The inclusion of aviation into the EU emission trading scheme – Impacts on competition between European and non-European network airlines

Transportation Research Part D 15 (2010) 14–25

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Transportation Research Part D journal homepage: www.elsevier.com/locate/trd

The inclusion of aviation into the EU emission trading scheme – Impacts on competition between European and non-European network airlines Janina Scheelhaase a,*, Wolfgang Grimme a, Martin Schaefer b a b

German Aerospace Center (DLR), Air Transport and Airport Research, Linder Höhe, Cologne, Germany German Aerospace Center (DLR), Institute of Propulsion Technology, Linder Höhe, Cologne, Germany

a r t i c l e Keywords: Aircraft emissions Airline competition Air transport policy Climate change Emissions trading

i n f o

a b s t r a c t In 2008, the European Commission, the European Parliament and the European Council agreed on including international aviation in the already existing European Union carbon market. From 2012, allowances will be required for all international flights landing at and departing from any airport in the EU. Domestic aviation will be subject to the same rules as international air traffic. Model-based empirical estimations presented in this paper indicate a diverse set of effects influencing competition between European and non-European aircraft operators. Initially, this paper provides an overview on recent political developments on EU as well as on International Civil Aviation Organisation level on the subject of emissions trading and aviation. Subsequently, our modelling approach and the main results concerning impacts on operating costs, ticket prices and cargo rates for European and non-European aircraft operators are presented and discussed. Finally, conclusions about the impacts on competition between European and non-European airlines are drawn. Ó 2009 Elsevier Ltd. All rights reserved.

1. Background According to recent Intergovernmental Panel on Climate Change (IPCC) (2007) estimations, international aviation contributes about 3% to anthropogenic global warming. Climate relevant emissions from aviation include carbon dioxide (CO2), water vapour (H2O), nitrogen oxides (NOx), sulphate particles (SOx) and soot, whereas CO2 is the most important greenhouse gas (Sausen et al., 2005). Furthermore, particulate emissions from aircraft engines may trigger the formation of contrails and cirrus clouds, which are believed to contribute to global warming. Even though a lot of research has been carried out in the last years, the level of scientific understanding is still poor for some effects. This is especially true for contrails and cirrus clouds and their contribution to global warming. To cap CO2 emissions of the aviation sector, the European Union (EU) will include this sector in the European Emissions Trading Scheme (EU-ETS), which is currently limited to stationary sources of CO2. The European Commission’s (EC) proposal for a directive as agreed by the European Parliament and the Council of the European Union (2008) was published in 2008. It will come into force in 2009. According to this directive, aircraft operators will be obliged to surrender allowances for virtually all commercial flights landing at and departing from any airport in the EU from 2012 onwards. This way, the EU-ETS will not only affect European airlines, but also airlines from third-countries like the US or developing countries. In December 2006, the Commission of the European Communities (2006) published a first version of this proposal. As a reaction to this proposal, a number of non-EU countries such as the US, Canada, Australia, Japan, South Korea and Brazil were

* Corresponding author. E-mail address: [email protected] (J. Scheelhaase). 1361-9209/$ - see front matter Ó 2009 Elsevier Ltd. All rights reserved. doi:10.1016/j.trd.2009.07.003

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arguing strongly against the inclusion of non-EU carriers in the EU-ETS. It has being argued that the proposal conflicts with international law, especially the Chicago Convention on Civil Aviation, but economic and competitive reasons are probably relevant, too. This legal argument was brought forward on ICAO as well as on a bilateral level. The EC has a diverting view on this issue. The Commission believes that the proposal conforms to international law and that the inclusion of non-EU carriers in the EU-ETS is preventing competitive distortions in the international air transport market. The EC’s position is supported by a number of legal experts, who have concluded that the EU’s unilateral inclusion of all aircraft operators into the ETS irrespective of their origin and without the consent of the respective governments is legally feasible (Petersen, 2008). Also a number of economic studies on these highly controversial issues have been conducted lately, e.g. Faber et al. (2007), Forsyth et al. (2007), Boon et al. (2007) as well as Scheelhaase and Grimme (2007). These studies focus on different aspects of the topic such as the method of initial allocation of allowances, the impacts on tourism as well as the economic impacts on different airline types. The following analysis is based on these recent findings. This article analyses how the EU directive on the inclusion of international aviation in the EU-ETS affects competition between European and non-EU airlines and if competitive distortions are likely to appear. Initially, we will provide an overview on recent political developments on EU as well as on ICAO level on the subject of emissions trading and aviation. This is followed by a brief description of our modelling approach. The economic and competitive impacts on operating costs, ticket prices and cargo rates for European and non-European aircraft operators are estimated considering a US and a German full service airline as examples. For this purpose, different benchmark variants of the EU-ETS and their impacts on airline costs and passenger demand are analysed. On this basis, conclusions about the impacts on competition between European and non-European full service airlines are drawn.

2. Recent developments on EU- and on ICAO-level The EC’s proposal for a directive was agreed by the European Council and the European Parliament in 2008 (Council of the European Union, 2008). As mentioned above, it will become effective in 2009. It contains the following provisions for the inclusion of aviation into the existing EU-ETS in 2012: – The EU-ETS will cover virtually all flights departing from or arriving at EU airports from 2012 onwards. Domestic flights will be subject to the same rules as international air traffic. Taking into account that a number of non-EU countries did not ratify the Kyoto protocol (or any other international treaty on climate protection), this is indeed remarkable. The EC justified this approach by stating that a distortion of competition in the international airline industry needs to be avoided to the most possible extent and that this approach will improve the environmental effectiveness of the scheme. If any nonEU country introduced alternative measures with similar climate protecting effects, the geographical scope of the EU-ETS could be modified such that flights arriving from or departing for this particular country are excluded from the scheme. – Aircraft operators will be obliged to hold and surrender allowances for CO2 emissions. – Allowances are required for flights by aircraft with a maximum take-off mass of or above 5700 kg. Flights performed under visual flight rules and rescue flights (amongst a number of other exemptions) are excluded from the scheme. – Exemptions from the EU-ETS will be also granted for flights performed in the framework of public service obligations on routes within outermost regions or on routes where the capacity offered does not exceed 30,000 seats per year. Also excluded from the EU-ETS will be flights performed by a commercial air transport operator operating either fewer than 243 flights per 4-month period for three consecutive 4-month periods (so-called ‘de minimis’ clause) or flights with total annual emissions lower than 10,000 tons per year. The ‘de minimis’ clause was mainly added to exclude aircraft operators from developing countries with a low number of flights to and from Europe. – Regulations for emission monitoring and reporting will take effect in 2010 while an emission cap for all aircraft operators will be introduced in 2012. Further rules in the directive include the following issues: – In the first year of the inclusion of aviation into the EU-ETS, the total quantity of allowances to be allocated to aircraft operators shall be equivalent to 97% of the historical aviation emissions. The historical aviation emissions will be calculated on the basis of the average total emissions reported for the years 2004–2006 by the operators taking part in the scheme. – Initially, allowances will be allocated to aircraft operators mostly free of charge. In 2012, 85% of the allowances shall be allocated for free. In contrast to the existing scheme for stationary installations, the method of allocating allowances will be harmonized within the EU. The EC has obviously learnt its lesson from the sometimes generous supply of allowances for operators of stationary sources in the past. – The total number of allowances allocated for free to each aircraft operator will be determined by a benchmark which is calculated in three consecutive steps: First, the share of auctioned allowances is subtracted from the overall cap. Second, the remaining amount of CO2 emissions is divided by the sum of verified tonne-kilometre data for flights falling under the geographical scope of the ETS in the monitoring year 2010, as reported by all participating aircraft operators. Third, the specific amount of allowances each operator receives is calculated by multiplying the respective individual

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tonne-kilometre value of the monitoring year with the benchmark. Each operator’s revenue tonne-kilometres are calculated by multiplying the mission distance (great-circle-distance plus an additional fixed factor of 95 km) by the payload transported (cargo, mail and passengers). – In the first year of the inclusion of aviation into the EU-ETS, allowances allocated to aircraft operators will be valid within the aviation sector only. However, it will be possible to purchase additional permits from other sectors or from the project based Kyoto instruments ‘‘Joint Implementation” and ‘‘Clean Development Mechanism”. In 2012, aircraft operators may use emission permits from ‘‘Joint Implementation” and ‘‘Clean Development Mechanism” up to 15% of the number of allowances they are required to surrender for this year. Allowances not used in 2012 can be ‘banked’ to the third trading period of the EU-ETS. This means unused allowances issued in 2012 can be carried over for use up to 2020. It is understood that most of the regulations for 2012 will be further applied to aviation in the period 2013–2020, while presumably the overall cap will be reduced and the level of auctioning will be increased. On ICAO level, emissions trading for aviation is being intensively discussed, too. By February 2007, the ICAO/CAEP Emissions Trading Task Force worked out ‘‘ICAO Guidance for Emissions Trading in International Civil Aviation”. This guidance is for use by ICAO Contracting States, as appropriate, to incorporate emissions from international aviation into Contracting States’ emissions trading schemes consistent with the UNFCCC (Parties to the United Nations Framework Convention on Climate Change) process. The guidance was adopted by the ICAO-CAEP/7 (Committee on Aviation Environmental Protection) in February 2007. Concerning the EC’s proposal for the inclusion of international aviation into the EU-ETS which was published in 2006 for the first time, strongly diverting views of non-EU countries were expressed at the ICAO-CAEP/7 meeting as well as at the ICAO Assembly in September 2007. In contrast to the EC and the EU Member States, most ICAO contracting states believe that an inclusion of non-EU carriers is only possible on the basis of a mutual agreement. Both parties argue on the basis of the Chicago Convention on Civil Aviation. By the end of the Assembly it eventually proved not possible to reach an agreement on the controversial issues and the Resolution text therefore reflects the position of the majority of States. As a result, Europe could not agree to a Resolution text that urges States to refrain from unilateral implementation of greenhouse gas measures and entered a formal reservation on the relevant part of the ICAO Assembly Resolution.

3. Modelling the economic and competitive impacts of the EU-ETS Our model-based analysis focuses on the competitive impacts of the EU-ETS on EU- and US-based network carriers. Exemplarily, a comparison will be drawn between Lufthansa and Continental Airlines. Lufthansa was chosen as a representative European network carrier which is heavily dependent on feeder flights for its intercontinental operations. Roughly 40% of all long-haul passengers carried by Lufthansa are directly originating at its hubs in Frankfurt and Munich, while about 60% are transfer passengers. This heavy dependence on feeder flights in the hub-and-spoke operations business model influences the environmental performance of air transport as shown by Morrell and Lu (2006). Continental is an important competitor of European network carriers. Its business model in recent years focussed strongly on decentralised intercontinental services. Between July 2000 and July 2006, Continental has increased the number of weekly flights between the USA and Europe by more than 70%, with the number of seats increasing by more than 30%, according to flight schedules provided by OAG. The disparity between the growth in the number of flights and the number of seats lies in the fact that Continental has redeployed a considerable number of Boeing 757 aircraft from domestic to transatlantic markets, serving a large number of secondary airports in Europe. In comparison to other aircraft types used on transatlantic services, the 757 is relatively small with only 175 seats. Our model-based analysis is divided into three main parts: In a first step, the fuel consumption and CO2 emissions will be calculated. The fuel consumption and emissions calculations are prerequisites for the subsequent estimation of the benchmark used for initial allocation and the total emissions of the airlines’ flights subject to the EU-ETS. In the second step of the analysis, the initial allocation of allowances will be modelled. This includes the estimation of the underlying benchmark and the tonne-kilometres performed by each carrier in 2010. This year will become the monitoring year on which the initial allocation to individual airlines will be based. In the third step, the total CO2 emissions for both airlines in 2012 (when international aviation will be included in the ETS) will be roughly estimated, as well as the deltas between allowances allocated free of charge and the total amount of allowances needed by the airlines. In a final step, the resulting impacts of the EU-ETS on ticket prices and freight rates are estimated. 3.1. Mission fuel consumption and CO2 emissions 3.1.1. Overview To calculate the airlines’ yearly fuel consumptions and CO2 emissions, flight schedules delivered by the Official Airline Guide (OAG) were used in combination with a Deutsches Zentrum für Luft- und Raumfahrt (DLR)-developed mission analysis tool. This ‘‘VarMission” software is run, in principle, for every flight contained in the schedules. It uses aircraft performance data contained in the EUROCONTROL Base of Aircraft Data (BADA) to determine the fuel consumption of a given flight. BADA

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has a history of being used for global emission inventories (e.g. the FAA’s SAGE inventories) and can be considered a standard for such applications (Federal Aviation Administration, 2005). In its latest edition, the database contains information on 91 aircraft types including most airliners and a number of smaller types. Aircraft for which no data are available can be represented by models with similar characteristics. 3.1.2. Aircraft performance modelling with BADA BADA data and formulae assume the aircraft as a point mass. In principle, they balance the rate of work done by forces acting on the aircraft and the rate of increase in potential and kinetic energy (EUROCONTROL, 2004). This approach, mostly referred to as a Total Energy Model, is represented by the following equation:

ðT  DÞ  v TAS ¼ m  g 

dh dv TAS þ m  v TAS  dt dt

ð1Þ

T is the thrust (Newton), D the aerodynamic drag (Newton), m the aircraft mass (kg), vTAS = true airspeed (m/s), g the gravitational acceleration (m/s2), and h = altitude (m). When modelling a cruise flight segment, for example, the Total Energy Equation can be used to calculate the engine thrust required at any given operating point. The aircraft’s cruise speed is usually known, while – assuming a constant cruise altitude – the rate-of-climb becomes zero. Since the aerodynamic drag is required in Eq. (1), lift and drag coefficients as well as the respective forces need to be calculated using BADA data and elementary equations of aerodynamics. Given the thrust from Formula (1), the corresponding fuel flow can be determined. In the BADA model, thrust-specific fuel consumption g is a function of true airspeed. via g, the fuel flow f (in kg/min) is calculated utilising aircraft-specific fuel flow coefficients:



g ¼ C f1  1 þ

v TAS



C f2

fcr ¼ g  T  C fer

ð2Þ ð3Þ

Cf1 = the 1st thrust specific fuel consumption coefficient (kg/min/kN) Cf2 = 2nd thrust specific fuel consumption coefficient (kt) Cfcr = cruise fuel flow correction coefficient (–) The absolute amount of fuel burned in a flight segment can be found by multiplying fuel flow with time. Since altitude and airspeed are changing during a flight and the aircraft’s mass is decreasing (as fuel is burned), an iterative approach is required for performance calculations: Starting at a given gross weight, fuel consumption is calculated for a sufficiently small flight segment. For the following segment, the above equations are applied again, while the aircraft’s mass is debited by the amount of fuel burned in the previous segment. 3.1.3. Assumptions for mission analyses The VarMission software performs the calculations explained in the previous section by considering climb, cruise and descent flight phases supplemented by taxi and take-off phases. To calculate an airline’s consumption from flight schedule information, a number of assumptions are required, most prominently regarding the flight profile, the actual payload and the fuel reserves taken onboard of each flight. The main assumptions include:  The estimation of actual flight distances by considering route inefficiencies due to ATC constraints. As an approximation, we applied factors of 1.06 and 1.03 to the great-circle distances of short/medium distance flights and long distance flights, respectively.  Constant cruise altitudes assumed for short- and medium-haul flights, while step climb profiles were considered for some long-haul missions. We assigned typical cruise altitudes as function of mission distance and aircraft type or category.  Aircraft seat and cargo capacities and the respective load factors were obtained from the airlines’ websites and annual reports.  Typical reserve fuel policies were assumed for mission analyses: Aircraft carry 5% of the trip fuel as a contingency plus an amount of diversion fuel specified separately for long haul and short haul flights following Eyers et al. (2004). With these assumptions and given an aircraft’s empty weight, VarMission is capable of determining the fuel burn along the flight path. Since the take-off mass of a flight is initially unknown, the program performs the calculation process ‘‘backwards”, i.e. starting with reserve fuel quantities and hence analysing all flight phases in reverse order. Fig. 1 shows an example of a flight profile and the fuel burn of an A330-200 aircraft on a 1500 km mission. It should be noted, that emissions of CO2 are directly proportional to fuel consumption. 3.1.4. Airline fuel consumption and CO2 emissions The VarMission tool was applied to flight schedules delivered by OAG to estimate fuel consumption and emissions of Continental Airlines and Lufthansa. OAG data analysed for this paper include Lufthansa schedules for 2004–2006 and

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Flight Profile and Fuel Burned vs. Distance 40000

14000

35000

12000 10000

25000 8000 20000 6000 15000

Fuel Burned [kg]

Altitude [ft]

30000

4000

10000

2000

Flight Profile

5000

Fuel Burned 0

0 0

200

400

600

800

1000

1200

1400

1600

Distance [km] Source: German Aerospace Center (DLR), Institute of Propulsion Technology. Fig. 1. Flight profile and fuel burn of an A330-200 aircraft on a sample mission.

Continental Airlines schedules for 2004–2007. Furthermore, forecast schedules for Continental Airlines in 2012 were created artificially, while less complex forecasting methods were utilised to gain the corresponding Lufthansa results for 2012. A special treatment was applied to Continental Airlines’ Boeing 787 flights assumed on some transatlantic routes in our future scenario. Since no detailed performance data are currently available for this aircraft, the A330-200 was chosen as a replacement model for fuel burn calculations. During post-processing, the fuel consumption of these flights was reduced by 20%. This figure corresponds to the promised advantage of the 787 in terms of fuel efficiency compared to ‘‘similarly sized airplanes” (Boeing Commercial Airplanes, 2007). In all flight schedules used for this paper, only flights affected by the EU-ETS were considered for fuel burn calculations. Besides, it should be noted that the schedules cover the months of January and July of a given year, and yearly figures of fuel consumption and CO2 emissions were extrapolated from this 2-month period. 3.2. Modelling the free initial allocation of allowances The total number of allowances available to the aviation industry (i.e. cap) in 2012 will be determined by the average of historical emissions of all aircraft operators taking part in the EU-ETS of the years 2004–2006 multiplied by 0.97. As mentioned above, the total number of allowances allocated free of charge will then be determined by subtracting the amount of auctioned allowances. In 2012, 15% of allowances will be auctioned. The next step is the estimation of the number of allowances to be allocated to each aircraft operator. For this purpose, each aircraft operator has to submit verified tonne-kilometre data to the EC. Based on the sum of the submitted tonne-kilometre data of all flights subject to the ETS by operators i = (1, . . . , n), a benchmark will be calculated in the following way:

Benchmark ¼

P ð1  quota of auctioned allowancesÞ  ð1  reduction quotaÞ  ni¼1 average annual emissions20042006 Pn i¼1 RTK of the monitoring year 2010 ð4Þ

This benchmark in turn will be multiplied by the number of tonne-kilometres submitted by operator i to calculate the individual amount of allowances allocated free of charge. Formula (4) is proposed by the EC for the calculation of the benchmark. The decision to use RTKs here was made on a political basis after long discussions with various stakeholders. The actual calculation of the benchmark is not an easy task for two reasons: First, it is unknown which EU- and especially non-EU-airlines will take part in the EU-ETS in 2012. Second, both data on the total emissions of all flights arriving at and departing from the EU from 2004 to 2006 and the total performed tonne-kilometres in 2010 are not publicly available, respectively, have to be prognosticated. Therefore, the following approach has been chosen to roughly estimate the benchmark. Based on a set of representative missions (see Table 1) for each airline category (full service network carriers (FSNC), low cost carriers (LCC), holiday carriers, cargo carriers and regional airlines) and mission type (short-haul, medium-haul and long-haul), the CO2 emissions per RTK were calculated. From the mission-specific calculations presented in Table 1, it can be seen that carriers operating modern cargo aircraft over long distances have the lowest specific emissions. Overall, it is likely that airlines carrying a relatively high share of

Mission type

Route

Aircraft type

Great circle distance (in km)

RTK (passenger & Cargo)

CO2–emissions (in t)

Specific emissions (in kg CO2 per RTK)

Mission type average specific emissions (in kg CO2 per RTK)

Regional – FSNC Regional – FSNC Regional – FSNC Shorthaul – FSNC Shorthaul – FSNC Shorthaul – FSNC Shorthaul – LCC Shorthaul – LCC Shorthaul – LCC Shorthaul – holiday carrier Mediumhaul – holiday carrier Longhaul – FSNC Longhaul – FSNC Longhaul – FSNC Longhaul – FSNC Longhaul – FSNC Longhaul – FSNC Longhaul – FSNC Longhaul – Cargo Longhaul – Cargo

FRA-STR DUS-DRS VIE-TXL FRA-LHR FRA-FCO MUC-ESB HHN-STN CGN-BCN LTN-ATH FRA-PMI FRA-LPA FRA-DXB EWR-BHX MUC-YUL FRA-EWR FRA-ORD FRA-DEN FRA-SIN LUX-ORD HKG-FRA

CRJ100 ATR42-500 CRJ100 A321-100 A320-200 B737-300 B737-800 A320-200 A319-100 A320-200 B737-800 A340-300 B757-200 B767-300 B777-200ER A330-300 B747-400 A340-300 B747-400F MD11F

153 488 544 695 954 1912 572 1133 2447 1250 3183 5000 5441 6149 6211 6967 8085 10,603 6873 9171

500 1434 1993 8967 10,359 16,412 8237 15,771 30,539 18,488 50,323 163,000 92,134 164,473 228,185 204,701 306,394 317,030 639,189 583,276

1.58 2.51 3.77 10.40 12.65 20.56 8.20 14.45 23.05 15.72 34.68 121.90 77.89 122.96 154.85 140.07 283.22 271.30 268.01 280.78

2.83 1.75 1.89 1.13 1.38 1.37 1.00 0.92 0.75 0.85 0.69 0.75 0.85 0.75 0.68 0.68 0.92 0.86 0.42 0.48

2.16

1.29

0.89

0.77 0.78

0.45

J. Scheelhaase et al. / Transportation Research Part D 15 (2010) 14–25

Table 1 Representative missions used to estimate the emissions benchmark.

Source: German Aerospace Center (DLR), Air Transport and Airport Research.

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J. Scheelhaase et al. / Transportation Research Part D 15 (2010) 14–25

cargo benefit systematically from the proposed benchmarked allowance allocation, as their specific emissions are lower compared to airlines with a smaller share of cargo. Therefore, airlines with a high cargo share will receive a higher amount of allowances for free than their counterparts with a lower cargo share. The average benchmark of each mission type is subsequently weighted according to plausible assumptions about the overall share of emissions of each mission type. As it is rather difficult to estimate the exact emission share for each mission type, three benchmark variants are considered, each with slightly different weighting factors for the individual missions’ emission shares. The weighting factors for the three options considered were chosen in a way that in variant 1 a relatively higher share of short-haul FSNC and regional flights occur, leading to a benchmark that reflects relatively higher specific emissions, while in variant 3, long-haul FSNC and short-haul LCC flights were weighted higher, resulting in a more stringent overall benchmark. Variant 2 combines assumptions that lead to an average benchmark between variants 1 and 3. Data by EUROCONTROL available to the authors shows that the total emissions attributable to intercontinental flights arriving at and departing from airports in the EU amount up to about two thirds of the total emissions of flights subject to the EU-ETS. Therefore, in the three benchmark variants analysed, the share of long-haul flights was set to 60% in variant 1, 65% in variant 2 and 70% in variant 3. The share of emissions by all-cargo aircraft (8.3–14.3% of total long-haul flight emissions) is oriented at the value that can be found in the German transport forecast, where the freighters’ share is estimated at 11.7% of total emissions (ITP et al., 2001). Albeit steadily growing and drawing great attention for several years now, the low cost carriers’ share of total intra-European traffic measured by flight movements is only between 15.8% (EUROCONTROL, 2007) and 19% (Deutsches Zentrum für Luft- und Raumfahrt, 2007). The share of LCCs’ short-haul flight emissions compared to all short-haul flights is assumed to be 15% in option 1, 20% in option 2 and 26.7% in option 3. As low cost carriers generally use larger aircraft, it seems plausible that the emissions share is slightly higher than their share by air traffic movements. Finally, also the politically determined reduction of the cap by 3%, the quota of auctioned allowances of 15% and the overall tonne-kilometres growth until 2010 have been considered in the calculation of the benchmark. Overall, these considerations result in the following numerical values (see Table 2): The next step within our analysis is the calculation of the tonne-kilometres performed by the two airlines under consideration in the scope of the EU-ETS. This is done on the basis of OAG timetable data and load factors provided by the airlines’ annual reports. Overall tonne-kilometre data by Association of European Airlines, 2005 and the annual reports (Lufthansa, 2007; Continental Airlines, 2007a) were used to validate the calculations. In our analysis, only Lufthansa flights were considered that were actually performed by Lufthansa (mainline jet operations) and Lufthansa Cityline (regional jet operations) with an origin and/or destination within the EU. For Continental Airlines, all flights listed in the OAG database between the USA and the EU are considered. Due to the methodological approach chosen, liabilities for CO2 emissions incurred by either Lufthansa or Continental for code-share flights operated by a different carrier cannot be considered here. Although the costs incurred may shift to the non-operating code-share partner, the perspective taken in our calculations is strictly from the point of view of the aircraft operator, which is liable for holding and surrendering carbon allowances. For the initial allocation of allowances, as well as the subsequent emissions modelling we designed two alternative future emissions and traffic growth scenarios: A so-called ‘‘zero traffic and emissions growth scenario” and a so-called ‘‘moderate traffic and emissions growth scenario”. Both scenarios are further described below. Based on these scenarios and in combination with the benchmark variants derived from Table 2, we estimate that Lufthansa will receive a free allocation of allowances for the emission of between 8.4 and 10.8 megatons of CO2, while Continental Airlines will receive allowances for the emission of between 2.2 and 2.9 megatons of CO2. 3.3. Modelling the airlines’ emissions The final prerequisite for our economic analysis is the delta between the amount of allowances allocated for free and the amount of allowances actually needed for flight operations by Lufthansa and Continental. To calculate this delta, the tonnekilometres of the monitoring year 2010 as well as the expected emissions of 2012 are needed. (Tables 3 and 4.)

Table 2 Estimated distribution of emissions and the resulting benchmark. Shorthaul – LCC Shorthaul – FSNC Longhaul – FSNC Regional – FSNC/other IFR Short-/mediumhaul – holiday Longhaul – Cargo Sum Cap percentage Quota of auctioned allowances Overall RTK growth between 2006 and 2010 (monitoring year) Resulting benchmark (in kg CO2 per RTK) Source: German Aerospace Center (DLR), Air Transport and Airport Research.

6.0% 22.5% 55.0% 4.0% 7.5% 5.0% 100% 97% 15% 4% 0.61

7.0% 20.0% 57.5% 3.0% 5.0% 7.5% 100% 97% 15% 4% 0.60

8.0% 17.0% 60.0% 2.5% 2.5% 10.0% 100% 97% 15% 4% 0.58

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J. Scheelhaase et al. / Transportation Research Part D 15 (2010) 14–25 Table 3 Revenue tonne-kilometre data for flights subject to the EU-ETS. Growth rate, reported tonne-kilometres (%)

Growth rate CO2-emissions (%)

Year

Airline

Flown tonnekilometres (in million)

Reported tonnekilometres (in million)

Emissions in million t CO2

Specific emissions in kg CO2 per flown tonne-kilometre

2004

Lufthansa/ Cityline Lufthansa/ Cityline Lufthansa/ Cityline

12,745

13,207

12.747

1.00

13,531

13,996

13.301

0.98

5.98

4.35

14,078

14,569

13.608

0.97

4.09

2.30

Lufthansa/ Cityline

17,112

17,709

15.919

0.93

5.00

4.00

Lufthansa/ Cityline

18,866

19,524

17.218

0.91

5.00

4.00

2813

2855

2.072

0.74

3241

3291

2.432

0.75

15.23

17.33

3735

3785

2.609

0.70

15.03

7.28

Continental Airlines

4615

4681

3.204

0.69

5.45

5.27

Continental Airlines

5129

5205

5.205

0.69

5.45

5.27

2005 2006 ... 2010 ... 2012

2004 2005 2006 ... 2010 ... 2012

Continental Airlines Continental Airlines Continental Airlines

Source: German Aerospace Center (DLR), Air Transport and Airport Research.

For each of the two different scenarios the following methodology has been applied: The ‘‘zero traffic and emissions growth scenario” is based on the airlines’ tonne-kilometres and emissions for 2006. These have been calculated on the basis of each of the carriers’ aircraft/city-pair combinations that can be found in the OAG schedule database, combined with seat and cargo load factor data derived from the annual reports. The general assumption for this scenario is that both future traffic and future emissions for the two airlines remain constant at 2006 levels, while overall traffic will grow by 4% annually. The results of this emissions modelling are shown in Tables 5 and 6. The underlying assumption for the ‘‘moderate traffic and emissions growth scenario” is that the growth of CO2 emissions due to traffic growth will exceed the autonomous efficiency increases. The emissions’ forecast is based on the same methodology as in Scheelhaase and Grimme (2007). For Lufthansa, the future traffic growth rate is estimated at 5% per annum, while autonomous efficiency increases are estimated at 1% annually. The estimation at the upper bound of our earlier forecast is based on the fact that Lufthansa placed orders for a total of 62 aircraft in 2006 and 63 aircraft in 2007, the highest number of aircraft ordered ever in two consecutive years. According to ASCEND Online Fleets, 119 aircraft are planned to be delivered between 2009 and 2012 and only partly to be used as a replacement for the ageing short-haul fleet. For Continental Airlines, a different approach of forecasting the airline’s traffic and emissions in 2010/2012 was chosen, as Continental’s schedule of European operations is relatively concise in comparison to the one of Lufthansa. Based on the summer schedule of 2007, the announced new services for 2008 (Continental Airlines, 2007b) and the aircraft deliveries

Table 4 Free initial allocation of allowances in the ‘‘zero traffic and emissions growth scenario” and the ‘‘moderate traffic and emissions growth scenario”. Airline

RTK (in million) estimated for the monitoring year 2010

Zero traffic and emissions growth scenario Lufthansa/Lufthansa 14,078 Cityline Continental Airlines 3735 Moderate traffic and emissions growth scenario Lufthansa/Lufthansa 17,112 Cityline Continental Airlines 4615

Free initial allocation of allowances in 2012, variant 1 (in Mt CO2)

Free initial allocation of allowances in 2012, variant 2 (in Mt CO2)

Free initial allocation of allowances in 2012, variant 3 (in Mt CO2)

8.923

8.671

8.448

2.318

2.253

2.195

10.845

10.539

10.269

2.867

2.786

2.714

Source: German Aerospace Center (DLR), Air Transport and Airport Research.

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Table 5 Results for Continental Airlines. Benchmark variant 1

Benchmark variant 2

Benchmark variant 3

0.61 0.69

0.60 0.69

0.58 0.69

Zero traffic and emissions growth scenario (no traffic and emissions growth beyond 2006) 2.609 Required allowances in 2012 (i.e. 2006 emissions, in Mt CO2) 2.318 Free allocation of allowances in 2012 (in Mt CO2) 0.291 Acquisition of allowances in 2012 (in Mt CO2) Percentage of free allocation 89% Value of required allowances in 2012 (in €m) 52.18 Value of allowances to be acquired in 2012 (in €m) 5.82 Value of allowances per flown RPK (in €-cents) 0.14 Acquisition cost of allowances needed per flown RPK (in €) 0.02 Value of allowances per passenger and typical trip (6924 km, in €) 9.67 Acquisition cost of allowances per passenger and typical trip (6924 km, in €) 1.08 Total value of allowances per kg belly cargo and typical haul (6924 km, in €) 9.67 Acquisition cost of allowances per kg belly cargo and typical haul (6924 km, in €) 1.08

2.609 2.253 0.356 86% 52.18 7.13 0.14 0.02 9.67 1.32 9.67 1.32

2.609 2.195 0.414 84% 52.18 8.28 0.14 0.02 9.67 1.54 9.67 1.54

Moderate traffic and emissions growth scenario (56 additional weekly services in 2012 Total required allowances in 2012 (in Mt CO2) Free allocation of allowances in 2012 (in Mt CO2) Allowances to be acquired in 2012 (in Mt CO2) Percentage of free allocation Value of total required allowances in 2012 (in €m) Value of allowances to be acquired in 2012 (in €m) Value of allowances per flown RPK (in €) Acquisition cost of allowances per flown RPK (in €) Total value of allowances per passenger and typical trip (6924 km, in €) Acquisition cost of allowances per passenger and typical trip (6924 km, in €) Value of allowances per kg belly cargo and typical haul (6924 km, in €) Acquisition cost of allowances per kg belly cargo and typical haul (6924 km, in €)

3.551 2.786 0.765 78% 71.02 15.31 0.14 0.03 9.59 2.07 9.59 2.07

3.551 2.714 0.837 76% 71.02 16.73 0.14 0.03 9.59 2.26 9.59 2.26

Benchmark in kg CO2 per RTK Airline specific emissions in kg CO2 per flown RTK

compared to 2006) 3.551 2.867 0.684 81% 71.02 13.69 0.14 0.03 9.59 1.85 9.59 1.85

Source: German Aerospace Center (DLR), Air Transport and Airport Research.

scheduled until 2012, a model schedule for 2012 was created, under the assumption that 50% of newly delivered long-haul aircraft will be deployed on routes to Europe, among them very fuel efficient Boeing 787, which are scheduled for delivery to the airline starting June 2009. This approach translates into an average annual RTK growth of about 5.4% between 2007 and 2012, while emissions are expected to grow by 5.3% on average. The results of the emissions modelling within the ‘‘moderate traffic and emissions growth scenario” are also shown in Tables 5 and 6. 4. Empirical results: Competitive effects of the EU-ETS on European and third-country airlines 4.1. Continental Airlines Assuming Continental’s revenue tonne-kilometres and CO2 emissions would stabilise at the level of 2006 (‘‘zero traffic and emissions growth scenario”), the airline would receive between 84% and 89% of the allowances needed in 2012 for free. In this article we assume a price of €20 per ton of CO2. This assumption can be supported by the recent prices for emission permits in the EU-ETS, which were around €20 for most of 2008. At a price of €20 per ton of carbon dioxide, the remaining allowances to be bought on the market would have a value of between €5.8 m and €8.3 m, depending on the benchmark value applied. Under the assumptions of the ‘‘moderate traffic and emissions growth scenario” Continental Airlines would receive only 76% to 81% of the allowances needed for free. Based on an allowance price of €20, the acquisition of the additional needed allowances (19–24% of the total) would cost between €13.7 m and €16.7 m. Based on data provided by Lufthansa (2006) on the average length for trips between the US and Europe (6924 km) this would translate into an acquisition cost per passenger of between €1.85 and €2.26, respectively, a total value of €9.59 for allowances needed per typical one-way trip. If we now assume that the average fare per passenger for a one-way trip between Europe and the US was about €400 in 2006 (Continental Airlines, 2007a), this would result in a price increase of 2.5% on average. With the median of the own price elasticity of demand for international long-distance air travel at 0.79 (Gillen, Morrison and Stewart, 2004), the demand reduction caused by a full pass-through of total ETS costs can be roughly estimated at 2%. Table 5 presents our results for Continental Airlines for both emissions scenarios in detail. Although Continental Airlines exclusively operates modern, fuel efficient aircraft on long-haul routes, which have relatively low specific emissions, the airline still exceeds the proposed benchmark and has to acquire allowances, even if its emissions remain at 2006 levels. This is caused by the fact that the total amount of allowances available for free allocation is significantly smaller than the average of historical emissions between 2004 and 2006. The resulting benchmark

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is therefore relatively low and at least passenger airlines are unlikely to undercut this benchmark by employing currently available aircraft technology. Nevertheless, Continental could further reduce its emissions if more than the assumed 50% of newly purchased 787 aircraft would be deployed on routes to Europe instead of routes to Asia or South America. 4.2. Lufthansa Under the assumptions of the ‘‘zero traffic and emissions growth scenario”, Lufthansa would have to purchase a greater share of allowances than Continental. Lufthansa receives only between 62% and 66% of allowances from the free initial allocation. At a price of €20 per ton of CO2, Lufthansa would have to buy allowances for between €93.7 m and €103.2 m. In the ‘‘moderate traffic and emissions growth scenario”, Lufthansa would even have to purchase additional allowances for between €127.5 m and €139.0 m in 2012. In comparison to Continental Airlines, Lufthansa experiences a significantly greater disadvantage from the inclusion in the EU-ETS. This disadvantage is due to the fact that not only all long-haul flights arriving at and departing from airports in the EU will be included into the EU-ETS, but also all short-haul flights, which are less environmentally efficient than long-haul flights (calculated on the basis of emissions per RTK or RPK). In fact, specific emissions of the about 24,000 Lufthansa missions analysed range from 0.67 kg CO2 per RTK on a mission from Frankfurt to Chicago with an Airbus A330300 to 4.62 kg CO2 per RTK on a mission from Frankfurt to Cologne with an Avro RJ85 regional jet. The mix of both longand short-haul flights translates into the fact that the overall specific emissions of Lufthansa’s flights subject to the EUETS are considerably higher than those of Continental Airlines. Moreover, due to the relative low seat load factor on short-haul flights with about 64% in 2004 and the extensive use of less fuel efficient Boeing 737–300 and 500, Lufthansa exceeds all three benchmark variants by far. In this regard, the newly in the EU directive introduced fixed factor of 95 km can be regarded as a slight remedy for airlines operating relatively short flights: As mentioned earlier, this factor has to be added to the great circle distance of each flight when calculating the tonne-kilometres used for the application for a free allocation of allowances. Proportionately, this factor increases the number of tonne-kilometres reported by airlines operating a large number of relatively short flights in contrast to airlines operating a smaller number of long flights and by this, the free allocation of allowances. However, the biggest disadvantage Lufthansa is facing in comparison to Continental is that all feeder services needed to achieve and surpass the break-even seat load factor on its long-haul flights are subject to the EU-ETS. Continental in turn

Table 6 Results for Lufthansa. Benchmark variant 1

Benchmark variant 2

Benchmark variant 3

Benchmark in kg CO2 per RTK Airline specific emissions in kg CO2 per flown RTK

0.61 0.91

0.60 0.91

0.58 0.91

Zero traffic and emissions growth scenario (no emissions growth beyond 2006) Required allowances in 2012 (i.e. 2006 emissions, in Mt CO2) Free allocation of allowances in 2012 (in Mt CO2) Acquisition of allowances (in Mt CO2) Percentage of free allocation Value of required allowances in 2012 (in €m) Value of allowances to be acquired in 2012 (in €m) Value of allowances per flown RPK (in €) Acquisition cost of allowances per flown RPK (in €) Value of allowances per passenger and typical trip (6924 km, in €) Acquisition cost of allowances per passenger and typical trip (6,924 km, in €) Total value of allowances per kg belly cargo and typical haul (6924 km, in €) Acquisition cost of allowances per kg belly cargo and typical haul (6924 km, in €)

13.608 8.922 4.685 66% 272.15 93.70 0.19 0.07 13.39 4.61 13.39 4.61

13.608 8.670 4.937 64% 272.15 98.74 0.19 0.07 13.39 4.86 13.39 4.86

13.608 8.448 5.159 62% 272.15 103.19 0.19 0.07 13.39 5.08 13.39 5.08

Moderate traffic and emissions growth scenario (annual growth of emissions = 4%) Required allowances in 2012 Free allocation of allowances in 2012 (in Mt CO2) Acquisition of allowances (in Mt CO2) Percentage of free allocation Value of required allowances in 2012 (in €m) Value of Allowances to be acquired in 2012 (in €m) Value of allowances per flown RPK (in €) Acquisition cost of allowances per flown RPK (in €) Value of allowances per passenger and typical trip (6924 km, in €) Acquisition cost of allowances per passenger and typical trip (6924 km, in €) Value of allowances per kg belly cargo and typical haul (6924 km, in €) Acquisition cost of allowances per kg belly cargo and typical haul (6924 km, in €)

17.218 10.845 6.373 63% 344.36 127.45 0.18 0.07 12.64 4.68 12.64 4.68

17.218 10.539 6.678 61% 344.36 133.57 0.18 0.07 12.64 4.90 12.64 4.90

17.218 10.269 6.949 60% 344.36 138.98 0.18 0.07 12.64 5.10 12.64 5.10

Source: German Aerospace Center (DLR), Air Transport and Airport Research.

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operates its own feeder network on the other side of the Atlantic and is therefore with this part of its operations not included in the EU-ETS. The effects of this imbalance may be illustrated by the example of a trip from Cologne to San Francisco. With Continental Airlines, only the long-haul flight segment between Cologne and its hub in Newark (a distance of 6098 km) is subject to the EU-ETS. This flight, broken down on emissions per passenger kilometre is very efficient, as shown by the exemplary long-haul missions in Table 1. On a trip with Lufthansa, both the environmentally relatively inefficient feeder flight between Cologne and Munich (437 km) and the relatively efficient long-haul flight from Munich to San Francisco (9461 km) are subject to the EU-ETS. However, in total, the distance travelled with Lufthansa under the EU-ETS is more than 60% longer than with Continental Airlines.

5. Conclusions Based on our analysis it is possible to draw the following conclusions. First, under the EU-ETS Continental Airlines would gain significant competitive advantages compared to Lufthansa on the market for long-haul air services. It could be shown that Continental Airlines will receive a proportionately higher share of allowances for free than Lufthansa, as the US airline exclusively operates relatively efficient long-haul services under the ETS. Lufthansa instead, also operates its relatively inefficient short-haul feeder network within the scope of the ETS. More generally speaking, this means that network carriers based outside the EU and with a moderate growth of emissions between 2006 and 2012 will most likely gain a significant competitive advantage compared to European network carriers. Our results are applicable for all European network carriers competing with non-EU network carriers on markets for longhaul air services. This is because European network carriers are likely to encounter two systematic competitive disadvantages compared to airlines from non-EU countries on long-haul flights: First, given the same origin/destination city pair, European network carriers will in most cases fly a longer distance under the EU-ETS than their third-country-counterparts. Second, at least a part of the total distance will be covered with environmentally relatively inefficient short-distance flights subject to the EU-ETS. Network carriers from third countries, however, operate their short-distance feeder flights with relatively high specific emissions outside the scope of the ETS. The incentives provided by the ETS could lead to an optimisation of the network structures of European carriers by offering more direct long-haul flights instead of widespread hubbing. However, at present and expected future price levels for emission allowances, the benefits of hub-and-spoke networks still outweigh the costs of the ETS. Besides traffic rights limitations restricting the optimisation, many European network carriers are committed to their hub airports with irreversible investments in facilities. Another optimisation solution within the hub-and-spoke framework could be the use of larger aircraft and a reduction in frequencies. However, existing wave structures at hubs often require a high number of frequencies with relatively small aircraft to provide short waiting and overall travel times, which are an important factor for the marketability of itineraries. A possible solution to avoid this systematic competitive disadvantage of the EC’s directive for the inclusion of aviation in the EU-ETS could be the introduction of separate benchmarks for different types of routes, separating at least long-haul from short-haul flights to avoid or at least reduce the competitive distortion as described in this paper. This, however, would certainly complicate the handling of the EC’s directive considerably. Second, concerning the general design options of the EU-ETS, the system as outlined in the directive creates an incentive for airlines to maximise their output in terms of RTK in 2010, regardless of the emissions caused. In case an airline would drastically increase the number of tonne-kilometres performed in 2010, it would receive a higher number of allowances allocated for free in 2012. Any emissions caused for the production of these tonne-kilometres are not taken into account, as the emissions cap is based on the average of emissions of the years 2004–2006. The 95-km-fixed factor, which has to be added to the great circle distance for the calculation of tonne-kilometre data to be reported for the application for the free allocation of allowances, is beneficial for those operators offering a high number of relatively short flights, such as regional and network airlines. In our comparison of Lufthansa and Continental, the transport performance of the German carrier is boosted by 3.5% compared to the actual transport performance, measured by the great circle distance. The US carrier’s transport performance increases only by 1.4%, as it operates a smaller number of flights than Lufthansa and these flights are also considerably longer than Lufthansa’s. Third, concerning the issue of additional operating costs, increasing ticket prices and cargo rates, which led to sharp criticism by airlines in the past, our model finds only moderate price increases in the area of €10 – €13 per typical long-haul one-way journey. With an average own price elasticity of demand at 0.79 and one-way fares of about €400, the demand reduction can be estimated in the area of 2%. This estimation is based on the assumption of a full pass through of the opportunity costs of freely allocated allowances and the cost of allowances to be acquired on the market, given an allowance price of €20. However, as Forsyth et al. (2007) and Forsyth and Gillen (2007) have shown, the pass through of any additional costs incurred by airlines through environmental instruments onto passengers is highly dependent on the prevailing market conditions. For instance, in case of a highly competitive market, all costs are likely to be passed through to passengers, while in situations of oligopolistic competition or monopolies, the pass through can be considerably smaller. In cases of constrained airport capacity with no competition from alternative airports, no pass through at all is likely to occur, as any additional costs would be borne by airlines in the form of reduced slot rents. Given that airlines apply a multitude of revenue management concepts oriented at the willingness to pay of travellers and their price elasticities, it is very likely, that the pass through strategies will be manifold.

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