The aviation sector will be included in the European Emissions Trading System (EU ETS) from 2012. Directive 2008/101 will amend the EU Emissions Trading Directive (2003/87) to include aviation in the ETS. The Directive enters into force on 2 February 2009 and Member States have until 2 February 2010 to implement it into national laws.

The aerospace industry is already involved in EU ETS and was previously involved in the now defunct UK voluntary ETS after entering into a Climate Change Agreement in the UK, therefore the principle of emissions trading will already be familiar to many. As a result of the new directive, ETS will now extend to include emissions from air flights and 2010 and 2011 will be the first years when aviation operators must report emissions, if they wish to be allocated any free allowances, but the requirement to surrender allowances to account for actual emissions and tonne kilometres will begin in 2012. In 2012, 85% of all allowances for the aviation sector will be allocated free of charge, and the remainder will be auctioned. The free allowances will be allocated on the basis of the emissions for the calendar year 2010, which have to be reported to the Commission by 31 March 2011.

Allowances will be allocated between airlines according to Member States' National Allocation Plans, for the period 1 January 2011 to 31 December 2012, which must reflect the principles of non-discrimination and equal treatment. Operators will need to be vigilant that their rights to free allowances are not infringed through non-adherence to these principles, and therefore early and consistent engagement with the national authorities is advisable. From the third trading period starting on 1 January 2013, there will be a single EU-wide cap. Allowances will be allocated on the basis of harmonised rules. This means that engagement with the authorities will move from the national to the European level.

Emissions trading might appear to be a dry and technical regulatory compliance area, but experience with the first phase of the EU ETS shows that it raises important commercial issues that can end up in court. It is not just that compliance with the rules is important; participants must also ensure that their rights are not infringed by others.

Self-evidently, the potential for dispute in this area would not arise if the aviation sector retained unfettered rights to emit greenhouse gases (GHGs). However, when valuable assets become scarce, whether through operation of the market or through governmental intervention, disputes over diminishing assets may arise, and it becomes important to know your rights.

With the EU ETS, the potential for dispute is built in to the system. The principle is that over time (1) the cap on total GHG emissions should reduce – i.e. fewer allowances are allocated, so operators must either reduce their GHG emissions or buy credits to cover the excess, or pay an excess emissions penalty[1] (2) fewer allowances are allocated free of charge on the basis of historic emissions, but instead auctioned.

So far, there have been four principal types of court action:-

  • Where EU Member States have failed properly to implement the EU ETS Directive (Directive 2003/87/EC) into national law on time, proceedings have been taken by the European Commission against those Member States in the European Courts. A Member State may dispute with the European Commission the quantity of allowances which that Member State may allocate to installations within its territory.
  • Enterprises subject to the EU ETS may dispute the allocation of free allowances they receive, and the methodology by which historic emissions are measured and taken into account.
  • Enterprises subject to the EU ETS who fail to surrender the number of allowances or credits to account for their actual emissions may be required to pay a fine, which fine might then be appealed.  

The third category may be particularly instructive for the future. It is very important for an airline to get its fair share of aviation allowances, based on its historic emissions. There are two aspects of this. First, it is in the industry's interest to have the appropriate baseline from which to calculate the maximum allowances available. The Commission has used the average annual emissions in the years 2004-2006. The total allowances available in 2012 will be 97% of this total, and in 2015, 95% of this total. That much is part of the legislative deal and the Commission is due to take a formal decision on that baseline within six months of the main Aviation ETS Directive coming into force – so approximately August/September 2009, on current estimates.

The second, and more important aspect, is to ensure that each operator gets its due from the freely-allocated part of the 97%-of-baseline pot. Airlines must take part in the monitoring, reporting and verification processes (MRV) if they are to receive free allowances at all. The Commission is still developing these MRV processes, but the essential principle is to measure emissions in tonnes per kilometre, which will be independently verified. The data for 2010 will be used to base the allocation in 2012.

The crunch may come if one airline considers that it has received too few allocations, as compared to another airline. Annex III, paragraph 5, of the EU ETS Directive provides that national allocation plans shall not discriminate between companies or sectors in such a way as to favour unduly certain undertakings or activities. There is also the general EU law principle of equal treatment to consider.

Two cases outside the aviation sector have been particularly interesting. They will not in any way be precise analogues for the detailed disputes that may arise in the aviation sector, but they may nonetheless be illustrative of the types of problems that exist.

In the first, a UK cement producer "C" argued that it received too few allowances under the UK's National Allocation Plan (NAP) 2008-2012 for a particular plant, R. The question was how much of C's overall allocation for all its installations should be allocated to R, as opposed to its other allocations. The case turned in large part on the correct calculation of existing emissions. The problem was that some installations might commission new plant. Emissions from the plant during commissioning were far lower than during full use. Therefore if commissioning took up a large part of the period to be used for calculating existing emissions, it could under-state that baseline, and therefore the allocated allowances would be too few. C was successful in applying for judicial review of the DTI's decision, but unsuccessful in its substantive claim, even though the judge admitted that the "Commissioning rule" involved an element of "rough justice"[2].

Although it does not appear that the same facts could arise in the aviation sector, because the rules will be different (depending for example on how Member States implement the proposed Aviation ETS Directive into national law), there are distinct complexities within the aviation industry that may become important. For example, who precisely is an "aviation operator"? Definitions are not entirely consistent. In the UK an "operator" of an aircraft is the person who for the time being has the management of the aircraft[3]. Under the proposed Directive, the "operator" is the person who operates an aircraft at the time it performs an aviation activity, which are flights which arrive or depart from an airport situated in the territory of a Member State to which the Treaty applies. This can include the owner of an aircraft. When airlines code-share, it may become important to allocate commercial responsibility for emissions for particular flights, to cover the possibility that an aircraft might be "operated" by one company, but for the customers of another.

In the second case, a referral by France to the European Court of Justice (ECJ), Arcelor and other steel producers challenged what they considered to be discriminatory treatment. The claimants argued that the exclusion of the plastics and aluminium sectors from the original EU ETS had breached the Community law principle of equal treatment with regard to the steel sector. Specifically, the EU ETS Directive did not treat comparable sectors in a comparable way because the ferrous metals sector was subjected from the start to the legal obligations arising from the EU ETS inter alia to surrender allowances equivalent to its emissions, whereas the plastics and aluminium sectors were not. The ECJ found that there was an obligation of equal treatment, but that there was also an objective justification for not treating equally, ferrous metals on the one hand and plastics and aluminium on the other – given the step-by-step introduction of the EU ETS and the administrative complexity of introducing the whole system.[4]

You would think that a similar argument of discriminatory treatment could be made for aviation. In 2012 (the last full year of phase 2 of the EU ETS), the non-aviation sectors will receive 90% of allowances free, whereas the aviation sector will get only 85% of its necessary allowances free, decreasing to 82% in 2013, with 3% allocated towards new market entrants and rapidly growing airlines (subject to ETS phase 3 proposals to be agreed). Some might argue, that since the aviation sector receives free allocated allowances on the basis of a later baseline (2004-6) as compared to other sectors originally included in the ETS, aviation has thereby received more allowances in absolute terms, which is an unfair advantage. Could the aviation sector argue that it has not been treated equally with other sectors? Perhaps not, as it might equally be argued, following the Arcelor case, that the Commission had discretion not to introduce aviation into the ETS on the same terms as other sectors, given the difficulty of doing so – caused e.g. by the number of operators whose emissions needed to be monitored, and the methodological complexity of doing that reporting.

What happens if the UK Government decides by 31 December 2012 (after one year of aviation's inclusion within the ETS) to include emissions from international aviation as part of UK emissions? Under section 30 of the newly-passed Climate Change Act, the Secretary of State can make regulations for including emissions from international aviation subject to the overall carbon budget of achieving an 80% reduction in emissions by 2050 (against 1990 levels). Furthermore, there is power under section 44 of the Climate Change Act to introduce regulations for emissions trading schemes. Presently, the only scheme planned to be introduced is the Carbon Reduction Commitment, applying to non-energy intensive industries. However, in a quickly-evolving legal framework, the industry will need to be alert to the possibility that if international aviation emissions are included in the UK carbon budgets from 2012, the Government may consider further regulation of the aviation sector to be necessary.

The final category relates to operators, who can receive penalty notices if they fail to surrender under the ETS the proper number of allowances. In the UK, four operators have been fined. One company, Alphasteel appealed the penalty notice to Welsh Ministers. Welsh Ministers then appointed an inspector to determine the appeal. That inspector recommended that the appeal be declined, which it duly was. The inspector found that such penalties are to be regarded as "civil" rather than "criminal" matters for the purposes of the European Convention on Human Rights, Article 6 (presumption of innocence unless proven guilty, and procedural safeguards for defending against criminal charges). However, some consider the matter still to be doubtful, and it is possible that further challenges may arise to penalties on the basis that if they were to be considered in certain cases to be "criminal" further safeguards ought to apply before penalties are levied.

In conclusion, there is an important question for the aviation industry of how far existing case law under the existing EU ETS may apply to it as it joins the EU ETS. The case-law is still thin, and the decisions have turned on specific facts, but as the right to emit GHGs becomes steadily more curtailed in years to come, we may expect more disputes on who has the right to emit, and how much.