Airline winners and losers as future EU ETS carbon costs and emission levels climb, says Standard & Poor's
Mon 7 Mar 2011 – Although initially marginal compared to existing charges such as escalating fuel expenses, the EU Emissions Trading Scheme (EU ETS) will add further long term cost pressure to a cyclical, capital-intensive and highly competitive airline industry, concludes a report just published by Standard & Poor’s. The financial services and credit ratings agency says the EU ETS is unlikely to have a significant impact on rated European airlines such as British Airways, Lufthansa and SAS in the short term. Over a longer timeframe, however, an airline’s ability to pass on the additional carbon cost will be a key differentiator, one that is likely to vary from operator to operator, and could impact a carrier’s credit quality. Those operating long-haul routes with more fuel efficient aircraft and earning a higher proportion of premium revenues are likely to be less impacted.
“Moreover, we believe that EU-based airlines may be more severely affected than non-EU based carriers, which could create a competitive mismatch and introduce the risk of carbon leakage – the transfer of airline activities to non-EU operators or to routes not covered by the EU ETS,” says S&P credit analyst Stuart Clements.
S&P estimates that in the first year of trading for airlines – 2012 – the cost to the industry of the EU ETS will be around 1.125 billion euros ($1.58bn), based on the current carbon price of 15 euros per tonne of CO2 and assuming the cost is not passed on to customers. At that price, the cost impact of the EU ETS is relatively low compared to volatile fuel costs but over a period of time will become a potentially significant variable. Another impact on airline performance will be the number of carbon allowances allocated for free, and the level of allowances being auctioned could have a noticeable effect on operating profits.
“In our opinion, the substantial amount of freely allocated carbon allowances available under the scheme will mitigate to a large degree any immediate costs to the airlines, compared with other industries. That said, the projected growth in airline emission levels could erode this protection over time,” notes the report.
It warns of disruptive events adding to a carbon liability risk for airlines, for example the impact last year of the ash cloud from the Icelandic volcano eruption. Some airlines saw their normal RTK proportion reduced in relation to their competitors so they will be allocated fewer allowances for free. Not only will they have to buy those that they have lost but also their competitors may be allocated more allowances as a result.
Airlines that see significant growth in demand on EU ETS-covered routes between 2010 and 2012 are also likely to face a relatively higher carbon liability. This is because free allowances will represent a smaller percentage of their total emissions, compared to airlines with lower growth or declining demand. The report points to a forecast by Hong Kong-based carbon data and risk analytics company RepuTex that some EU-based airlines may be required to purchase up to 45% of their total emissions on EU ETS-covered routes in 2012.
The degree to which an individual airline is able to pass on EU ETS costs is likely to be influenced by the efficiency of its route network, its market pricing point and market dynamics, says S&P. Given that a significant proportion of fuel is burned on take-off, non-stop long-haul routes are relatively more fuel-efficient than the same aircraft and payload on two or more short-haul routes. Airlines with a higher proportion of premium revenues may find it easier to pass on carbon costs to passengers because these costs will be a proportionately lower percentage of the ticket price than for low-cost and economy passengers.
Overall, S&P considers the global network carriers to be best-placed to cope with the introduction of the EU ETS. “Conversely, we think that low-cost and short-haul airlines that have lower premium revenues, and particularly those with older aircraft fleets, may be somewhat more adversely affected,” it says.
In the worst case of a high carbon price and low cost pass-through scenario, S&P believes carriers might abandon some routes, with further economic and social consequences on regional connectivity and local employment. More price-sensitive and competitive routes – short-haul leisure, for example – may be the most exposed.
The report suggests carbon leakage could affect some carriers, with the risk of traffic being diverted from EU operators to the benefit of non-EU operators. While this is not an option for EU-based or bound passengers, European airport hubs may also become less competitive for passengers coming from outside the EU and transiting through to an end destination outside Europe. These hubs may increasingly be bypassed by these passengers, it warns, who will connect through other global airports, primarily those in the Middle East.
Concluding, the report suggests that the industry could face added regulation once the climate impacts of non-CO2 emissions from aircraft have become better understood by scientists. This could potentially have a more significant impact on the airline industry than the EU ETS in its current form, it warns.
The report, ‘Airline Carbon Costs Take Off as EU Emissions Regulation Reach For The Skies’, is published by Standard & Poor’s Ratings Services and is available to subscribers of S&P’s RatingsDirect on its Global Credit Portal. Non-subscribers may purchase a copy by calling +1 212 438 7280 or emailing research_request@standardandpoors.com.
