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Monday 29 April 2024 in Regulation , Operational Cost Landscape

Why non-EU airlines flying to Europe could face EU carbon tariffs

Justine El Amrani-Joutey
Analyst at Ishka

Update: This report was updated on 30th April 2024 to include comments by the European Commission’s DG TAXUD.

Non-EU airlines operating into the EU could be faced with emissions-related charges in the second half of the decade, as part of an effort to level the playing field with EU counterparts. The charges could be introduced by adding aviation to the Carbon Border Adjustment Mechanism (CBAM), a pioneering piece of legislation taking full effect in 2026 which imposes carbon tariffs on carbon intensive products imported into the EU. CBAM will not cover aviation until the end of its provisional phase in 2025, but that could change from 2026, answering European airlines’ pleads for a more equitable treatment.

European airlines have been largely supportive of EU measures to steer the sector towards lowering its emissions, but they are also critical of how these measures make them less competitive versus non-EU rivals. ReFuelEU Aviation (the EU’s SAF mandate) or the revision to the EU ETS phasing out free emissions allowances for airlines by 2026 are just some of the measures set to increase the operational costs of European airlines. In this report, Ishka examines how aviation’s inclusion in CBAM could level the playing field.

What makes CBAM a solution to carbon leakage?

A fixture of globalisation is that an increase in production costs for goods and services in one region makes other regions more price competitive. When carbon-intensive goods and services are involved, this often results in carbon leakage: when efforts to cut emissions in one area lead to increased emissions elsewhere due to shifting production.

The EU’s CBAM exists to rebalance costs between non-EU and European producers, who pay a tax on their embedded climate emissions through the EU ETS. In many cases, CBAM also exists to compensate for the phase-out of free EU ETS allowances (a measure also impacting aviation). Industries covered by CBAM in its provisional phase include hydrogen, electricity, fertilisers, aluminium, cement, as well as iron and steel. Aviation is not yet covered.

Do airlines find value in CBAM?

In short, yes. The extension of CBAM to aviation has been a demand of European airlines ever since EU Green Deal-driven legislation began to alter their cost landscape. Trade body Airlines for Europe (A4E) has supported aviation’s CBAM inclusion as far back as January 2022, when in a position paper it said it could be applied in a way that would enable the EU to “forcefully drive emissions abatement measures in a competitive international environment”.

More recently, in a 2024 European Policy Priorities report, Air France-KLM stated it “[welcomed] a CBAM initiative seeking to level the playing field and address carbon leakage”, while a 2024 Lufthansa Group policy brief special directly called for “applying CBAM to air transportation”.

When could aviation be included in CBAM?

Under Article 30 of the Regulation establishing the CBAM, the European Commission is required, before the end of the transitional period which runs from October 2023 to December 2025, to present a report to EU national ministers (the Council) and the European Parliament containing an assessment of the possibility to extend the scope of the mechanism to embedded emissions in transportation services.

However, Ishka notes that this could slide into 2026 or later pending a review of the CORSIA assessment report due in 2026. If the review assesses that CORSIA is not sufficiently delivering the goals of the Paris Agreement, the scope of the EU ETS could be extended to departing flights, which would alter the design of a potential aviation CBAM.

Ishka understands that a European Commission official speaking at an aviation event in Brussels last March suggested that a version of CBAM could be used to protect European long-haul carriers against non-European competition. The person making these remarks also confirmed that the Directorate-General for Taxation and Customs Union (DG TAXUD) is working on a proposal to include aviation in CBAM with an initial consultation to be potentially launched in the coming months.

DG TAXUD told Ishka on 30th April that they could not confirm whether they are working on a proposal to include aviation in CBAM “and neither is a consultation planned to be potentially launched in the coming months.” However, DG TAXUD noted that the Commission is currently studying “carbon leakage risks stemming from more stringent environmental policies applicable to the aviation sector more broadly, including air passenger transport”.

A November 2023 call for applicants to CBAM’s informal expert group by DG TAXUD also describes the group’s tasks as “providing advice and expertise in relation to […] the extension of the scope of the CBAM to other sectors covered by the Emissions Trading System (ETS)3, especially those at risk of carbon leakage”. DG TAXUD did not lay out which sectors are most at risk, but a study by French trade association of large companies AFEP reviewing carbon leakage risks for industries at the EU level shows air transport is the fourth most susceptible industry to carbon leakage (12%), behind the chemical (35%), metal (33%), and cement (14%) industries.

How could a non-EU airline carbon tariff be calculated?

The application of CBAM to non-EU airlines, if it goes ahead, is likely to be a function of equivalent ETS costs for EU, fuel tax (if the EU proceeds with ending jet fuel’s tax exemption) and/or costs associated with SAF mandates. Compliance cost expectations for other industrial sectors are difficult to extrapolate to aviation, given the unique carbon intensity of each good and their ETS applicability.

Will CBAM succeed in reducing emissions?

CBAM has barely gotten under way and its effectiveness is yet to be measured. So far, one 2022 paper by Austrian and German researchers found it would only have marginal effects on emissions. The modelling was based on the main industries covered in CBAM’s mid-2021 proposal and showed that CBAM would lead to a 0.24% CO2 emission increase in the EU and a 0.08% reduction in global emissions. Another paper by the University of Cambridge Institute for Sustainability Leadership, published in 2021, found similarly minimal impacts on emissions. The study writes that the real utility of the EU CBAM would be to enable more ambitious domestic national policies and to improve the political acceptability of high carbon prices. On the other side of the trenches, some researchers in developing countries have criticised the scheme’s effect on their economy.

Until free allowances in CBAM sectors are completely phased out in 2034 (such as for steel), the CBAM will apply only to the proportion of emissions that do not benefit from free allowances under the EU ETS. A Wood Mackenzie article argues that CBAM-induced price increases for steel could go as high as 56% (for Indian steel), 52% (Russia), and 49% (China). Despite the increases, steel from these regions could remain competitive in Europe even with the high carbon prices due to comparatively lower base production costs.

The Ishka View

The medium-term impact of the EU Green Deal on the competitiveness of European carriers has been a recurrent topic of discussion by industry and NGOs. A Transport & Environment (T&E) study published in 2022 assessing the potential carbon leakage linked to the cost of EU climate measures for departing flights found that “some of the aviation industry’s claims on carbon leakage risks [were] unfounded”. Nevertheless, air travel is a price-sensitive product and non-EU airlines have increased their market share on long-haul connecting flights to and from Europe through, among other factors, cost competitiveness. The introduction of aviation in CBAM should lead to an increase in average ticket prices for long-haul flights from European countries, but would make European aviation decarbonisation policies more even-handed.

But before thinking that far, the EU still needs to get CBAM right. EU legislators must walk a narrow path to construct a system which provides substantial fixes to the ETS’ flaws (carbon leakage, market distortions) but does not cross the red lines of extra-EU stakeholders. The University of Cambridge research paper cited earlier in this report has a good analysis on the WTO legal challenges facing the legislation in pages 37- 45. It states that “the politics of EU CBAM make a WTO dispute quite possible, even likely” and that therefore, “the design of an EU CBAM must be crafted carefully, to remain consistent with international trade law and to minimise the risks of trade dispute or retaliation”.

How the EU approaches CBAM will also set an example for other nations with carbon taxation systems including ETSs, some of which already include domestic aviation. The UK, which has an ETS system that mirrors the EU’s, has also announced it would roll out its own CBAM starting in 2027, while Australia and Canada are currently holding reviews on carbon leakage risks from ETS and CBAM consultations.

Tags: CBAM, EU, EU ETS, Tax

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