The announcement on 12 November 2012 by the EU Commission to "stop the clock" on the implementation of the international aspects of the EU Emissions Trading System ("EU ETS") as it applies to the aviation sector came as a surprise to the market. Although the Commission has been facing regular international and commercial demands to abandon the application of the EU ETS aviation scheme to non-EU aircraft operators for some time now, this latest announcement following on the back of the council meeting of the International Civil Aviation Organization ("ICAO") on 9 November 2012 still comes as a surprise. This surprise is because no alternative scheme has yet been agreed by the ICAO or its members, and certainly no alternative scheme is going to be in place for a few years yet, even if one was to assume such an agreement was reached in the next annual ICAO assembly in 2013.

Therefore, the proposal to "stop the clock" for the EU ETS aviation scheme raises a lot of questions for which, at present, most answers will be merely speculative.

Scope and impact on competition in the market: According to the memorandum from the Commission published on 12 November 20121 (the "Memorandum") and the press conference given by Commissioner Connie Hedegaard2, the "obligations relating to all operators’ activities within the EU will remain intact and compliance with the EU law will be enforced". It seems to suggest that an EU aircraft operator like British Airways or Air France would have to comply with its EU ETS obligations for its EU-only flights during 2012, but not for those of its flights originating in the EU but not ending within an EU Member State (or vice versa).

The suggestion, however, is that non-EU operators who do not have flights that both originate and end within a Member State will not have to surrender any allowances on 30 April 2013 in relation to their emissions emitted during 2012. Non-EU based international carriers such as United Airlines, Air Canada or China Airways should therefore fall within the category of airlines which benefit from this proposal.

This treatment of non-EU operators as distinct from pure EU operators, such as small low budget airlines or from those airlines that have both pure EU and non-EU flights (e.g. British Airways, Air France etc.), seems to defeat one of the core legal principles upholding the validity of the original inclusion of aviation in the EU ETS – that of non-discriminate treatment of aircraft operators – and is likely to generate significant protest from an already economically hard-pressed EU aviation sector.

Bearing in mind that other alternative solutions exist to the international dispute over the so-called extra-territoriality of the EU ETS aviation scheme that would not have the same potential to distort competition – for example, a suspension of the EU ETS aviation scheme in its entirety – it is surprising that the Commission has opted for a solution that has the very same potentially distortive impacts that it relied upon to justify including non-EU airlines in the first place.

Readers will no doubt recall the competition-based arguments deployed by those seeking to justify the inclusion of non-EU airlines at the time, as exemplified in the following extract from the Opinion of Advocate-General Kokott in rejecting the Air Transport Association of America’s legal challenge to the extra-territorial features of the EU ETS aviation scheme before the European Court of Justice in 20113:

199. If the EU legislature had excluded airlines holding the nationality of a third country from the EU emissions trading scheme, those airlines would have obtained an unjustified competitive advantage over their European competitors. Such a course of action would not have been compatible with the principle of fair and equal opportunity laid down in Article 2 of the Open Skies Agreement and which also underpins Directive 2008/101 itself.

200. If the EU legislature had excluded flights to or from an aerodrome in a third country from the EU emissions trading scheme, there would have been a risk – in relation to transatlantic flights, for instance – of long-haul flights being treated more favourably than short-haul flights. Such favourable treatment would have been equally unjustified in view of the objective of Directive 2008/101. The EU legislature was concerned to incorporate aviation activities in the EU emissions trading scheme as comprehensively as possible with the aim of reducing greenhouse gas emissions originating from aviation.

Although Commissioner Hedegaard has stated that she has been in contact with the European Council regarding the decision to "stop the clock", a legislative decision (e.g. an amendment to the EU ETS Directive, or the passing of a new Regulation) will nevertheless be required to give a formal legal basis for airlines avoiding a penalty for non-compliance. Therefore, although the Commissioner appears confident that the legislation will pass, there is still the possibility that either the European Council, or more likely the European Parliament, raises objections to the decision to "stop the clock", meaning that the obligations on non-EU operators would remain in place. On the other hand, if a decision is taken of the kind proposed there must be a significant risk of renewed legal challenges to the validity of that decision, in many respects relying on the exact mirror image of some of the arguments deployed by non-EU airlines first time around.

Deferral and not waiver: The Memorandum also seems to suggest that the compliance obligation of such non-EU operators is not permanently waived but is merely suspended pending the outcome of the ICAO assembly meeting in 2013. Should the meeting not produce the desired outcome, the deferred obligations are said to apply "automatically". This position begs the question: what will happen if an agreement is reached at the ICAO assembly, but the measures so agreed are not implemented for a number of years further? Is the situation regarding the compliance obligations of such non-EU operators or the compliance obligations of those EU operators in relation to purely international flights originating in the EU to remain in limbo until such time as the new measures, if agreed, are actually implemented?

If the assembly fails to reach an agreement, how does an aircraft operator meet its 2012 (i.e. EU ETS Phase 2) obligations "automatically"? The Memorandum states that monitoring obligations are to be deferred. Does this mean that no further monitoring should occur during the remainder of 2012 and most of 2013? If the obligation is reinstated, how does one retrospectively "monitor" unless one has already captured the necessary fuel usage per flight as required for monitoring calculations to be performed? In the absence of actual data, such fuel usage is to be determined on the basis of "standardised tiered methods" which may not benefit aircraft operators that have been efficient in their consumption and usage.

Furthermore, does the deferral mean that the 2012 obligations must be met by surrendering the necessary quantity of allowances by the compliance deadline for 2013 (i.e. by 30 April 2014)? If so, what types of allowances may be used by such aircraft operators? The EU ETS Directive specifies that units issued for Phase 2 of the EU ETS can only be used to meet obligations in that period. Similarly, a Phase 3 unit can only be used to meet a compliance obligation in that period. So, assuming a compliance deadline of 30 April 2014 for the 2012 obligations, will aircraft operators be expected to surrender Phase 2 allowances or Phase 3 allowances?

Impact on Phase 2 to Phase 3 carry-over/banking: This leads on from the previous comment. The EU ETS directive envisages the carry-over (or "banking") between Phase 2 and Phase 3 of the EU ETS of all unused EU allowances ("EUAs") or EU aviation allowances ("AEUAs"). According to the Commission’s prior statements, such banking is scheduled to take place by the end of July 2013. The process of such banking envisages the cancellation of all Phase 2 EUAs and AEUAs and their immediate replacement with Phase 3 EUAs4. Therefore, if such banking has been completed on time, come April 2014, no Phase 2 EUAs or AEUAs will exist towards allowing an aircraft operator to meet any surrender obligations that it may "automatically" have as a result of an unsuccessful ICAO assembly meeting. Since, according to the EU ETS Directive, a Phase 3 AEUA or EUA is not valid for meeting a Phase 2 compliance obligation, one of two things must happen:

  • The EU ETS Directive will have to be amended to allow Phase 3 EUAs or AEUAs to be used by such aircraft operators towards their 2012 compliance obligation, or
  • The Commission will have to delay the carry-over process pending the outcome of the ICAO assembly meeting.

If this latter option is chosen, it raises further questions as to whether such a delay in carry-over should only be applied to Phase 2 AEUAs and not to Phase 2 EUAs. Neither of these two situations appears to be either ideal or helpful. The former will require an amendment to the EU ETS Directive which may be time-consuming and may require local implementation by Member States unless achieved through an EU Regulation. The latter will have significant commercial impact on market positions taken by participants in reliance on the banking timing advised in the EU ETS Directive, the relevant registry regulation, and separately confirmed by the Commission.

The case may be that the Commission will use the opportunity it is taking to amend the EU ETS Directive to deal with the Commission’s ability to alter the auction calendar in the context of its ‘back-loading’ proposal to include further changes necessitated by this "stop the clock" announcement. If so, it remains to be seen whether the Commission takes the opportunity to introduce other changes that have not been previously discussed with the market. Any significant legislative amendment proposal of this nature introduces uncertainty as to what other issues may be re-opened and the likelihood of a further round of intense lobbying.

Impacts on others: Amidst all this confusion, there may be a degree of unintended "benefit" to other indirectly affected groups. In a close parallel with the aviation sector, the shipping industry, for example, has been in the Commission’s sights for a number of years as the next sector the Commission would like to see brought into the EU ETS, given the failure of the International Maritime Organisation (like the ICAO before it) to broker an international deal on reducing shipping GHG emissions. Will this week’s developments, in respect of aviation, curb the Commission’s ambitions for taking on the shipping sector? The Commission of course is keen to present its decision on aviation as a victory (presenting the "concession" as only having been made after the EU has finally forced action by ICAO), but others will see this as a significant climb-down that may, at least temporarily, ease pressure on the shipping sector.

Another sector that theoretically benefits is the circa 30,000 ground-based installations that were the original members of the EU ETS, since the suspension of part of the EU ETS aviation scheme will in theory reduce demand for the EUAs they need. However, in reality, this effect is likely to be minimal and more than outweighed by the adverse impacts on the market of reduced liquidity and regulatory uncertainty.

Next steps: As of today, a technical briefing promised by the Commissioner expected to add more colour to the Commission’s proposals, has not been circulated. We will update this note when further information is available from the Commission.

This proposal from the Commission has come on the back of the EU ETS struggling, with the over supply of allowances leading to low carbon prices. Recent proposals (e.g. ‘back-loading’) and other market developments, such as the linking to the Australian scheme, indicate that the market is in a state of transition and upheaval.

As a result, investment decisions in the short term will be challenging, and small policy proposals may cause large impacts on participants who have made investments in the carbon trading market.