Is the Sky Falling for Airline Profits in the European Union?

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blue skies proj

K PHOTO

Is the Sky Falling forAirline Profits in the

European Union?The Consequences or Airlines rom the Inclusion

o Aviation in the EU Emissions Trading System

By Samuel Grausz and Nigel Purvis with Rebecca Leton

ebruary 2012



ii Blue Skies Project | Is the Sky Falling for Airline Profits in theEuropean Union?

About the Blue Skies project

Te Blue Skies projec is a collaboraive research iniiaive ha works o help make

aviaion sae, aordable, secure, and clean. Te projec provides in deph legal,

poliical, and economic research on issues ha vially aec he aviaion secor.

Trough his research and oureach o key sakeholders, he projec seeks o buildconsensus and posiive collaboraion.

Our rs repor, a collaboraion beween Climae Advisers and he Cener or

American Progress, seeks o creae common undersanding o he economic con-

sequences o one o he mos conroversial aviaion emissions policies currenly

under consideraion, he inclusion o aviaion in he European Union Emissions

rading Sysem. Tis repor is analyical and does no atemp o advocae or a

specic policy or se o policies.

For more inormaion on he Blue Skies projec or his repor, please conac SamuelGrausz o Climae Advisers by phone a (206-851-6156) or by email a grausz@

climaeadvisers.com, and Rebecca Leon o he Cener or American Progress by

phone a (202-478-5323) or by email a [email protected].



iii Blue Skies Project | Report Title

Is the Sky Falling for

Airline Profits in the

European Union?

The Consequences or Airlines rom theInclusion o Aviation in the E.U. Emissions

Trading System

By Samuel Grausz and Nigel Purvis with Rebecca Leton

February 2012



Contents 1 Introduction and summary

5 EU aviation policy context

8 Research approach

10 Overall impacts

10 The right and wrong way to measure impacts

11 Out-of-pocket costs

12 Emissions costs and changes in ticket prices

13 Changes in demand

14 Changes in profits

18 Subgroup results

18 Measuring subgroup impacts

20 Airline nationalities

21 Airline types

22 Flight types

24 Further research needed

27 Appendixes

36 About the authors and acknowledgements

37 Endnotes



1 Blue Skies Project | Report Title

Introductionand summary

The European Union’s decision to include the aviation sector

in its Emissions Trading System as o January 1, 2012,

sparked considerable ire across the world. The new policy, an

expansion o the European Union’s existing greenhouse gas cap-

and-trade system, seeks to reduce greenhouse gas emissions

rom one o the astest-growing sources o emissions—the

aviation industry. The new policy will require airlines to obtain

permits or each ton o greenhouse gas emissions produced by

all o their ights departing rom or arriving in the European

Union and other participating states.



2 Blue Skies Project | Is the Sky Falling for Airline Profits in theEuropean Union?

Mos conroversially, he policy includes all airlines—no jus EU airlines—and all

emissions over he enire igh pah, including ouside EU airspace. Airlines based

inside and ouside o he European Union, as well as some counries where hese

non-EU airlines are based, allege ha he policy is illegal and will resul in subsanial

increases in coss and icke prices, resuling in a decline in demand or air ravel. Te

European Union couners ha he policy is well wihin is righs and will have mini-mal adverse impacs on he aviaion secor.

Scholars around he world have atemped o weigh in on hese quesions, bu unil

now no consensus has emerged among he expers. Tis repor atemps o clariy he

economic impacs o he European Union’s acions by synhesizing and summarizing

available economic sudies. Alogeher, we looked a 37 sudies o produce his repor.

Our review shows ha he exising lieraure makes he ollowing ndings:

• In he near erm, he EU aviaion policy will increase airline pros because

carriers are likely o be overcompensaed by aspecs o he policy designed oreduce he cos or airlines o complying wih he new rules.

• EU airlines will pro more han non-EU airlines because EU airlines have

more ighs covered by he new policy, even hough he policy isel is no

overly proecionis.

• radiional so-called “nework” airlines—hose ha use a radiional hub-and-

spoke sysem or scheduling ighs—will receive a larger increase in pros

han low-cos airlines ha operae mosly wihin he European Union because

nework airlines have more operaions covered by he policy and because he

demand or nework airline ighs is less responsive o changes in price.

• Some airlines may coninue o oppose he EU aviaion policy or oher reasons,

enumeraed oward he end o his repor.

Te ndings presened here necessarily rely mos heavily on a limied number o

sudies (16 o he 37 papers reviewed) ha model policies similar o he acual EU

emissions policy being implemened and ha provide sufcienly deailed resuls

wih respec o pros and oher key merics. In he ineres o improving cerainy abou he consequences o his policy, he repor describes how uure sudies

could provide more clear and useul resuls.




Glossary o terms

European Union Emissions Trading System, or EU ETS.

The greenhouse gas cap-and-trade program established

by the European Union in 2005 that covers emissions

rom electricity generation, industry, and aviation.For more inormation, see http://ec.europa.eu/clima/

policies/ets/index_en.htm.

Clean Development Mechanism, or CDM. A system

initiated by the Kyoto Protocol whereby countries

identied as Annex I—generally developed countries—

can invest in emissions reduction projects in countries

identied as non-Annex I—generally developing

countries—countries and receive Certied Emissions

Reduction, or CER, credits or use in international oset

markets. The European Union Emissions Trading System

accepts CER credits. For more inormation, see http://

cdm.unccc.int/.

Cap-and-trade program. An emissions control policy

under which a regulator species an upper limit on

emissions by covered entities (the “cap”) but allows cov-

ered entities to trade permits (“allowances”) that entitle

those entities to emit. The market or the allowances

generates a price or emissions comparable to a tax on

emissions. For more inormation, see http://www.epa.

gov/captrade/.

Greenhouse gases, or GHG. A set o gases that, when

emitted, cause additional heat to be trapped by the

Earth’s atmosphere, raising the surace temperature o

the Earth. The most common is carbon dioxide, or CO2.

Others include methane, or CH4, and nitrous oxide, or

N2O. For more inormation, see http://epa.gov/climat-echange/emissions/index.html.

Allowances. The permits traded by covered entities un-

der a cap-and-trade program that entitle those entities to

emit a certain quantity o emissions. In the case o the Eu-

ropean Union Emissions Trading System, one allowance

entitles an entity to emit greenhouse gases equivalent inglobal warming impact to one metric ton o CO2.

Free allocation. The allowances given or ree by the

regulator to covered entities under a cap-and-trade

program. In the case o the European Union Emissions

Trading System, ree allocation is given out based on

historical fight volume.

Network airlines. Airlines that use a traditional hub-

and-spoke system or scheduling fights. These airlines

tend to be older and larger than low-cost airlines.

Low-cost airlines. Airlines that oer fights at lower

prices by ollowing a generally recognized business

model that may include a single passenger class o

service, standardized aircrat utilization, limited in-fight

services, use o smaller and less expensive airports, and

lower employee wages and benets.

Soot. A general term that reers to a black, carbona-

ceous substance resulting rom the incomplete combus-

tion o coal, wood, oil, or other hydrocarbons.

NOx. A general term that reers to the mono-nitrogen

oxides NO and NO2, which are produced by the reaction

o nitrogen and oxygen gases in the air during combus-

tion. Not to be conused with N2O.

SOx. A general term that reers to various mono-sulur ox-ides, which are produced by the reaction o sulur in coal

and petroleum and oxygen in the air during combustion.

http://ec.europa.eu/clima/policies/ets/index_en.htm


http://cdm.unfccc.int/


http://www.epa.gov/captrade/


http://epa.gov/climatechange/emissions/index.html













Black carbon. A general name or a set o specic com-

ponents o soot with climate orcing attributes.

Allowance auctions. The regular sales o allowances

by the regulator o a cap-and-trade program. Underthe European Union Emissions Trading System, the

European Union auctions 15 percent o allowances to

the aviation sector, with the other 85 percent given out

or ree to the airlines.

Out-o-pocket costs. A general term that, in the context

o this paper, reers to the costs aced by the airlines. It

is calculated as the emissions cost minus value o ree

allocation. Out-o-pocket costs do not take into account

the changes in revenues and costs that result rom the

policy and thus are not a good measure o the policy’s

economic impact on the airlines.

Emissions costs. A general term that, in the context

o this paper, reers to the costs o all emissions rom

the airlines not taking into account the ree allocation.

When the ree allocation is granted based on historical

metrics, economic theory predicts that airlines will seek

to pass through the ull emissions cost.

Pass through. An economic term that reers to the abil-

ity o an entity that aces an increase in costs to deray

the increase in costs by increasing prices. In the aviation

context this reers to the rates at which airlines are able

to pass through the cost o emissions into ticket prices.This is most easily calculated as the ratio o the change

in ticket prices to the costs per ticket that the airlines are

attempting to pass through.

Air Passenger Duty, or APD, and Air Passenger Tax, or

APT. A type o policy that places a tax on each passen-

ger on a qualied fight leaving a given country. These

policies exist in many countries. Particularly prominent

examples o such policies include the United Kingdom’s

APD and Germany’s APT.

Elasticity. An economic term that reers to the percent

change in one metric resulting rom a percent change in

another metric. In the context o cap-and-trade policies,

two elasticities are particularly important. The price

elasticity o supply reers to the percent change in quan-

tity supplied resulting rom a percent change in price.

The price elasticity o demand reers to the percent

change in quantity demanded resulting rom a percent

change in price. These two metrics—along with various

other metrics described in the main report—jointly

determine the pass-through rate in the aviation context.




EU aviationpolicy context

The European Union decided to include the aviation industry

within its Emissions Trading System because it is one o the

astest-growing sources o greenhouse gas emissions, currently

representing 3 percent o global CO2 emissions,1 and potentially

increasing by 290 percent to 667 percent by 2050.2 Airplanes

also emit water vapor, soot, NOx, SOx, and black carbon. (See

Glossary on page 3 or precise denitions o the terms used in

this report.) Airplanes emit all o these greenhouse gases directly

into the upper atmosphere, potentially doubling the overall

climate impact o aviation emissions.3




Furher, inernaional aviaion emissions are specically excluded rom he Kyoo

Proocol, which direcs governmens o work hrough he Inernaional Civil

Aviaion Organizaion, or ICAO, o develop a global mechanism o reduce avia-

ion emissions. Te European Union decided o move ahead o he ongoing ICAO

process as i el ha process was proceeding oo slowly.

Te EU aviaion policy isel is as ollows: Saring in 2012 airlines will be required o

obain permis, also known as “allowances,” or each on o emissions produced by all

o heir ighs deparing rom or arriving in he European Union and oher parici-

paing saes.4 Te allowances are no like radiional air polluion permis, speciy-

ing complicaed limiaions and exac acions ha he polluing eniy mus ollow.

Insead hey are more like a orm o currency, eniling he eniy o emi one meric

on o CO2. Mos conroversially he policy includes all airlines, no jus EU airlines,

and all emissions hroughou he enire igh pah, including ouside he EU airspace.

Covered airlines can acquire allowances hrough a number o sources. Te larg-es source will be he allowances issued o he airlines or ree by he European

Union, which will add up o 85 percen o all he allowances he European Union

will creae or airlines.5 Te ree allowances are divided beween airlines based on

each airline’s share o pas operaions.6 Airlines can also “borrow” allowances rom

uure years o mee obligaions in a given year.

Ouside o ree allowances airlines can purchase he allowances hrough ofcial

EU allowance aucions. Tese aucions will sell o he remaining 15 percen

o he allowances creaed by he European Union. Furher, airlines can buy he

allowances rom oher airlines or companies in oher secors covered by he EU

Emissions rading Sysem such as elecriciy generaors and many indusries in

he European Union. Tis is he “rade” par o “cap and rade.”

Finally, airlines can obain allowances by paricipaing in he Kyoo Proocol’s Clean

Developmen Mechanism, which allows regulaed eniies o obain allowances by

demonsraing hey have helped reduce emissions in developing counries. Once

hey acquire hese allowances, airlines can choose o use he allowances o mee heir

obligaions in he curren year or o hold he allowances o mee heir obligaions

in uure years, a pracice known as “banking” in cap-and-rade circles. Te policy reduces oal CO2 emissions by only issuing enough allowances o cover a porion o

airline emissions. Tis upper limi on oal emissions is known as he “cap.” Te cap




will immediaely orce airlines o eiher reduce emissions or buy addiional allow-

ances rom oher nonaviaion sources, orcing heir emissions o decrease. Tis limi

will only reduce more emissions over ime as he aviaion secor grows.7




Researchapproach

Even beore the European Union ocially proposed the

inclusion o aviation in the Emissions Trading System in

2005, reports were released estimating the economic impact o

the potential policy. In this study we summarize all these reports

without respect to their source and without delving extensively

into their assumptions or methodology.8




We reviewed a large number o sudies bu presen he resuls or only he sudies

ha esimae impacs on he overall airline secor or specic airline or igh sub-

groups.9 All he sudies reviewed, broken down by which are and which are no

included in he daa ables, are deailed in Appendix B on page 30. We excluded

resuls ha were developed prior o he nalizaion o he policy and do no model a

policy similar o he nal EU emissions policy. Major mehodological decisions arediscussed in Appendix D on page 34.

One major challenge we aced is ha sudies oen presen resuls in dissimilar

ways. As an example, a number o sudies esimae ou-o-pocke coss while oh-

ers esimae only ou-o-pocke coss per passenger. Wihou making hese coss

comparable, we would no have been able o include he resuls o all o he sudies

wihin a single range.

Forunaely he Inernaional Air ranspor Associaion, or IAA, did a 2007

sudy on he issue, Financial Impacs o Exending he EU ES o Airlines, whichprovides esimaes using a wide variey o merics. (In his repor we will use

parenheical ciaions or he 37 sudies we examine. Tey are all lised in ull in

Appendix A o his repor on page 27.) As such, we oen used IAA (2007) o

exrapolae he resuls o oher sudies ino oher merics, such as ranslaing coss

ino cos per passenger. All he numbers ha were exrapolaed are idenied in

he Appendix C ables on page 31.

In presening he resuls we look rs a impacs on all ighs covered by he policy

and second a specic subgroups, such as EU versus non-EU airlines and low-cos

versus radiional nework carriers. Wihin each o hese groups, we ocus on ve

key merics:

• Cos• icke prices• Demand• Pros• Compeiiveness

In he main repor, we presen he range o available esimaes. Te resuls or eachsudy included in he range are presened in Appendix C.




Overall impacts

The right and wrong way to measure impacts

Many studies measure the impacts o the EU aviation policy

by estimating out-o-pocket costs or airlines. They calculate

these costs as the emissions costs (emissions multiplied by the

emissions price) minus the value o the ree allowances provided

to the airlines. This is the wrong way to measure the impact

on airlines as airlines pass through much o the emissions cost

to consumers in the orm o higher ticket prices, generating a

reduction in demand that afects both costs and revenues.




Te correc way o measure impacs is o calculae he eec o he EU policy on

airline pros. Tis calculaion requires a a minimum deermining he emis-

sions cos, how much o ha cos is passed hrough o consumers, how demand

will respond o he increase in icke prices, and wha eecs hese changes have

on revenues and coss. Only hree sudies we reviewed made his calculaion or

all covered airlines (IAA, 2007; Boon e al., 2007; Erns & Young, 2007).

In he end he change in pro in broad erms is equal o he sum o he emissions cos,

he increase in revenue rom he increase in icke prices, he decrease in revenues and

coss rom he decrease in demand, and he value o he ree allocaion. 10 Exising sud-

ies ulimaely nd ha he emissions cos, revenue rom increased icke prices, and

revenues and coss rom he decrease in demand approximaely cancel each oher ou,

and he value o he ree allocaion resuls in he EU policy generaing posiive pros.

Out-of-pocket costs

We sar by considering he esimaes o ou-o-pocke coss as ha is wha mos

sudies esimae. Exising sudies predic ha he EU policy will no resul in very

signican ou-o-pocke coss. Te sudies ound ha ou-o-pocke coss would be

beween $316 million and $8 billion per year or beween $0.70 and $17.90 per pas-

senger. Tis is a very wide specrum bu mos o he esimaes are closer o he lower

end—wih all bu our o he sudies esimaing coss below $4 billion per year.

Tese coss are modes compared o exising operaing coss. Te cos o EU avia-

ion policy ranslaes ino roughly 0.2 percen o 4.4 percen o orecased oal

annual coss in 2012 or ighs covered by he policy.11 Furher, he ou-o-pocke

coss rom he new policy are small relaive o oher variable cos changes recenly

aced by he airline indusry, especially uel cos. According o he Inernaional

Air ranspor Associaion, prices or je kerosene grew o $126.70 per barrel rom

$29.10 per barrel rom 2002 o 2008, largely causing uel cos or airlines covered by

he policy o increase o $38.5 billion rom $8.8 billion.12 Tis $29.7 billion increase

in uel coss dwars he increase in coss projeced o be caused by he EU policy.

Compared o oher regulaory burdens, he ou-o-pocke coss are also small. According o one sudy he new policy will cos approximaely 1.4 percen o he

annual cos o he U.K.’s Air Passenger Duy and 5 percen o he German Airline

Passenger ax (Bloomberg, 2011).




As hese comparisons show, he ou-o-pocke coss are no large relaive o oher

coss. Tis comparison is helpul because i indicaes ha he relaive eec o

he EU aviaion policy will no be large compared o oher policies ha have and

coninue o impose coss on he indusry. Tis comparison does no, however,

compleely measure he impacs o he EU aviaion policy, as i does no consider

he eecs o he policy on icke prices, demand, and, ulimaely, pros.

Emissions costs and changes in ticket prices

Te rs sep in deermining he eec on pros is o calculae emissions coss.

Te dierence beween ou-o-pocke coss and emissions coss is, by deniion,

he oal value o all allowances. Te European Union plans o creae 212 million

allowances in 2012 and 208 million allowances every year hereaer or aviaion.13

Tis ranslaes, a emissions price o $15 and $33 per meric on CO2 (he prices

assumed by IAA 2007) ino $2.7 o $5.8 billion dollars or all airlines.

Only wo sudies (IAA, 2007; SEC, 2006) esimae he emissions coss explic-

ily. Tey calculae ull coss as beween $1.1 billion and $11.8 billion or beween

$2.40 and $25 per passenger.14 Exrapolaing rom IAA (2007), he emissions

cos implied by he range o ou-o-pocke coss rom all sudies described above

is beween $1.1 billion and $25.6 billion or beween $2.40 o $63 per passenger.15

As exising sudies ound ha emissions coss are no relaively large, and as

airlines can only pass hrough a porion o emissions coss, exising sudies

unsurprisingly ound relaively small changes in icke prices. Te sudies reviewed

esimaed changes in icke prices o beween $0.50 and $39.16 Tis ranslaes

ino a percen change in price o beween 0.1 percen and 6.5 percen. Assuming

ha airlines will pass hrough he coss o he EU aviaion policy coss in he

same way hey have passed hrough he oher similar axes and uel price changes,

he changes in icke prices resuling rom he inclusion o aviaion in he EU

Emissions rading Sysem will pale in comparison o he oher governmen axes

on aviaion (such as he Unied Kingdom’s Air Passenger Duy and Germany’s

Airline Passenger ax) and he decade-long increase in uel prices.

Leaving aside he eec o he changes in icke prices on demand, which we

will discuss in he nex secion, he increase in icke prices drives a subsanial

increase in revenues. Unorunaely only one sudy (IAA, 2007) explicily esi-




maes he change in revenue resuling rom he change in icke price. Tis sudy

nds ha an increase in average icke prices o beween $8.90 and $19.00—near

he mean o esimaes by oher sudies—causes an increase in revenue o beween

$4.2 billion and $8.9 billion. Exrapolaing rom his sudy and he changes in

icke prices esimaed by oher sudies shows ha he $0.53 o $39 increase in

icke prices ound or all sudies resuls in an increase in revenue o beween $248million and $18 billion.

Te icke price changes described above require some explanaion. Firs, no all

sudies ha esimae emissions coss also calculae changes in icke prices and

vice versa. As a resul he range o emissions coss is no direcly comparable o

he range o icke price changes. Looking only a he wo sudies ha esimae

boh emissions coss and changes in icke prices, he range or emissions coss is

beween $2.40 and $25.30 per passenger, and he range in changes in icke prices

is beween $2.40 and $19.

Second, dieren sudies assume very dieren raes a which airlines will pass

hrough coss o consumers. Te sudy by Erns & Young (2007) assumes a pass-

hrough rae o 29 percen o 35 percen, depending on he ype o airline and he

year, while IAA (2007) assumes a pass-hrough rae o 75 percen, and Boon e

al. (2007) assumes a pass-hrough rae o 100 percen.

Te exen o which airlines pass hrough o consumers heir emissions coss depend

on a number o acors on boh he supply and demand side.17 Mos sudies consider

a subse o hese issues when deermining pass-hrough raes. A mos hey discuss

wo key parameers: he elasiciies o demand and supply. Tese reer o he aggre-

gae willingness o consumers o coninue o purchase ickes despie acing higher

coss and he willingness o airlines o oer ighs a lower prices. Our sudy does

no atemp o delve ino hese elasiciies or he resuling pass-hrough raes.

Changes in demand

Te changes in icke prices in urn could drive a reducion in demand or airline

ickes. Te poenial reducion in demand is deermined by he size o he change inicke prices and he elasiciy o demand or airline ravel, wih a more elasic demand

causing a larger decrease in icke prices. As exising sudies ound small changes in

icke prices, i is unsurprising ha hey also showed small changes in demand. Only




hree sudies ou o he 37 reviewed esimaed oal change in demand. Tose sudies

ound demand reducions o beween 180,000 and 18.1 million ickes, which rans-

lae ino a reducion in demand o beween 0.04 percen and 3.9 percen.

Tese reducions in demand drive decreases in boh revenues and coss. Revenues

decrease because ewer passengers buy ickes, and coss decrease because airlineshave o pay or uel and services or ewer passengers. Only one sudy (IAA,

2007) explicily esimaes hese changes in revenues and coss. Tey nd ha a

reducion in demand o beween 1.8 percen and 3.9 percen resuls in reducions

in revenues o beween $4.4 billion and $9.5 billion, and reducions in coss o

$2.5 billion o $5.3 billion.

Exrapolaing hese resuls o he oher wo sudies ha esimae changes in

demand implies ha he reducion in demand or all sudies o beween 0.04

percen and 3.9 percen resuls in reducions in revenues o $93 million o $9.5

billion, and reducions in coss o $52 million o $5.3 billion. Noe ha hesereducions in revenue and coss should no be consrued as he ull changes in rev-

enues and coss caused by he policy as hey do no include he emissions coss,

he revenues rom increased icke prices, and he value o allowances.

As wih changes in icke prices, no every sudy ha esimaes changes in icke

prices also esimaes changes in demand and vice versa. Only one sudy (IAA,

2007) esimaes changes in boh merics. Tis sudy nds changes in icke prices

o beween $8.90 and $19 or beween 1.5 percen and 3.2 percen, and reducions

in demand o beween 8.5 million and 18.1 million ickes or beween 1.8 percen

and 3.9 percen.

Changes in profits

Te change in pros—he nal meric ha heoreically is he mos imporan

or airlines—is he sum o he emissions coss, he value o ree allowances, he

increase in revenue rom he increase in icke prices, and he decrease in revenue

and coss rom reduced demand. Only hree sudies (Boon e al., 2007; Erns &

Young, 2007; IAA, 2007) esimae a nal change in pros or all aeced air-lines, and none o hose sudies model he exac nal EU policy, as hey all assume

ha he European Union will aucion a dieren share o allowances han he nal

policy requires.

In the near-term,

the EU aviation

policy will increa

airline prots

because carries

are likely to beovercompensate

by aspects o the

policy designed

to reduce the co

o complying wit

the new rules orairlines.




O hese hree sudies IAA (2007) models a version o he policy closes o he

acual nal EU policy.18 IAA (2007) also assumes a pass-hrough rae ha alls

beween he more exreme assumpions o Boon e al. (2007) and Erns & Young

(2007), as described above, hough his is no a primary concern o his sudy as

we do no ocus on he validiy o modeling assumpions.19 As such we look pri-

marily a he resuls o IAA (2007), hough reer o Boon e al., Erns & Young,and oher sudies o check he IAA (2007) resuls.

IAA (2007) nds ha pros or covered ighs will increase by beween $590

million and $1.4 billion, which represens a 31 percen o 76 percen increase

in oal pros or covered ighs. Te posiive change in pros resuls because

he ne negaive change in pro resuling rom he compliance coss, increase in

icke prices, and reducion in demand is more han ose by he value o he ree

allocaion. Specically, IAA (2007) nds ha he ne negaive change in pros

will be $2.5 o $5.4 billion and he value o he ree allocaion will be $2.9 o $6.5

billion dollars, depending on he allowance price.

Writen in a dieren way, his increase in pros represens an increase in he

overall pro margin o covered airlines o beween 0.2 percen and 0.5 percen.20

Tis is a subsanial increase in pros, especially given he highly compeiive air-

line indusry. Te ranges o pros or IAA (2007) are shown in able 1 on page

16, and he resuls or all o he sudies are provided in Appendix C.

As IAA (2007) assumes oo much ree allocaion, his pro change esimae is likely

an overesimae o he acual pro change increases. A back-o-he envelope calcula-

ion using he daa provided by IAA (2007), however, indicaes ha heir modeling

would nd pro changes under he acual nal allocaion scheme o beween $380

and $570 million. Tis ranslaes ino beween a 20 percen and 30 percen increase

in pros and an increase in margins o 0.13 percen and 0.20 percen.

wo addiional sudies also provide resuls ha sugges ha he nal pro

changes or all airlines will be posiive. Vivid Economics (2008) esimaes changes

in pros wihou ree allocaion or a number o dieren ighs. Tey nd ha

airlines are likely o lose pros equal o beween 20 percen and 40 percen o

emissions coss beore ree allocaion. As airlines are likely o receive ree alloca-ion equal o much more han 20 percen o 40 percen o heir emissions cos,

namely 65 percen o emissions coss according o Bloomberg (2011), he Vivid

Economics analysis implies ha airlines may make signican posiive pros.




More clearly, Malina e al. (MI, 2012) model he acual EU policy and esimae he

change in pros or U.S. airlines only. Tey nd ha U.S. airlines will gain $116 mil-

lion in pros per year, which ranslaes ino an increase in overall pro margins o

0.15 percen. Tis resul, hough no covering non-U.S. airlines, suggess ha a leas

airlines ying exra-EU roues will likely gain pros as a resul o he EU policy.

Te naure o hese addiional pros deserves explanaion. Firs, hese addiional

pros are no a one-ime ranser. Te European Union grans ree allowances o

airlines every year unil hey revise he law. As such, he increase in pro margins

will persis year aer year as long as he ree allocaion is graned. Second, i as

he years go on, airlines coninue o grow aser han hey can improve he energy

efciency o heir airplanes, hen hey will need o buy more and more allowances

rom oher secors in he EU’s Emissions rading Sysem and oher eligible iner-

naional emissions and ose markes. As a resul he airlines will have o pay more

or allowances relaive o heir allocaion o ree allowances, increasing coss and

reducing pros. Tus, i growh oupaces efciency, airlines could a some poinin he uure, depending o course on he uure price o allowances and credis in

inernaional carbon markes, begin o lose money as a resul o he EU policy.

TABLE 1

Overall impacts o EU aviation policy on airlines

Category Units Range

Out-o-pocket-costs

Total Million USD $316 to $8,352

Per passenger USD $0.68 to $17.89

Emissions costs

Total Million USD $1,118 to $29,590

Per passenger USD $2.39 to $63.36

Change in ticket prices

Total USD $0.53 to $38.54

Percent change Percent 0.09 to 6.50

Change in demand

Total Million tickets -0.18 to -18.10

Percent change Percent -0.04 to -3.90

Change in costs

Out-o pocket Million USD $316 to $8,352

Eect o change in demand Million USD -$52 to -$5,305




Change in revenues

Eect o change in ticket price Million USD $248 to $17,995

Eect o change in demand Million USD -$93 to -$9,506

Change in profts Million USD $591 to $1,447

Note:Out-o-pocket costs are the dierence between emissions costs and the value o allowances.

Source: Various studies. See above text and Appendix C on page 30 or more details.




Subgroupresults

Measuring subgroup impacts

Existing studies o the EU aviation policy nd that the overall

impacts o the policy on airline prots will be positive and

signicant relative to current prots. This is a positive sign or

airlines. Not all airlines will gain the same amount rom the

policy, however, which raises concerns about competitiveness.




Beore diving ino a discussion o subgroups and eecs on compeiiveness, i is

imporan o describe exacly wha we mean by compeiiveness and in wha sense

i maters o airlines. A good working deniion o he eecs o a policy on com-

peiiveness could be he exen o which i helps or hurs one airline more han

anoher. In general each airline seeks o maximize is own pros, so compeiive-

ness really reers o he relaive eec o he policy on each airline’s pros.

Tere are wo primary pro impacs ha are likely o dier beween airlines. Firs,

airlines receive dieren amouns o ree allocaion depending on heir hisorical

emissions. I an airline receives relaively more allocaion han anoher, he airline

can be said o gain a compeiive advanage. Tis ype o compeiive advanage,

however, does no necessarily resul in he advanaged airlines aking any marke

share rom he disadvanaged airline.

Second, he changes in icke prices caused by he program have a complex eec

on coss, revenues, and pros. As described in deail in he previous secion, heprice on carbon will raise icke prices, causing consumers o buy ewer airline

ickes. Te exen o which each airline increases is prices and each passenger

reduces or shis is demand depends on a number o acors, which inerac in

complex ways. Te acors include he efciency o he airline’s curren ees,

he abiliy o he airlines o reduce emissions cheaply, he compeiiveness o he

markes he airlines operae in, he characerisics o he passengers wihin each

marke, and he responsiveness o he passengers wihin each marke o changes in

icke price.21

None o he sudies we examined provided resuls a a level o deail o deermine

he causes o dieren changes in pros. Very ew o he sudies, in ac, even cal-

culaed changes in pros or subgroups. Careully dening compeiiveness and

he mechanisms or dierences in los pros will help by enabling us o heorize

why sudies ound dieren changes in pros or dieren subgroups and o draw

some conclusions rom he available resuls.

As we show in he nex secion, we expec EU airlines as a whole o gain signi-

canly more pros han non-EU airlines as a resul o he policy. Tis is largely

because EU airlines have hisorically had a larger volume o operaions covered by he policy, no because he EU policy is inherenly discriminaory. In ac he EU

aviaion policy reas all airlines equally by requiring each airline, regardless o is




naional origin, o urn in one allowance or every on o carbon emissions and by

providing he same amoun o ree allocaion or each on o hisorical emissions.

Wihin EU airlines, he sudies expec nework airlines o ouperorm low-cos

airlines, wih low-cos airlines poenially losing pros. Tis is likely because ne-

work airlines have more o heir operaions in ighs in and ou o he EuropeanUnion—so called exra-EU ighs—and less in inra-EU ighs han do low-cos

airlines. In he uure, his divergence o impacs likely will cause airlines, espe-

cially low-cos airlines, o swich more o heir ighs o exra-EU roues, hough

he available daa do no indicae he size o his shi.

Airline nationalities

Te highly conroversial naure o he new policy and he elevaion o he debae on

is efcacy o he level o naional governmens and inernaional regulaory bodiesmake he relaive eec o he EU aviaion policy on airlines o dieren naionali-

ies paricularly imporan. Only one sudy (Boon e al., 2007) calculaed changes

in pros or airlines o dieren naionaliies.22 As noed above, Boon e al. (2007)

assumes ha he EU policy grans more ree allocaion han he nal policy allows,

causing Boon e al. (2007) o overesimae posiive pro changes. Even wih his

inconsisency, however, he Boon e al. (2007) resuls sill provide useul indicaions

o he relevan impacs o he EU policy on airlines o dieren naionaliies.

Boon e al. (2007) ound ha EU airlines would gain up o $9.2 billion in annual

pros while non-EU airlines will gain up o $5.5 billion annually. Rephrased in

erms o pro margins, he EU policy will cause he pro margins o EU air-

lines o increase by up o 2.3 percen and he pro margins o non-EU airlines o

increase by up o 0.6 percen.23

In ligh o he general conclusion ha airlines aeced by he new policy will

gain signican pros, hese resuls make sense. EU airlines conrol more o he

European aviaion marke and will have more o heir operaions covered by he

EU policy, meaning ha hey will receive more ree allocaion and hus gain more

pros and larger increases in heir pro margins. Boon e al. (2007) does noprovide enough addiional daa o say wheher his larger increase in pros is also

he resul o EU airlines paying ewer coss due o a more efcien ee or losing

less demand as a resul o having more exible coss.

EU airlines will p

more than non-E

airlines because

airlines have mo

fights covered b

the new policy, e

though the policy

itsel is not overtl

protectionist.




wo oher sudies (Schaeer e al., 2010; IAA, 2007) nd ha EU airlines will

ace signicanly more ou-o-pocke coss han non-EU airlines. As discussed in

he secion on overall resuls, he relaive ou-o-pocke coss say very litle abou

he relaive eec on pros. Te resuls rom all o hese sudies are shown in

able 2 as well as he ables in Appendix B.

As discussed above, hese resuls do no necessarily imply ha he EU aviaion policy

is discriminaory. Te policy reas all airlines he same by requiring each airline o

urn in one allowance or each meric on o emissions and by providing he same ree

allocaion or each on o hisorical emissions. Te remaining dierences in eecs on

pros are he resul o economic acors beyond he conrol o he policymakers.

TABLE 2

Policy impacts by airline nationality

Category Units EU airlines US airlines Non-EU airlines

Out-o-pocket costs

Total

Schaeer et al 2010 Million USD $1,270 to $2,032 $258 to $413

IATA 2007 Million USD $1,095 to $2,124 $172 to $334 $322 to $625

Change in profts

Total

Boon et al (Delt) 2007 Million USD NA to $9,216 NA to $5,532

Malina et al (MIT ) 2012 Million USD $116

Margin

Boon et al (Delt) 2007 Percent NA to 2.30 NA to 0.60

Malina et al (MIT) 2012 Percent 0.15

Airline types

Te airlines hemselves are probably mos concerned abou he relaive eecs o he

EU aviaion policy on hem and heir compeiors. Alhough radiional nework

airlines compee regularly agains each oher, hey also increasingly compee agains

low-cos airlines or shor- and medium-disance ighs. Tis compeiion is par-icularly erce in Europe, wih he rise o low-cos airlines such as RyanAir, easyJe,

and many ohers. Faced wih his increased compeiion, boh nework and low-cos

airlines are likely very concerned wih he relaive eecs o he EU aviaion policy.




Only one sudy (Erns & Young, 2007) esimaes he pro impacs o he EU avi-

aion policy on dieren airline ypes. As noed beore, his sudy does no model

he acual EU policy bu a version wih signicanly more o he allowances auc-

ioned raher han given away or ree. Due o his addiional aucioning, airlines

lose raher han gain pros in heir modeling. Despie his, he relaive eecs

shown in he Erns & Young (2007) modeling provides some useul inormaion.

Te repor nds ha nework airlines will lose signicanly more pros han low-

cos or cargo airlines. Tey calculae ha nework airlines will lose beween $580

million and $2.6 billion while low-cos airlines will lose beween $144 million and

$565 million.24 Tis is likely largely because nework airlines have a much higher

igh volume covered by he EU aviaion policy han low-cos or cargo airlines.

Te higher igh volume is shown by he resuls o wo oher sudies (Schaeer

e al., 2010; IAA, 2007), boh o which ound ha nework airlines ace much

higher ou-o-pocke coss han low-cos or cargo airlines.

Te larger hisorical igh volume under he EU aviaion policy migh indicae

ha, under a modeling o he acual EU policy, nework airlines would acually

gain more pros han low-cos airlines. Lacking addiional modeling, however,

his resul is enaive a bes. Moreover, he nex secion on igh ypes poenially

provides a clearer answer o his quesion.

Flight types

Anoher way o viewing he relaive impacs on airlines o dieren naionaliies

and ypes is by he relaive impac o he policy on dieren ypes o ighs, spe-

cically inra-EU and exra-EU ighs. EU airlines are involved in boh he inra-

EU and exra-EU markes. Non-EU airlines likely do no have much o a presence

in he inra-EU marke. Similarly, nework airlines have sakes in boh he exra-

EU and inra-EU markes, while low-cos airlines depend on he inra-EU marke.

Tus i he policy creaes more pros or exra-EU ighs han inra-EU ighs,

hen i will bene boh EU and non-EU airlines. I will also bene nework air-

lines o a greaer exen han low-cos airlines.

One sudy (IAA, 2007) nds ha airlines will lose pros on inra-EU ighs bu

gain pros on exra-EU ighs. Tis repor calculaes ha in oal, inra-EU ighs

will lose beween $70 million and $150 million per year while exra-EU ighs will




gain beween $660 million and $1.6 billion per year. In erms o pro margins,

inra-EU ighs will lose approximaely 0.1 percen o pro margin while exra-

EU ighs will gain 0.4 percen o 0.9 percen o pro margin.

Tese resuls generally make sense. Exra-EU ighs creae more emissions and

hus airlines will receive more allowances or having underaken hem in he pas.Passengers on exra-EU ighs also have ewer alernaive opions o ying han

hose on inra-EU ighs, meaning heir demand will be less elasic and airlines

will be able o pass hrough more o he cos and lose less o heir sales. Inra-EU

ighs, in conras, will draw ewer allowances, and heir passengers have more

alernaives o ying. As such, he airlines making hese ighs will gain less ree

allocaion, pass hrough less cos, and lose more sales.

Te IAA (2007) repor does no address he relaive ee efciency o low-cos

versus nework airlines. Commenaors requenly poin ou ha low-cos airlines

have a newer, more efcien ee o planes. I his is rue, hen low-cos airlines will incur ewer coss han nework airlines, increasing he pros o low-cos

airlines relaive o nework airlines. Tis migh explain he coninuing suppor o

he low-cos airlines or he EU aviaion policy. Lacking daa, however, we canno

conrm his heory.

Based on he IAA (2007) resuls, we would expec boh EU and non-EU ne-

work airlines o gain signican pros. We would also expec EU low-cos airlines

o gain signicanly ewer pros and poenially lose pros. Based on he above

daa, we canno esimae he size o he dispariy in pros. Tese resuls are par-

icularly ineresing in ligh o he ongoing suppor o he low-cos airlines or he

EU aviaion policy.

Much o he divergence in pros rom hese ighs likely depends on he rela-

ive amouns o ree allowances each o hese ighs provides o he operaing

airlines. Tese ree allowances are allocaed based on hisorical emissions, which

means ha hey will have no impac on he ongoing relaive proabiliy o inra-

and exra-EU ighs. Consumers o inra-EU ighs have more elasic demand,

and hus airlines canno pass hrough as much o he carbon cos o hese ighs,

meaning heir proabiliy relaive o exra-EU ighs will all. Tus airlines, espe-cially low-cos airlines, may swich o more exra-EU ighs in he uure.

Existing studies show airly clearly that EU aviation policy will




Comparison toairline views

Existing studies show airly clearly that EU aviation policy will

increase prots or many—i not all—airlines. These nd-

ings do not comport well with the strong, continuing opposition

o some airlines to the policy. Why would the airlines oppose a

policy that most studies expect will increase their prots?




Tere are a number o possible explanaions. Te airlines showing he sronges

opposiion, namely U.S. and oher non-EU nework carriers, migh oppose he

policy because hey are concerned ha heir compeiors, he EU nework airlines,

will gain a compeiive advanage. U.S. and non-EU nework airlines may also

oppose he EU policy because i migh open he door or uure, less accommo-

daing climae regulaion in heir own counries, creaing a risk o los pros.

Furher, airlines in general may be concerned ha he European Union will give less

ree allocaion in uure years, as he European Union has done or oher covered

secors under he EU Emissions rading Sysem. Airlines may also be worried ha

increasing emissions will evenually overwhelm he value o he ree allocaion,

decreasing pros in he long erm. Tey may urher be araid ha increasing icke

prices will in he long erm hreaen he growh o he aviaion indusry, wih avia-

ion demand being replaced by demand or less carbon-inensive ways o moving

people and goods such as rains and ships, or ways o avoiding air ravel such as

video conerencing.25 Te exising sudies do no evaluae hese poenial claims orprovide any inormaion suggesing wheher hey are reasonable or no.

Exising sudies could go urher in describing he basic impac o he EU aviaion

policy on pros. As explained above, only hree sudies we reviewed esimae pro

impacs or all airlines, and only one o hose sudies modeled a policy ha closely

maches he acual EU policy. Fuure sudies should cerainly esimae pros and

preerably would disaggregae hose esimaes o he level o individual airlines.

Addiional research also needs o be done o explicily answer more quesions

regarding compeiiveness. Cerain currenly available resuls, such as he pro

impacs or EU and non-EU airlines and nework and low-cos airlines, give some

indicaion abou he comparaive advanages conerred by hese policies. Tey

do no answer more specic quesions such how much he policy will enable EU

airlines o ake passengers rom U.S. airlines or nework airlines o ake passengers

rom low-cos airlines, or larger quesions such as wheher his policy will drive

cerain low-cos airlines ou o business. Tese quesions are very imporan rom

he perspecive o indusry and many governmens, and provide imporan inor-

maion or business, policy, and advocacy planning.

Fuure research also needs o delve ino he causes o he dierences in hese sud-

ies. As his paper explicily examines only he resuls o he sudies and no he

assumpions ha drive hose resuls, i is no a ull mea-analysis. Such an analysis




would also make clear oher sources o disagreemen beween he sudies, such as

assumpions abou price elasiciies and he reamen o hisorical allocaion o

emission allowances. Tis would allow uure scholars o more accuraely model

he impacs o he policy in he uure and more promply evaluae he resuls o

ohers. In suppor o his ype o analysis, uure sudies need o conron dier-

ences beween heir resuls and he resuls o oher sudies head on by discussinghe reasons or he dierences.




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Appendix B

Studies reviewed and included or not included in this report

Te ollowing secion liss all he sudies reviewed, broken down by hose

included and no included in he aggregae ables (in Appendix C). As menionedabove, sudies were reviewed bu no included or a number o reasons. Mos sud-

ies were excluded eiher because hey did no model he acual EU aviaion policy

or because hey did no provide resuls or eiher a subse o or he whole covered

aviaion secor.

Studies reviewed

Included Not included

1 Wit et al (Delt) 2005 1 Oxera 2003

2 SEC (European Commission) 2006 2 Cames et al 2004

3 Boon et al (Delt) 2007 3 Frontier Economics 2006

4 Ernst & Young 2007 4 ICF Consulting 2006

5 IATA 2007 5 Tol 2006

6 Anger et al 2008 6 Morrell 2007

7 Ernst & Young 2008 7 Scheelhaase and Grimme 2007

8 Knight et al (Merrill Lynch) 2008 8 Mayor and Tol 2007

9 Schaeer et al 2010 9 Vivid Economics 2007

10 Scheelhaase et al 2010 10 Mendes and Santos 2008

11 Bloomberg 2011 11 Vivid Economics 2008

12 Faber and Brinke (ICTSD) 2011 12 Macintosh and Wallace 2009

13 Heyman and Hartel (Deutsche Bank) 2011 13 Anger 2010

14 Vesperman and Wald 2011 14 Anger and Kohler 2010

15 OAG 2012 15 Malavolti and Jenvrin 2010

16 Malina et al (MIT) 2012 16 Mayor and Tol 2010

17 Morrell 2010

18 Abrell 2011

19 Dorbian et al 2011

20 Hihara 2011

21 Winchester et al 2011




Appendix C

Estimates in the reviewed studies

Te ollowing ables are broken ou by individual sudy. In each able, cells marked

wih grey boxes are exrapolaed rom he available resuls. All exrapolaions werecalculaed by muliplying he available meric (coss) by he average o he raio

beween he wo merics (coss and cos per passenger) rom IAA (2007)—he

only sudy ha consisenly provides resuls in muliple merics.

Estimates o costs by existing study

Out-o-pocket costs Emissions costs

Estimates Million USD USD per passenger Million USD USD per passenger

Bloomberg 2011 $1,779 to $8,352 $3.79 to $17.89 $5,625 to $26,561 $12.05 to $56.88

Heyman and Hartel (Deutsche Bank) 2011 $1,463 $3.13 $4,652 $9.96

OAG 2012 $1,314 $2.81 $4,655 $9.97

Schaeer et al 2010 $1,528 to $2,445 $3.27 to $5.24 $4,859 to $7,774 $10.41 to $16.65

EU airlines $1,270 to $2,032

Non-EU airlines $258 to $413

Network $1,329 to $2,126

Low cost $199 to $319

Scheelhaase et al 2010

EU airlines $6.13 to $6.78 $16.81 to $17.81

US airlines $1.44 to $3.01 $12.75 to $12.86

Vesperman and Wald 2011 $4,881 $10.45 $15,522 $33.24

Ernst & Young $4,072 to $6,650 $8.72 to $14.24 $12,948 to $21,147 $27.73 to $45.28

Knight et all (Merrill Lynch) 2008 $3,966 $8.49 $12,611 $27.00

Ernst & Young* $1,538 to $7,226 $3.29 to $15.47 $3,418 to $15,341 $7.32 to $32.85

IATA 2007 $1,619 to $3,224 $3.47 to $6.90 $5,528 to $11,832 $11.84 to $25.34

EU airlines $1,095 to $2,124

US airlines $172 to $334

Non-EU airlines $322 to $625

Network airlines $911 to $1,768

Low cost airlines $184 to $356




Intra-EU fights $288 to $574 $4.63 to $9.94

Extra-EU fights $930 to $1,849 $24.95 to $53.36

SEC (European Commission) 2006 $316 to $1,578 $0.68 to $3.38 $1,118 to $5,590 $2.39 to $11.97

* Not included in ranges in text due to its modeling o a policy signifcantly dierent rom the fnal policy. See Appendix B or more details.

Estimates o ticket price changes by existing study

Change in ticket price Change in revenue

Estimates USD Percent Milion USD

Faber and Brinke (ICTSD) 2001 $7.71 to $38.54 1.30 to 6.50 $3,599 to $17.995

Boon et al (Delt) 2007* $5.99 to $17.96 1.01 to 3.03 $2,795 to $8,384

Ernst & Young 2007* $0.19 to $2.79 0.03 to 0.47 $87 to $1,304

IATA 2007 $8.88 to $18.99 1.50 to 3.20 $4,147 to $8,871

Intra-EU fights $3.47 to $7.45 1.10 to 2.30 $1,041 to $2,234

Economy passengers $3.47 to $7.45 1.20 to 2.60

Premium passengers $3.47 to $7.45 0.40 to 0.90

Extra-EU fights $18.73 to $40.02 1.70 to 3.60 $3,106 to $6,637

Economy passengers $18.73 to $40.02 2.20 to 4.60

Premium passengers $18.73 to $40.02 0.60 to 1.30

SEC (European Commission) 2006 $2.39 to $11.97 0.40 to 2.02 $1,118 to $5,589

Wit et al (Delt) 2005 $0.53 to $1.73 0.09 to 0.29 $248 to $807


Estimates o demand changes by existing study

Change in demand Change in revenue Change in cost

Estimates Million tickets Percent Milion USD Million USD

Anger et al 2008 -0.18 to -4.56 -0.04 to -0.98 -$93 to -$2,391 -$52 to -$1,341

Boon et al (Delt) 2007* NA to -9.40 NA to -$8,189 NA to -$4,635

EU airlines NA to -3.30

Non-EU airlines NA to -0.90

Intra-EU fights NA to -2.21 NA to -2.50 NA to -$2,226 NA to -$1,145

Extra-EU fight NA to -7.19 NA to -4.10 NA to -$5,963 NA to -$3,490IATA 2007 -8.50 to -18.10 -1.80 to -3.90 -$4,442 to -$9,506 -$2,504 to -$5,305

Intra-EU fights -5.20 to -11.10 -1.70 to -3.70 -$1,524 to -$3,270 -$797 to -$1,655

Economy passengers -5.10 to -11.00 -1.80 to -3.80

Premium passengers -0.04 to -0.09 -0.30 to -0.70




Extra-EU fights -3.30 to -7.10 -2.00 to -4.30 -$2,918 to -$6,235 -$1,708 to -$3,650

Economy passengers -3.30 to -7.00 -2.20 to -4.60

Premium passengers -0.03 to -0.06 -0.20 to -0.40

Wit et al (Delt) 2005

EU airlines -0.70 to -2.10

Non-EU airlines -0.10 to -0.40


Estimates o proit changes by existing study

Change in proits

Estimates Million USD Change in margin

Malina et al (MIT) 2012

US airlines $116 0.15 percent

Boon et all (Delt) 2007* NA to $14,748 NA to 1.09 percent

EU airlines NA to $9,216 NA to 2.30 percent

Non-EU airlines NA to $5,532 NA to 0.60 percent

Ernst & Young 2007* -$1,053 to -$4,489 -0.36 to -1.54 percent

Network -$576 to -$2,638

Low cost -$144 to -$565

Cargo -$333 to -$1,286

IATA 2007 $591 to $1,447 0.20 to 0.50 percent

Intra-EU fights -$68 to -$145 -0.10 to -0.10 percent

Extra-EU fights $660 to $1,592 0.40 to 0.90 percent

* Not included in ranges in text due to its modeling o a policy signifcantly dierent rom the fnal policy.

See Appendix B or more details.




Appendix D

Notes on methodology

All coss convered rom euros o U.S. dollars a an exchange rae o 1 EUR o

1.33 USD.

We ranslae oal resuls o per passenger and vice versa by assuming ha he policy

will cover 467 million passenger ickes. Tis number is aken rom IAA (2007).

In all cases, he lower and upper bound esimaes in each range are he resuls

associaed wih a low and high allowance price respecively.

In all cases where oal resuls are presened or sudies ha calculae resuls or

shor-haul, medium-haul, and long-haul ighs, only he resuls or medium-haul

ighs are presened. Tis applies o Wi e al. (2005), SEC (2006), Erns & Young(2007), and Boon e al. (2007).

Boon e al. (2007) esimae economic impacs or versions o he EU policy wih

dieren allocaion regimes. Tis sudy presens resuls or heir Sub-Varian 1,

100 percen ree allocaion based on hisorical emissions, as his is he closes o

heir modeled scenarios o he acual EU policy. For heir change in demand or

EU and non-EU carriers, we presen he percen change in RK raher han he

percen change in passengers, as hey do no provide daa on he laer. As Boon e

al. (2007) model a policy ha is signicanly dieren rom he nal EU policy, we

do no include heir resuls in he ranges in he ex, hough we do include heir

resuls in he appendix ables.

Erns & Young (2007) nd sarkly dieren impacs rom he oher exising

sudies. Tese dieren resuls are largely because he sudy assumes ha more

allowances are aucioned han he acual policy requires. Te addiional increases

coss, icke price changes, demand reducions, and, as a resul, pro loses. As his

sudy does no acually model he policy, i is no included in he ranges or overall

resuls presened in he main repor. I is used, however, in he ranges or impacs

on airline subgroups, as ew oher sudies are available or hese resuls, and we dono expec he aucion percenage o drasically impac he disribuional impacs

o he policy. All he sudy’s resuls are included in he appendix ables.




Also Erns & Young (2007) do no explicily calculae ull coss. We exrapolae

ull coss rom heir resuls by dividing he cos o aucioning revenue by he auc-

ioning percenage o ge he value o all allowances and hen adding he value o

allowances purchased rom oher secors.

IAA (2007) does no make any saemens abou hisorical versus updaed allo-caion. Tey do, however, implicily assume ha ree allowances are given based

on hisorical emissions by assuming ha he moneary value o he ree allowances

are no passed hrough ino icke prices.




About the authors

Samuel Grausz is an associae a Climae Advisers and manages is energy pracice.

Samuel also holds a research posiion a Resources or he Fuure, where he works

wih leading economic scholars on a broad se o energy and environmen policy

issues. Samuel previously worked a Naional Economic Research Associaes, aleading economic consuling rm.

Nigel Purvis is he ounder and presiden o Climae Advisers. Previously, Nigel

direced U.S. environmenal diplomacy, serving mos recenly as depuy assis-

an secreary o sae or oceans, environmen, and science. Laer Nigel served

as vice presiden or policy and exernal aairs a Te Naure Conservancy. He

holds senior research appoinmens a Resources or he Fuure, he German

Marshall Fund o he Unied Saes, and he Brookings Insiue. Early in his career

Nigel worked as an inernaional lawyer a he Sae Deparmen, as a securiies

atorney a he law rm o Sullivan & Cromwell, and as a lecurer a GeorgeownUniversiy.

Rebecca Leton is a Policy Analys ocusing on inernaional climae and energy

policy a he Cener or American Progress. Rebecca began her work wih CAP

in he TinkProgress War Room. Prior o joining CAP she worked a he Pew

Chariable russ Environmen Group. She holds a maser’s degree in public

policy rom he Harris School o Public Policy a he Universiy o Chicago. As a

graduae suden Rebecca worked wih a coaliion o ciies in he Unied Saes

and Canada o creae susainable urban environmens and proec waer resources

wih he Grea Lakes and S. Lawrence Ciies Iniiaive.

Acknowledgements

Special hanks o Annela Anger o he Universiy o Cambridge, Dallas Burraw and

Ray Kopp o Resources or he Fuure, and Gerno Wagner and Ruiwen Lee o he

Environmenal Deense Fund or reviewing his paper and providing commens.




1 International Civil Aviation Organization. “ICAOEnvironmental Report 2010” (2010), available at http://www.icao.int/environmental-protection/Pages/EnvRe-port10.aspx.

2 Artur Runge-Metzger, “Aviation and Emissions Trading:ICAO Council Brieng,” September 29, 2010, available athttp://ec.europa.eu/clima/policies/transport/aviation/docs/presentation_icao_en.pd . Percent change rela-tive to a 2006 baseline.

3 International Civil Aviation Organization. “ICAO Envi-ronmental Report 20 10.”

4 Other participating states include Iceland, Lichtenstein,and Norway. Croatia, when it joins the European Unionin 2013, will become part o the program. The policydoes not include ights with a minimum take-of weight less than 5,700 kg, training and military ights,and ights to remote regions. For more, see: EuropeanCommission, “Reducing Emissions rom the AviationSector” (Brussels: European Commission, 2011), avail-able at http://ec.europa.eu/clima/policies/transport/aviation/index_en.htm.

5 In 2020, 85 percent o the allowances will be issued orree to existing airlines. Each year rom 2013 to 2020,82 percent o the allowances will be issued or ree toexisting airlines and 3 percent will be kept in reserve orast-growing and new airlines.

6 Measured in tonne-kilometers in passengers andreight in 2010.

7 The European Union will create enough new allow-ances to cover 97 percent o average aviation emissionsrom 2004 to 2006 in 2012, and 95 percent in 2013 andthereater.

8 Most importantly, we do not compare allowance priceassumptions. These assumptions, more than anythingelse, are likely drive the variety o results.

9 This importantly leaves out a number o studies thatestimate impacts on the European or global economy

and studies that estimate impacts on specic airlinesor specic ight patterns. In a ew cases, we did includeestimates or specic airlines when the results or thoseairlines are intended to represent an airline subgroup.

10 The value o the allowances is not actored into thechanges in ticket prices and demand and is included as asource o prots because the EU policy allocates ree al-lowances based on historical emissions. Economic theorysuggests that this will occur because ree allowancesbased on historical emissions do not afect the marginalcost o emissions and thus airlines will not pass throughthe value o the allowances to consumers and will insteadkeep the ree allocation as prot. Economists havedocumented this efect empirically in a large number o studies. For good examples, see: Jos Sijm, S Hers, W Lise,and B Wetzelaer, “The impact o the EU ETS on electricityprices,” Environmental Protection (2008); Jos Sijm, KarstenNeuhof, and Yihsu Chen, “CO2 cost pass-through and

windall prots in the power sector,” Climate Policy 6(1) (2006): 49–72; Lans A. Bovenberg, and Lawrence H.Goulder, “Neutralizing the Adverse Industry Impacts o CO2 Abatement Policies: What Does it Cost?” NBER Work-ing Papers, available at http://ideas.repec.org/p/nbr/nberwo/7654.html; Dallas Burtraw and Karen Palmer,“Compensation rules or climate policy in the electricitysector,” Journal o Policy Analysis and Management 27 (4)(2008): 819–847.

11 No study estimates and presents total costs or allcovered airlines. We approximate total covered costsas the costs or all European air travel, calculated usingworldwide aviation costs and regional market sharesrom IATA. This approximation may be inaccurate tothe extent that the costs o airlines difer betweenregions and to the extent that the IATA Europe regiondoes not line up with the coverage o the EU policy.See: IATA, “Financial Forecast” (Geneva: International Air

Transport Association, 2011), available at http://www.iata.org/whatwedo/Documents/economics/Industry-Outlook-September2011.pd; IATA, “Air Transport MarketAnalysis” (Geneva: International Air Transport Associa-tion, 2011), available at http://www.iata.org/whatwedo/Documents/economics/MIS_Note_Sep11.pd.

12 Similar to above, we approximate total uel costs orcovered airlines using the uel costs or all Europeanair travel, calculated using worldwide aviation costsand regional market shares rom IATA. We use regionalmarket shares or 2010 in all years, as IATA only makesdata publicly available or that year.

13 European Commission, “Reducing Emissions romthe Aviation Sector” (Brussels: European Commission,2011), available at http://ec.europa.eu/clima/policies/transport/aviation/index_en.htm.

14 IATA (2007) does not explicitly show these numbersbut they do provide ull costs per passenger and totalnumber o passengers.

15 The diference between the out-o-pocket and emis-sion cost or IATA (2007) does not exactly match thevalue o ree allocation calculated in the previousparagraph because IATA (2007) assumes a 10% auctionrate rather than the 15% auction rate included in thenal policy. We corrected or this in the extrapolationo the other studies. Also, we chose to extrapolate romIATA (2007) rather than just add the calculated value o ree allowances to the out-o-pocket costs rom eachstudy because not every study identies its assumedallowance price.

16 The changes in ticket prices described above represent

the change in price or the average ticket, with respectto both distance and price. For those studies thatestimated price changes or short-, medium-, and long-haul ights, we included changes in ticket prices or themedium-haul ight. Obviously the EU policy will resultin diferent ticket price changes or ights o diferentlengths, as short- and long-haul ights use diferentamounts o uel and have diferent base ticket prices.

17 On the supply side, pass through depends on thenumber o rms in a market, the concentration o market shares, whether the rms seek to maximizeprots or other objectives, and the ability o other rmsto enter and exit the market. On the demand side, passthrough depends on the number o diferent types o passengers and the willingness o diferent passengersto pay higher prices or a given ticket. For economiststhese actors are maniested in the size o relevant mar-ket and the characterization o the supply and demand

curve. Vivid Economics (2007 and 2008) provide morethorough examination o these issues.

18 This was determined by summing auction percentagesover the relevant modeling horizons and comparingthat to the sum o auction percentages or the actualpolicy.

Endnotes

http://www.icao.int/environmental-protection/Pages/EnvReport10.aspx



http://ec.europa.eu/clima/policies/transport/aviation/docs/presentation_icao_en.pdf


http://ec.europa.eu/clima/policies/transport/aviation/index_en.htm


http://ideas.repec.org/p/nbr/nberwo/7654.html


http://www.iata.org/whatwedo/Documents/economics/Industry-Outlook-September2011.pdf



http://www.iata.org/whatwedo/Documents/economics/MIS_Note_Sep11.pdf


http://ec.europa.eu/clima/policies/transport/aviation/index_en.htm.





















Endnotes

19 IATA (2007) assumes a 75 percent pass-through rate,while Ernst & Young (2007) assumes 29 percent to 35percent, and Boon et al. (2007) assumes 1 00 percent. Asdescribed previously the pass-through rate is the keydeterminant in a simple modeling ramework o theextent to which the airlines can increase ticket prices inresponse to increases in costs. This plays a major role insetting changes in revenues, costs, and, thus, prots.

20 Baseline annual prots o covered ights approximatedwith 2010 prots and prot margins in Europe romIATA (2011). We use the 2010 estimate to avoid includ-ing the efects o the EU policy (which may or maynot be included in the IATA orecast or 2012) and as2012 is predicted to be a particularly bad year by IATA,meaning that it may not be a good estimate o averageannual reerence prots under the EU policy.

21 The back-o-the-envelope calculation involves reduc-ing the amount o ree allocation to reect a switchrom 10 percent to 15 percent auctioning. No othermodications are necessary as under the IATA (2007)modeling the amount o ree allocation does not afectchanges in ticket prices or demand. This calculation isuniquely possible with IATA (2007) as it disaggregatesthe components o changes in revenues and costs,specically identiying the value o the ree allocation.

22 Malina et al. (MIT, 2012) also estimate changes inprots, but only or U.S. airlines. As such their resultscannot be used to compare the impact o the EU policyon airlines o diferent nationalities.

23 As noted beore, the Boon et al. (2007) estimateso prot changes seem large, but the direction o the prot changes and distribution o the changesbetween EU and non-EU airlines make s ense. Alsothese prot margins do not appear to be adjusted orcoverage, meaning that the EU policy increases protso non-EU airlines by 0.6 percent relative to the totalprots o non-EU airlines.

24 Ernst & Young (2007) also calculate that cargo will lose$188 million to $727 million.

25 Obviously, these alternatives will only replace certaintypes o air travel. Ships, or example, might replace aircargo or passenger ights over short distances. Theywill probably not substitute or transatlantic ights dueto time cost.



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