO₂-e emissions upstream in the fuel supply chain (such as refiners or distributors), the EU decided to impose liability on the operators of airlines. What made the EU's proposal most controversial however was the extra-territorial operation of the scheme to capture emissions from international airline operators flying in or out of the EU, in addition to domestic emissions.

The scheme, as it applies to airline emissions works in this way:

• CO₂-e emissions from the aviation industry are capped: initially at 97% of 2005 emissions levels, and from 2013 onwards at 95%. 
• From 1 January 2012, all flights arriving or departing EU airports were also to be included in the EU ETS. Airline operators flying to and from the EU would have been required to surrender one allowance for every tonne of CO₂-e emitted on a flight to and from (and within) Europe. 
• Free allowances covering 85% of the liability were allocated to aircraft operators and 15% of the CO₂ allowances were to be auctioned for 2012. 
• From 2013, 3% of permits will be allocated to a special reserve for later distribution to fast growing airlines and new entrants into the market. The due date for surrender in respect of emissions during 2012 is 30 April 2013. 
• The free allowances are allocated by a benchmarking process based on the activity of each operator in 2010.

Some exemptions to the scheme were to apply, including where the EU recognised that the country of origin for incoming flights was taking measures to limit aviation emissions from departing flights.

Criticism of the EU's aviation emissions plan

The proposal to include international aviation emissions in the EU ETS from 1 January 2012 was greeted with howls of displeasure and threats of non-compliance from some of Europe's biggest trading partners including China and the US. The US enacted legislation which prohibits US carriers from complying with the EU ETS and China forbade its carriers to participate in the scheme. Numerous legal challenges were also instituted, although these were ultimately unsuccessful, or discontinued.

There has also been more generic criticism of the scheme's application to aviation emissions including the potential advantage that newer fleets will experience by reason of them having more fuel efficient engines. In addition, specific emissions are often proportionally higher on short distances, so aircraft operators flying a greater number of short-haul flights may find themselves more strongly impacted. Further, it was argued that occupancy rates in the baseline period will have a substantial effect with passenger carriers able to achieve higher occupancy rates and freight carriers with greater loads having an advantage over competitors, because they will receive a greater number of free allowances.

The decision of the EU to put the extension of the EU ETS to cover international aviation emissions on hold has also not been without its criticism. The entire intention of including all emissions from airlines within, and travelling to and from the EU, was to avoid discriminating against any airline operator. Already complaints have been made by European domestic airline operators about the perceived competitive disadvantage resulting from the decision. Ironically, the decision gives rise to a risk of further legal challenges, this time by those EU domestic operators who retain liability for emissions.

What happens now?

The EU's stated reason for the postponement of the scheme was a result of the action by the ICAO Council, in which ICAO has formed a high-level group to provide near-term recommendations on a series of policy issues around the feasibility of a global market-based measure (MBM) scheme appropriate to international aviation. However, the EU Commission has made clear that in the event that the 2013 ICAO General Assembly fail to make the satisfactory progress on this issue, the EU ETS legislation would be applied in full again to all flights to and from non-European countries.

It is unclear if the decision will need to be given legislative force so that non-EU airline operators, such as Qantas, will not be in breach of their obligations come 30 April 2013. There is a suggestion that the decision of the EU does not confer an exemption from compliance, merely a deferral such that if the ICAO does not progress the issue to the satisfaction of the EU, the liability for emissions during 2012 and thereafter remains. This itself raises interesting issues and uncertainty about, if an agreement is reached with ICAO, how and when it can be implemented, and how this can be reconciled with obligations under the EU ETS.

Treatment of Australian aviation emissions

In contrast to the EU approach, the Australian Carbon Price Mechanism (CPM) neither applies to non-Australian airline operators, nor aviation fuels generally. Rather, a de facto carbon price is imposed on domestic aviation fuels through an increase in the fuel excise by an amount equivalent to the carbon price on an annual basis over the fixed price period (to 30 June 2015). International aviation fuel use is not subject to fuel tax and is therefore not subject to an effective carbon price.

Airlines that are eligible, like other large fuel users, may choose to opt in the CPM from 1 July 2013. This potentially provides those airline operators with the opportunity to manage their exposure to a carbon price. Businesses that opt into the CPM will be entitled to a fuel tax credit equal to the excise increase equivalent to the carbon price. Once an aviation business has opted into the CPM they will have the same obligations as other liable entities. Draft regulations setting out the eligibility criteria and threshold tests for participation in the CPM on an opt-in basis were released in October 2012 and are expected to be finalised by mid-December 2012.

For now, Australian international flights will not be subject to a carbon price, either in Australia, or the EU.

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