In this article TWC Aviation’s Carter Stewart examines some of the recent news on EU ETS (European Union Emissions Trading Scheme) and offers his perspective on some of the prominent stories of the past few weeks, and examines what may be next for the EU ETS controversy.

I feel compelled in each conversation that I have with clients, the public, or news outlets to say at the very start that I personally believe that the inclusion of Commercial Aviation into the EU ETS framework was not in the best interest of airlines, passengers, or the industry.   What is important to remember, however, is that this is now law both in the European Union and in each of its member states- including the United Kingdom.

While much noise has been made in the world media over the past few weeks about the formal introduction of aviation within the EU ETS, there appears also to be a great deal of media spin on the stories that are coming out.

Take for instance the reports that many U.S. airlines began collecting a $3.00 surcharge per passenger travelling to/from the European Union to offset the carriers EU ETS obligations.   I do not believe that this is necessarily true.   Some airlines have called this additional charge simply miscellaneous.      I believe that some carriers may well be using the revenue for the EU ETS obligations, while some others may well be using it as a form of fuel surcharge.    Spikes in Jet-A fuel prices in Q4, as well as unusually heavy west-bound Atlantic winds, have been slowly eating away at revenues.  There is also some considerable uncertainty over fuel prices and Iranian politics that are likely also influencing the various revenue teams around the world.

While it is reasonable to assume that carriers would want to offset their obligations, it is also important to point out that all carriers who had flight operations over a certain threshold have also received certain allotments of Aviation ETS credits from the E.U. nation who host the majority of their movements.    In effect, for this first year, both E.U. and foreign air carriers have been given an allotment of free credits that run into millions of Euros.   This is a fact that many trade groups, news outlets, and even foreign governments appear to leave out of their press statements. 

While the time for EU ETS political advocacy on behalf of the industry has long since passed us by, the rest of the world has seemingly only awoken up to the reality of these new laws.    While many trade groups and individual carriers had filed for hearings in the European Court of Justice, the court has made their position clear that their view is that EU ETS is not only legal, but does not violate international law.  It is at this point where I believe commercial aviation trade groups will turn their attention away from European Capital, and instead spend their valuable time and money lobbying their own legislators for a diplomatic solution.

Many other jurisdictions such the United States, China, and India take an opposite view and have begun exercising their diplomatic and legal powers in search of a remedy to this situation.

I do believe that the future of EU ETS is likely to place pressure on E.U. relations with some countries.     The United States Congress has introduced draft legislation in both the House of Representative and The Senate to propose making it illegal for a U.S. air carrier to acquire and spend E.U. ETS Credits.   India has hinted that they are to re-examine several bi-lateral agreements with E.U. nations, carefully only alluding to E.U. ETS as a primary driver.

 I personally believe that no country can afford an aviation trade war at this moment in time.     While it would appear that the European Union had not learned from British History that occasionally “taxation without representation” can create political difficulties, it does not yet appear to have successfully created a credible legal argument against the new laws that each individual member-state has passed in their own jurisdiction that make up E.U. ETS.    There is even some debate regarding which existing body is fit and proper to hear any new legal or treaty challenge. 

Having said that, U.S. Lawmakers may do well to also remember the post 9/11 TSA security fees and demands for APIS (Advanced Passenger Information) often flew in the face of other nations’ sovereignty as well.   While I am not comparing these items directly, what I would compare is the unilateral action taken by one party against another while exercising their treaty rights (i.e. operating international commercial airline flights).    

Whatever the lofty arguments for or against E.U. ETS may be, the real challenge is what individual member states will do with individual carriers who do not comply with the new emissions framework.    That is where I predict we will see the next credible legal set of arguments.

Article Overview

-EU ETS will include Aviation from 01 JAN 2012

-The UK Deadline for filing your benchmarking and emissions plans is 31 March 2011

-Are you included on the latest list of operators issued by EUROCONTROL in early February 2011?

-Do you know if you are covered by EU ETS?

-Do you know what flights are exempt from EU ETS, and are your included?

-If you are not sure what to do in regard to EU ETS, or even are unsure if you are covered by the new regulations please feel free to get in touch.  We can help!

 The EU Emissions Trading Scheme (EU ETS) is set to include aviation from 01 JAN 2012.   EU ETS brings with it a whole new level of new dynamic market pricing that aircraft operators will need to  factor into their formulas, and if initial estimates are correct we could be talking about anywhere from €5-18 per passenger (depending on the route) if prices for EUAs stay at today’s levels.   

Before we get to that point, however, there are many foreign carriers and aircraft operators who may not be aware that they have been listed on the latest version of EUROCONTROL’s ANNEX I.    Are you?   If you are not sure you can refer  http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2011:039:0001:0120:EN:PDF

While many of the US carriers have filed suit to contest this EU Directive (and the individual EU Member State Laws related to it) and that the has not yet been ruled on by the European Court of Justice.  The US airlines involved are still, as we understand it, voluntarily complying with the requirements of the scheme.  For other carriers this means those who are not exempt from the scheme have hopefully already applied for the “allocation of free credits” as well as submitted benchmarking plans, obtained certifying bodies, and put in place monitoring plans that are acceptable to their respective EU State they have been allocated to by 31 MAR.  Carriers are due to hear in September of this year from their regulatory EU Member State as to what their share of the “special reserve” or other “free credits” are to be.   

Last Monday the EU made the formal announcement about the final CO2 caps, and the simple math says that while approximately 80% of the carbon credits needed by the industry will be part of the free allocations, that leaves 20% subject to market forces.  With an EUA trading at around €15-16 at the moment, there is some level of exposure to the several thousand of the world’s carriers operating into the EUROCONTROL zone. 

Some analysts are looking for a price correction with the introduction of AAs to the ETS marketplace, with some projections taking them up to €18-20 per credit.  I believe the number will be somewhere between €19-22 when AAs are introduced to the market, based on the projected shortfalls, and also a number of non-EU carriers who did not meet the criteria for a “free allocation” scramble to cover their exposure not fully understanding that the first point of surrender of these credits is not until MAR-APR 2013. So airlines, and other air carriers, have time to play the market a bit and participate in EU Member State auctions to make up their shortfalls.  Though we would not want to be in the market for significant AAs or EUAs in early 2013!

Many of our foreign carrier aircraft operators have required some assistance with the regulations, compliance, and even just the overall processes involved in the scheme.   If you are need of assistance or support, we would be happy to help!  Please feel free to contact us today at +44 208 588 0602 for an initial consultation.

Airline Anschluss

In my view, there are few carriers that can compare to Lufthansa for both strategic vision and execution. Their move to acquire the Austrian Group is just another in a series of decisions that demonstrating this strength. Unfortunately for Lufthansa something went a little amiss in this latest anschluss, but we do not think it is irreparable.

Ripe for Takeovers; but who can spare the cash?

Everyday more and more carriers are seeking shelter from the stormy marketplace through alliances, investment, and mergers. In just the past few months alone we have witnessed Ryanair’s hostile attempt to takeover Aer Lingus, as well as Italy’s new “Alitalia” emerge from a massive state-sponsored bailout. There has also been unprecedented consolidation in the Russian markets.

What is the source of Lufthansa’s Strength?

While certainly not a secret, Lufthansa goes about its business in such a way as to not court attention. While there has been some negative news for the Lufthansa Group, particularly in terms of their Cargo operations, they are still posting overall respectable €599 M profit today for the combined group which includes wholly owned SWISS, and Germanwings. Have a look at just how diverse the Lufthansa holdings really are.  (Please note, this opens a new window to the Lufthansa site, and the source file is in German- but you can get the idea.)

In February, Lufthansa made public its intention to add struggling carrier Austrian to its portfolio of fully owned subsidiaries. During the months of failed bids which included Russia’s S7, as well as several Gulf funds, Lufthansa carefully put together a deal to see that the integration of Austrian would success

What is wrong at Austrian and how does it affect the consumer?

Austrian suffered from the credit crunch much like any other carrier, and their latest strategy to expand their focus on long-haul connecting traffic did not get them either the load factors or yields that they had hoped for. After months of offers and due-diligence from an array of suitors, nothing materialised other than the deal from Lufthansa who are now offering €4.49 a share.

Even Austrian’s COO has gone on record as saying “the global economic crisis has now reached all markets, demand is collapsing and the outlook offers very little reason to be optimistic. We will continue as an airline, but not independently.” Now Austria’s State Holding Company obtained permission from the EC to keep the airline with a bridging loan flying while the deal with Lufthansa is being finalised.

From our view the integration of Lufthansa and Austrian makes sense. It has a complementary fleet type, the cultural ties are obvious, and Austria as a nation needs a carrier with a more diverse network of connections. Have you ever tried to fly from London to Salzburg? Your choices are fairly limited.

So what went wrong in Europe?

Enter stage right the cries of “foul state support and aid” from SkyTeam carriers who filed a motion with the European Commission to investigate the possibility that this deal could violate laws prevented so called “state support”. Where were these carriers when Italy’s Prime Minister was re-writing Italian Bankruptcy Code and making back end deals that resulted in the Italian State owning all of Alitalia’s debt, while it continues flying? Oh wait, Alitalia was one of SkyTeam’s very own.

Where are we now?

What we have now is a 200M Euro bridging loan that is keeping Austrian afloat, as the immediately slash costs and cut capacity while the issue of Lufthansa and Austrians tie-up is finalised by EU officials. In the meantime, SAS is looking to sell its stake in British Midland (bmi) along with their other holdings such as Spanair in a fight to get cash. Who might be the prime buyer for the bmi shares? I would think Lufthansa would have an interest.

One has to stand in awe of the Lufthansa strategic ability to position themselves in a weak market. From their negotiating majority ownership of British Midland (bmi) to their new investment in Lufthansa Italia the carrier has a strong strategic portfolio that is likely to pay off in the long term. They possess the diversity and required cash to survive this current economic downturn.

TWC’s Carter Stewart says, “If I were playing cards with Lufthansa I would be very conservative. We all know that Lufthansa is holding a winning hand, and unlike most carriers today they have the cash to make the bet. The question for all of us is how and when they are going to play it.”

In our next installment

In our next blog we will have a look at what we think the “Fantasy Playbook” for Lufthansa’s bmi holding could be.