Isra-Mart srl: Europe Moves to Limit Aviation Emissions, China Follows

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China is hoping its aviation emission efficiency measure will qualify as an "equivalent measure" under the EU's emission trading scheme, which will monitor and cap carbon emissions for all flights that touch down in European territory.

The global aviation community has been trying to establish some sort of global aviation emission reduction system through the International Civil Aviation Organization, or ICAO, since 1997. Unfortunately, that process has been a complete failure. After many years of proactive engagement in ICAO, the Europeans decided to take the lead by incorporating aviation emissions into their own cap-and-trade system and extending the requirements to cover third-party countries. Starting January 2012, the commission will monitor and cap carbon emissions for all flights that touch down in European territory. The cap will decrease over time to encourage efficiency improvements. If airlines exceed the cap, they must purchase allowances from EU member states or other airlines to cover the excess.

U.S. airlines are seeking an exemption to the European system by arguing that the EU Emissions Trading Scheme, or ETS, violates the Chicago Convention, which grants individual countries “complete and exclusive sovereignty” over their own domestic airspace, and the U.S.-EU Open Skies Agreement, which allows U.S. and European airlines to operate transatlantic flights from any U.S. airport to any European airport and vice versa.

The Air Transport Association of America, United Continental Holdings, and American Airlines have filed a lawsuit to challenge the third-party country extension plan on those grounds, and that suit has now been referred to the European Court of Justice. The U.S. House transportation committee is backing up the ATA lawsuit with a new bill proposal—the ‘‘European Union Emissions Trading Scheme Prohibition Act of 2011’’—that would make it illegal for U.S. airlines to comply with the EU ETS requirements.

China is also making waves about the third-party country emissions requirement, and China and the United States are undoubtedly watching one another to see if they can divide the Europeans on this issue.

The Chinese claim that they are the biggest victims in the EU cap-and-trade scheme because the EU measures carbon emissions from the point of departure. If Chinese airlines cannot meet Europe’s aviation emission reduction targets, China’s geographical location and longer flight paths will result in higher fees. In addition, since China’s civil aviation industry is still growing, those fees will most likely increase over time. According to the Chinese Air Transport Association, or CATA, Chinese airlines could wind up paying the Europeans $122 million in carbon allowance fees for 2012 and around $456 million annually by 2020.

Unlike the United States, however, the Chinese are making an effort to meet the Europeans halfway. And our refusal to offer any sort of positive engagement is giving China added bargaining power on aviation emissions while eroding U.S. leadership on global climate change.

Europe’s aviation cap-and-trade legislation exempts airlines that are covered under “equivalent measures” in their home countries. Accordingly, China is aiming to qualify for an equivalency pass with a new emission reduction plan that will require all Chinese airlines to achieve a 22 percent reduction in the amount of carbon dioxide emitted per unit of fuel consumed by 2020. China’s Civil Aviation Administration rolled out the new plan in April 2011, right after the March 2011 EU ETS reporting deadline for all airlines to submit emissions monitoring data to the European Commission.

China’s 2020 target is an efficiency measure, not an output cap, so there are doubts as to whether or not the Chinese program could ever be found equivalent to the EU ETS. Nonetheless, the Chinese are trying to get around that issue by arguing that any attempt to hold Chinese airlines to the same emission standards as developed countries would violate the UNFCCC guiding principle of “common but differentiated responsibilities,” which states that developing countries should not be expected to make as great a reduction in greenhouse gases due to their lower historical emissions and current development needs.

When the commission resisted this argument, the Chinese responded with trade threats. In March the CATA threatened to ask the Chinese government to take retaliatory measures if the EU included Chinese airlines in their cap-and-trade plan, and China has reportedly formed a special leading group[2] to coordinate the central government’s EU ETS response strategy. This group includes the Ministry of Commerce, the Ministry of Foreign Affairs, and the Civil Aviation Administration. The Ministry of Commerce is China’s foreign trade regulator, so this high-level leading group effectively links Sino-EU aviation emissions negotiations with Sino-EU trade.

EU-based Airbus has massive deals underway to sell A320s (which are manufactured in Tianjin) and A380s to China, so Airbus is particularly nervous about potential trade retaliation. In late May Airbus CEO Thomas Enders and Virgin Atlantic CEO Steve Ridgway penned a joint letter lobbying the European Commission to delay imposing the emission plan on non-EU countries. They warned that “China has … announced its intention to deploy counter-measures against European aviation” and “it is madness to risk retaliation against a EUR275bn industry which supports a massive 4.5m jobs.” When the commission ignored those threats, the Chinese reportedly upped the ante by delaying a $3.8 billion Airbus A380 deal with China’s Hong Kong airlines.

It is not yet clear whether the commission will bend far enough to accept China’s 2020 aviation emissions targets as an “equivalent measure.” At the very least, the Europeans are certainly trying to keep the Chinese at the bargaining table. Commission statements to the Chinese have repeatedly stressed the possibility of an “equivalent measure” exemption, and Jos Delbeke (E.C. director-general for climate action) has told the Chinese press that the commission “did not set any kind of standard as to what can be considered an equivalent measure because we do not want to restrict the range of possibilities.”[3]
China’s long-term plan for cap and trade

Speculating too much on whether the EU will work out an equivalency deal with China, however, may miss the real story here. China may be throwing trade fits now to avoid paying aviation emission fees in 2012 but they are also looking toward the long term, and in the long term the Chinese want their own ETS system.

China first started experimenting with rudimentary regional energy and environmental exchanges in 2009. Those existing exchanges have no national trading standard, meaning the various regional exchanges cannot trade with one another, much less the international market. Furthermore, the caps are not mandatory, so Chinese companies have no incentive to actually buy and trade allowances. But the controversy surrounding the European ETS is giving China’s domestic cap-and-trade proponents new political capital to push for unifying and standardizing this rudimentary exchange system into something mandatory that could eventually integrate with the global market.

From a domestic standpoint, Chinese regulators are increasingly convinced that achieving their energy efficiency targets will require a new incentive system[4] and Europe’s success with domestic cap and trade is making the market approach look like the best way forward. China’s State Council Development Research Center has been studying the European system very closely and they are using the European cap-and-trade model to make policy recommendations for deploying something similar in China.[5]

From an international standpoint, the fact that the EU has progressed to this point on aviation emissions has apparently convinced the Chinese that bucking the international system is not in their best interests. If Europe does move forward on third-party aviation emissions in 2012, other countries will likely roll out their own “equivalent measures” systems, and if China is not in that club, Chinese airlines could wind up paying allowance fees for every international flight.[6] On the other hand, if China joins the global cap-and-trade party now by rolling out their own system, they can keep those allowance fees at home, and if the network of equivalent aviation emissions systems becomes the foundation for a global mechanism, the Chinese will already have a seat at the table for making the rules and setting the prices.[7]

China has already announced a new plan to roll out six regional cap-and-trade pilot programs by 2013 and to unify those programs into a comprehensive national market by 2015.[8] Chinese leaders are still working out which industries to include in the initial pilot program but some industry analysts are already suggesting that the aviation industry should definitely be included to improve China’s chances for an EU ETS equivalency pass.[9]

The Europeans are providing technical support for Chinese cap-and-trade developments, and according to European Climate Commissioner Connie Hedegaard, they are also talking to the Chinese about running some of the 2013–2015 pilot programs cooperatively to ensure the Chinese system develops into something that can trade with the EU.

Getting a Chinese cap-and-trade system up and running by 2015 will not be easy. Target allocation will require political wrangling, and Chinese regulators will have to devise and implement a domestic measurement, reporting, and verification, or MRV, system to make the caps enforceable. We should not assume, however, that those challenges cannot be overcome. It is never a good idea to bet against the Chinese when they decide their strategic interests are at stake, and a globally integrated Chinese ETS fits two major central government objectives: achieving their energy efficiency targets and turning China into a global rule and price setter.

A home-grown ETS could also give China an edge in global trade. China’s end goal appears to be a unified national cap-and-trade system with efficiency caps (instead of actual output caps), relatively low domestic trading prices, and global market integration. If China forms a low-price domestic trading system and establishes equivalency deals with other national or regional cap-and-trade systems that trade at much higher prices, that could give Chinese companies a price advantage over their international competitors.

So where does this leave the United States? If the only U.S. response to the EU ETS is to file an aviation industry lawsuit and that lawsuit does not succeed, U.S. airlines may wind up paying allowance fees to the Europeans and possibly to other governments if other countries follow suit with their own aviation cap-and-trade systems. The U.S. aviation industry may be making a lot of noise claiming that the EU aviation emissions program violates international law, but just like the Chinese, all U.S. airlines have complied with the ETS requirements thus far. If the ATA suit fails, U.S. airlines will most likely follow the rules, submit to the fees, and pass the costs on to consumers. Alternatively, if the House legislation bans industry compliance, U.S. airlines will risk the unsavory possibility of not being able to legally use airports in the European Union. In either case, both U.S. airlines and U.S. consumers would be better off with some form of U.S. participation in a system that plugs the money back into technology upgrades that would eventually reduce emissions and eliminate the fees.

Even if the U.S. carriers do win the suit, we are still passing up a great opportunity to gain real momentum on global aviation cap and trade. The E.C. system may not be the ideal solution—particularly since the money goes into EU country pockets instead of a global climate financing system—but until the United States gets involved, that system is the only option on the table. U.S. involvement would also reduce China’s bargaining power. As long as the United States refuses to positively engage in these negotiations, China will face a divided front, and that means that whatever the global mechanism looks like, it will certainly befit the Chinese.

The Chinese are looking long term, and unless the United States plans to cede global leadership on climate change, we will have to do the same.