Why airlines want a carbon market

Professor Ross Garnaut summed up the mentality of big business quite nicely earlier this year, when he noted that they will always rail against the imposition of a new cost or tax, but will quickly work out the best way of minimizing the burden once the case is settled.

The airline industry has turned out to be a wonderful case in point. Even in the last days before the federal government's carbon pricing package was unveiled in early July, Virgin Blue and its flamboyant founder Richard Branson were arguing against a carbon price. But once the details were revealed, they were mortified that they were not included.

The nature of domestic politics meant that carbon emissions from transport were exempt from the Clean Energy Future package. Instead, the government chose a mechanism that would require transport companies to pay an effective carbon price through changes to fuel excise and fuel tax credit schemes.

Virgin and Qantas didn't want a bar of it and pleaded for their emissions to be included in the market mechanism that would take effect from 2015. Their wish was granted, and an “opt-in” arrangement was included in the legislation presented to parliament a fortnight ago. It is thought that about 20 companies may take up the offer.

The two airlines had a simple rationale for their request for inclusion. A tax is cumbersome and a blunt weapon – both airlines are used to managing massive price hedges for fuel. Qantas faced a bill of more than $110 million on its domestic operations, and Virgin a bill of around $40 million - both feel certain that the carbon cost will be far lower under a market mechanism.

"We welcome the opportunity to be able to opt in to the carbon pricing scheme as it will enable us to source abatement measures at least cost," a Virgin spokesperson said. Qantas, with domestic carbon emissions of around 5 million tonnes a year, also expressed its preference for managing its liability directly. It has previously canvassed the buying of international permits and is likely to do so again.

In any case, both companies expect to pass on the costs of the carbon price through to their customers. Citi analysts estimated this to be around $3.50 per sector per passenger, but might be less in a market system. It did not expect that to impact customer behaviour.

Now the world's airlines are going through a similar process with the European Union, which intends to impose a carbon cost on flights into the EU from 2012, and which announced earlier this week the broad terms of that agreement: the airlines will get 85 per cent of those credits free in the first year – falling to 82 per cent in the second. (In Australia, there are no free permits for domestic flights).

How that affects Australian passengers flying to Europe is yet to be seen. Virgin Australia doesn't make it that far, flying only as far as Dubai, where passengers continue with its partner airline, Emirates. Qantas has estimated the cost at around $5 to $8 million, but this could reduced because it intends to scale down services to Europe in any case. It is yet to say whether it will pass through the costs to passengers. The EU estimates the scheme will add up to $20 to a trans-Atlantic flight.

Jos Delbeke, the European director general for climate, said the free permits would amount to around $20 billion over the next 9 years, and suggested that airlines use this money to invest in new aircraft (such as the new fuel efficient Boeing) Dreamliner, improve fuel efficiency and use non-fossil aviation fuel.

The airlines dispute this is a windfall, with Lufthansa saying it would be difficult to pass on all the costs in a competitive environment. In any case, Lufthansa, like nearly a dozen other airlines, is already investing in alternative fuels. It has been experimenting with biofuels on regular flights between Hamburg and Frankfurt, including fuel sourced from jatropha plantations from the Australian-listed Jatoil.

Among those with added bills from the international flights, British Airways is thought to face the highest bill of up to €55 million, more than double that of some of the firm's U.S. rivals and no-frills EU competitors. The combined liability of the 10 largest airlines, including BA, Lufthansa and Virgin, would be €360 million next year, according to Thomson Reuters, and more than €1 billion for all 4000 airlines that operate in and out of Europe.

A Bloomberg analysis suggested that short-haul flights would face a greater burden – up to 36 per cent – than longer haul flights to New York (8 per cent) or Asia, because longer flights are less carbon-intensive per kilometer travelled because the higher energy demand required for taking-off and landing is spread over a longer journey. The impost per passenger on a long haul flight might be as low as $3.

The EU estimates that the measure will reduce emissions for air travel by 72 million tonnes of Co2-e a year by 2020. That's nearly one half of Australia's 5 per cent reduction target over the same period.

Some airlines – Chinese and American in particular – are still fighting the ruling in court or in trade forums. But for the rest, it is time to adapt. "The task now is to refine the carbon procurement and risk management strategies," Point Carbon analyst Andreas Arvanitakis was quoted as saying. "In such a keenly competitive industry, the emissions market may offer an advantage in terms of keeping costs below those of rival carriers."