EUAA trading should not be grounded (Source: David McKelvey)

Trading in the latest type of carbon credit, EU aviation allowances (EUAAs), has begun despite remaining doubts as to the viability of the new market, which have been exacerbated by diplomatic turmoil. The requirement that all airlines, including non-EU operators, comply with the EU ETS has provoked resistance from a number of key countries. It has also raised questions as to the regulatory wisdom of creating a market in emissions allowances where liquidity and price levels remain challenging to maintain.

Regulating aviation under the EU ETS

Under the EU ETS, all airlines flying from and to airports situated in the EU will be obliged to surrender allowances corresponding to their levels of flight emissions. Crucially, this obligation extends to non-EU airlines. The move to include aviation in the EU ETS brings the sector in line with the others covered by this environmental regulatory regime, such as energy and metal production industries. The inclusion of aviation in the EU ETS will require airlines to buy and sell emissions allowances in the market in order to ensure that they hold them in sufficient numbers for the purposes of surrender.

Political opposition

The UNFCCC and the International Civil Aviation Organisation (ICAO) have long supported the regulation of aviation emissions through trading, but no global agreement has yet been reached in this respect. The EU’s decision to unilaterally regulate this sector under the EU ETS represents the first practical expression of a focused effort to accelerate the creation of a global mechanism to reduce aviation emissions.

[long_ad_left]The brave step taken by the EU has not been without controversy. Notable jurisdictions such as the US, China and India have been particularly vociferous in opposing the extension of the EU ETS to their airlines. In particular, the US brought legal action arguing that the extension contravened a number of international agreements, namely the Chicago Convention, the Open Skies Agreement and the Kyoto Protocol. The European Court of Justice (ECJ) held that the EU’s move complied with the relevant agreements and did not infringe the sovereignty of the affected states. However, the judgment did not mark the end of the dispute, since US airlines continue to oppose the trading scheme.

A new market in allowances

The first exchange trade in EUAAs took place on 27 February 2012, and was carried out by Vertis Environmental Finance, a specialised environmental commodities broker, on the ICE exchange. It is early days yet, but other firms’ interest in EUAA trading will be indicative of the levels of liquidity that can be expected in this fledgling market. ICE Futures Europehas expressed its confidence in the EUAA market by launching a form of futures contract with allowances as the underlying product. Interest has also been expressed by other trading platforms, notably the European Energy Exchange (EEX) and BlueNext.

However, uncertainty as to the degree of participation in the scheme by non-EU airlines renders it harder for financial entities to ascertain the value of becoming involved in the EUAA market. China, for instance, has announced that its airlines are banned from complying with the EU ETS. It is unclear what practical steps the EU could take in international law in order to achieve compliance; the problems of monitoring and enforcement have been highlighted in an earlier Climatico post. This situation is markedly different from the beginnings of the EU ETS and its application to EU industrial operators, which was not faced with such serious jurisdictional challenges.

Saving EUAA trading

Active participation in the market is absolutely crucial to the success of the EU ETS to reduce emissions in the aviation sector. Low levels of liquidity would equal low EUAA prices and therefore little incentive for operators to reduce their emissions as opposed to simply continuing to purchase allowances in the market.

International opposition to the application of the scheme to non-EU airlines could potentially be very damaging. Such refusal to participate could drive away financial traders and substantially shrink the market in EUAAs while it is still in its incipient phase. Until the EU can achieve some degree of international cooperation, or at least a diminution in opposition, it is difficult to see how its environmental regulation can be enforced against unwilling parties.

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