2001 IATA Arthur Andersen

© Arthur Andersen, 2001.

International Air Transport Association

Emissions trading for aviation

Workstream 3: Key findings and conclusions

Contents

EXECUTIVE SUMMARY

1 DRIVERS FOR A POTENTIAL AVIATION EMISSIONS COMMITMENT ............................................... 1

2 EMISSIONS TRADING AS A TOOL TO MEET AVIATION EMISSIONS COMMITMENTS .................. 9

3 DESIGNING AN EMISSIONS TRADING SCHEME SUITABLE FOR AVIATION.................................. 12

4 KEY POLICY FINDINGS .............................................................................................................................. 18

5 ASSESSMENT OF OPTIONS FOR SCHEME DESIGNS – BY DESIGN ELEMENT................................ 26

APPENDIX 1: ANALYSING EMISSIONS TRADING SCHEMES ..................................................................... 3 9

APPENDIX 2: SELECTED BIBLIOGRAPHY ..................................................................................................... 4 3

Disclaimer: This Report has been prepared under a contractual agreement with the International AirTransport Association. It has been written as a contribution to the ongoing industry discussions and toprompt debate concerning a potential international aviation emissions commitment. However, in thecircumstances, no responsibility or liability for loss occasioned to any person acting on or refraining fromaction as a result of the material in this report can be accepted by Arthur Andersen. As a consequence, it isrecommended that specific professional advice is sought before any action is taken.

Executive Summary

The International Air Transport Association (IATA) commissioned Arthur Andersen (“Andersen”) toundertake a study on the potential for greenhouse gas (GHG) emissions trading schemes involvingthe international air transport sector. This report summarises findings and conclusions from the firsttwo phases of the project (Workstream 1: policy and stakeholder perspectives; and Workstream 2:economic analysis). The report is a discussion document that seeks to contribute to ongoingdiscussions and debate within the international aviation community of a potential internationalaviation emissions commitment.

Designing an emissions trading scheme suitable for aviation

The format of the project is detailed in chapter 3. It commenced with a review of literature relevantto aviation emissions commitments, complemented by an analysis of lessons learnt from selectedemissions trading schemes and emissions trading theory (sections 3.2 and 3.4). These formed thebasis of a background policy report. An expert panel – comprised of senior industry or emissionstrading figures - was also established to provide a critical review of key selected inputs and outputs(section 3.3). Stakeholder perspectives were conveyed at a stakeholder workshop in April 2001,and captured in a workshop report (section 3.5). Key issues were then subjected to economicanalysis, which provided new analysis, taking into account existing economic studies (e.g. theInternational Civil Aviation Organisation’s Forecasting and Economic Support Group) and usingexisting economic models (AERO) (section 3.6).

Drivers for a potential aviation emissions commitment

This report starts by assessing the potential drivers for an international aviation emissionscommitment (chapter 1). It outlines the goal and challenge of sustainable aviation, stressing theeconomic significance of the air transport industry and recognising that the predicted growth in airtravel will be accompanied by an increase in fuel use, and thus also an increase in GHG emissions(section 1.1).

The report identifies Article 2.2 of the Kyoto Protocol to the United Nations Framework Conventionon Climate Change (UNFCCC) as the key regulatory driver for a limitation on GHG emissions frominternational aviation, and details UNFCCC efforts to allocate international aviation emissions toParties. It briefly assesses the likelihood of the Kyoto Protocol entering into force – which wouldactivate the Article 2.2 commitment on aviation – and suggests that, even if the Kyoto Protocolwere to disappear, there would be strong pressure for a wider dominant agreement that woulddrive an aviation emissions commitment in a similar fashion to Kyoto (section 1.2).

The role of the International Civil Aviation Organisation (ICAO) in determining the nature of anyinternational aviation emissions commitment is discussed; there appears to be significantmomentum within ICAO to respond to the mandate given to it by the UNFCCC through the KyotoProtocol. The upcoming ICAO Assembly is expected to give a clearer indication of its intended roleand status (section 1.3).

Other potential drivers are also assessed (sections 1.4 – 1.6). The European Union may play a keyrole (section 1.4). Initiatives such as the European Climate Change Programme or the proposedEuropean Community emissions trading scheme may impact aviation emissions in the mediumterm. In the shorter term, there is significant potential for the EU to take unilateral action to restrictinternational aviation emissions, while the implications for intra-EU aviation of the EU’s Kyoto

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Protocol “burden-sharing” agreement remain to be decided. The impact of national level drivers -such as national climate change mitigation strategies – are equally unclear, but are thought tocurrently pose little threat to the industry (section 1.5). The same applies to international driversother than UNFCCC/ICAO, namely the guidelines for ‘environmentally sustainable transport’agreed by the Organisation for Economic Co-operation and Development (OECD), UNCommission on Sustainable Development (CSD), and the World Health Organisation (WHO)(section 1.6).

Emissions trading as a tool to meet aviation emissions commitments

Chapter 2 summarises the merits of emissions trading as a tool to meet aviation emissionscommitments. It relates the limitations, as assessed by ICAO, of the main possible options forachieving such a commitment: technology and standards, operational measures, market-basedoptions and voluntary initiatives (section 2.1). Noting the endorsement given in the ICAO Councildraft assembly Resolution for the development of an open emissions trading system, the reportthen provides a brief primer for emissions trading (section 2.2). It then identifies emissions trading’sthree key benefits: enabling emission reductions to be made at the lowest cost; offering thepotential to make emission reductions outside the industry; and allowing greater certainty over theachievement of environmental objectives (section 2.3).

Key policy findings

Chapter 4 identifies the key policy findings that resulted from the policy and stakeholder analysis inparticular. It is suggested that these guiding principles are likely to provide the framework for thedevelopment of an industry position regarding any aviation emissions trading scheme. Elevenbroad principles are identified, summarised below.

The first three principles relate to the drivers outlined in chapter 1. The Kyoto Protocol is thought tocurrently be the only regulatory driver for an aviation emissions limitation; but if the Protocol wereto collapse, UNFCCC - and perhaps other frameworks - would remain (section 4.1). It isconsidered that international aviation is very likely to be required to limit or reduce its greenhousegas emissions, most probably from 2013, but possibly from 2008. To this end, it is suggested thatthe industry will need to agree its position by the 34th ICAO Assembly in 2004, given thatnegotiations for the second commitment period (2013-2017) start in 2005 (section 4.2). Finally, theEuropean Community is thought likely to provide a regulatory driver, but other internationalprocesses are less potent forces (section 4.3).

Several key principles relate to the framework for any international aviation emissions commitment.It is suggested that retaining the international aviation emissions framework within ICAO mayenhance industry influence, but risks jeopardising access to the Kyoto mechanisms (section 4.4).There are thought to be good reasons to grant the industry special consideration, but not all wouldjustify lenient treatment, and they would risk the removal of access to Kyoto credits (section 4.5). Itis considered that any commitment is likely to be on Governments (probably UNFCCC Parties, butpossibly ICAO Member States), who then have the option to devolve this commitment to aviationentities (probably principally to airlines) (section 4.6).

It is suggested that the industry needs to consider whether it prefers a stand-alone target or atarget integrated into national assigned amounts. The latter case would be likely to result in avariety of implementation methods, and it is suggested that this would call for an overarchingstructure or guidance, perhaps through ICAO (section 4.7). Finally, it is recognised that it would bedesirable from an equity and environmental perspective to have global participation in any aviationemissions commitment, but warned that such an outcome may be politically difficult to achieve(section 4.8).

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The final set of key principles relate to the nature of emissions trading as an aid for internationalaviation. Given the industry’s high growth expectations, emissions trading is thought likely to be anappropriate tool to help meet emissions reduction commitments (section 4.9). An “open” emissionstrading system is shown to be a ‘no brainer’, but it is noted that being open to trade with othersectors means accepting relevant trading rules (section 4.10). Finally, it is suggested that there areadvantages in preparing for a mandatory commitment with a voluntary trading scheme (section4.11).

Assessment of options for design of an aviation emissions trading scheme – by designelement

Emissions trading schemes can be deconstructed into individual design elements (see Appendix).Workstreams 1 (policy assessment) and 2 (economic analysis) provide the basis for theassessment in Chapter 5 of options for each design element – in the international aviation context.The report discusses options for four ‘primary’ design elements and nine ‘secondary’ designelements.

Primary design elements

A key question is whether an aviation emissions trading system should be “open” (to credits andallowances from outside the system, presumably from activities under the UNFCCC) or “closed”(i.e. no access to such credits) (section 5.1). The open system concept has attracted wide supportand appears to be acceptable from a policy – and political – perspective. Economic analysisconfirms that an open scheme would more effective for meeting an emissions commitment: permitprices under a closed scheme could be perhaps 10 to 20 times higher than under an openscheme. However, it is noted that being open to another scheme entails developing rulescompatible with that scheme, or adopting that scheme’s rules.

Each of four types of trading scheme (‘cap and trade’, ‘baseline and credit’, ‘cap, credit and trade’,and the ‘performance standard’ approach) have their merits in an aviation context (section 5.2). Fora mandatory scheme and for the sake of simplicity, cap and trade would seem the mostappropriate approach. But it may be too rigorous to encourage participation in any voluntaryscheme. Baseline and credit would probably give reasonably good environmental assurance, butwould be less conducive to promoting market liquidity. A performance standard (or “carbonintensity”) approach, with permits allocated on the basis of fuel efficiency per unit of activity, wouldbe hard to negotiate. However, it may have merit, particularly for a voluntary scheme ahead ofmandatory requirements. Among other advantages, it should enable continued industry growthwhile incentivising energy efficiency.

The ‘extent’ of an aviation emissions trading scheme (section 5.3) covers several issues. Theseinclude: whether commitments should be imposed on countries or industry entities; which countriesshould face commitments (e.g. developed and/or developing countries; ICAO member states orUNFCCC Parties); and which industry sectors might expect to face commitments.

Under an intergovernmental framework (e.g. UNFCCC or ICAO), commitments can only beassigned to sovereign states (i.e. countries that are signatories to the relevant agreement).Thereafter, governments are entitled to devolve such commitments to legal entities, so theeventual impact is likely to be felt at entity level.

A commitment could be imposed on either ICAO member states or UNFCCC Parties. ICAO hasbeen delegated responsibility for international aviation emissions, while the UNFCCC retainsultimate authority. An ICAO framework might maximise industry influence and offer the potential forwide geographical coverage. But it might reduce prospects of access to the Kyoto mechanisms(which are under the UNFCCC framework and rules). In the longer run, acceptance of theUNFCCC framework may be beneficial.

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The UNFCCC framework currently limits commitments to developed countries. However,participation by developing countries in an international aviation commitment would beenvironmentally beneficial and would probably help mitigate competitive distortions betweencountries’ air transport industries (the result of imposing additional costs on one airline on a routeand not others). A route-based scheme, with equivalent commitments on all airlines (from allcountries) flying that route, would avoid such distortions. However, it is politically unrealistic toexpect developing countries to accept commitments in the short term. Doing so would contravenethe Rio Declaration principle of “common but differentiated responsibilities”, and would requiredisassociation of international aviation emissions from the UNFCCC timescale for the adoption ofdeveloping country commitments.

There is a general presumption that airlines would be best positioned to receive commitments, asdevolved from Governments. They are generally considered to have the greatest control overtechnology deployment and aircraft operations. However, it is too early to exclude discussion ofcommitments on other industry sectors (i.e. manufacturers, fuel providers, and Air Traffic Control(ATC) providers), whether in combination with, or in place of, airline commitments. Of these, themost likely recipients would seem to be fuel- and ATC-providers. Commitments on fuel providers –with permit-paid fuel sold onto airlines – would offer efficiency advantages, but could make airlinessubject to price risks that they would currently be unable to hedge. ATC providers could takeresponsibility for emissions associated with ATC delays and indirect routing, which result inincrease in emissions outside airline control (‘excess’ emissions).

There is no clear choice for permit distribution (section 5.4). Both grandfathering and auctioninghave their advantages.

Grandfathering forms the basis of most existing emissions trading schemes. Premised on gratisallocation, it is more likely to win industry buy-in. Caps are based on historical or present levels ofactivity, so are equitable to participants. However, it is hard to integrate new entrants equitably,there is potential for ‘gaming’, and free allocation of excess allowances risks contravening ‘stateaid’ regulations. Auctioning has economic advantages. It forces participants to focus on their actualneeds and attaches a value to these needs. It enables equitable participation of new entrants.Auction revenues could be recycled to the industry. With a permit price of $50/tCO2, some $17billion pa could be available in 2010 – e.g. for R&D into emissions-reducing technology or for ATCimprovements. However, auctioning imposes an immediate cost which risks deterring participation.

Enabling the participation of new entrants on a fair and equally competitive basis is important. Thiscould be done by grandfathering (from a ‘credit reserve’) on the basis of expected future activitylevels or by adopting a performance standard approach to grandfathering.

While some form of grandfathering would seem more logical from a policy perspective, economicanalysis suggests a preference for auctioning. A combination approach may be appropriate. Oneoption would be for Governments to grandfather the majority of permits, but retain a credit reserveto cover unforeseen eventualities in the rapidly growing industry, new entrants and perhaps forATC, and to auction for ‘over-emitters’ (this sending a price signal, promoting liquidity, and raisingrevenue).

Secondary design elements

The report also discusses the identified ‘secondary design elements’ in an aviation context.

On gases to be covered, there is strong rationale for restricting a commitment (and thus trading) toCO2, in the short term at least. Once “Global Warming Potentials” for other aviation GHGs havebeen determined, they too could be integrated into commitments, providing this is given legalbasis, not currently being listed in Annex A of the Kyoto Protocol (section 5.5).

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A system of seller liability would probably be of most benefit to the industry, as a likely net buyer,and would also facilitate compatibility with the wider carbon market (section 5.6).

To increase market and public confidence in the validity of emissions reductions from aviation andto enable wider carbon market compatibility, there are advantages in the industry adopting aninternationally accepted monitoring, verification and reporting protocol, consistent with UNFCCCprovisions, complemented by aviation-specific requirements. The standards could be applied byinternationally or nationally accredited independent verifiers (section 5.7).

A variety of institutional forms will needed to facilitate and regulate the international carbon market(e.g. registry, emissions allocating authority, regulatory body, independent verifiers, tradingplatform). They will represent a significant cost, and require suitable infrastructure and knowledge.Under a UNFCCC framework, the industry could ‘piggyback’ on national and internationalinstitutions that would be developed to facilitate wider emissions trading. Under an ICAOframework, ICAO and other industry bodies would need to establish and pay for their owninfrastructure. Under a voluntary trading initiative, the industry would need to balance the need forinstitutions with their cost (section 5.8).

A trading system may have full, limited or no “banking” of emissions allowances or credits from onecommitment period to the next. The industry ought to weigh up the flexibility and incentive for earlyaction provided by banking against its potential for hoarding, which might lead to market pricedistortions. Unlimited banking is likely to be preferable, and is likely to be compatible with UNFCCCprovisions (section 5.9).

‘CO2-equivalent’ is the most widely recognised and adopted permit denomination. Its use in anaviation scheme seems sensible for both commodity trading and compliance (section 5.10).

Trading systems require clearly defined rules. Under a UNFCCC framework, the industry would besubject to UNFCCC rules. In a voluntary scheme or under an ICAO framework, the industry maydevelop its own trading rules. The most appropriate form for the rules of action should be clearerafter agreement on the nature of the commitment and trading system. There could be advantagesin ensuring that rules are compatible with relevant UNFCCC provisions (section 5.11).

Penalties for non-compliance are standard for trading schemes. Under a UNFCCC framework, theindustry would be subject to UNFCCC–derived non-compliance provisions. Under an ICAOframework, ICAO may develop its own penalties. In a mandatory scheme, penalties could besufficiently rigorous to substantially exceed the benefits of non-compliance. In a voluntary scheme,penalties could be modest or absent, aiming to promote participation, not punish non-compliance(section 5.12).

Financial incentives are sometimes offered to entice participation in voluntary schemes. Given highabatement costs, any financial incentive for a voluntary aviation scheme would probably need to bevery high to elicit participation from entities who would not otherwise participate (section 5.13).

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1 Drivers for a potential aviation emissions commitment

1.1 The challenge: sustainable aviation

This chapter establishes the context for an aviation emissions trading scheme, and outlines someof the challenges facing the industry in achieving sustainable aviation1.

The chapter starts by summarising the global significance of the air transport industry, then detailsits growth and the consequent rise in aviation emissions. It describes key drivers shaping thecourse of development of the aviation sector, as well as the recent responses of the sector to thenew environmental challenges posed by potential carbon-constraints.

The air transport industry plays a major role in global economic activity. In 1998, the industry’sown turnover was estimated to be US$307 billion2. But the industry has far wider significance. Ithas contributed to the rapid growth in international trade over the last few decades by making itcheaper and quicker to move products and personnel across vast distances. Over 1,600 millionpassengers per year rely on the world’s airlines for business and vacation travel; by 2010, theworld’s annual gross output from tourism is expected to be around US$6,800 billion3. In 1998 over29 million tonnes of freight were transported by air, representing 40% of the monetary value of theworld’s manufactured exports. In all regions of the world, companies and countries depend on theaviation industry to stimulate their economic growth.

The economic contributions of the air transport industry are under pressure from newcommitments in the imminent carbon-constrained marketplace. The industry is under pressure torestrict or reduce its contribution to climate change. Yet the predicted growth in air travel (IPCC4

predict a 5% increase in passenger travel from 1990-2015), will be accompanied by an increase infuel use (IPCC predict a 3% increase over the same period), and thus an increase in carbondioxide (CO2) emissions (IPCC’s future scenarios suggests an increase by 2050 of 1.6-10 timesthe 1992 value). If aviation does not rise to meet the challenge of sustainability in this newenvironment, not only will its own opportunities for growth be stunted, but so will those for manyother industries, and countries across the globe.

1.2 UNFCCC, the Kyoto Protocol and aviation

The ultimate objective of the United Nations Framework Convention on Climate Change(UNFCCC), signed in 1992, is “to achieve… the stabilisation of greenhouse gas concentrations inthe atmosphere at a level that would prevent dangerous anthropogenic interference with theclimate system”. The UNFCCC commits developed (or “Annex I”) countries to: “adopt nationalpolicies and take corresponding measures on the mitigation of climate change, by limiting itsanthropogenic emissions of greenhouse gases and protecting and enhancing its greenhouse gassinks and reservoirs” (sub-paragraph 4.2(a)). This commitment was expanded by those countries’acceptance of legally binding quantified emission limitation or reduction commitments (QELRCs)through the 1997 Kyoto Protocol.

1 ATAG (2000) Resolution on Sustainable Aviation. Air Transport Action Group. Defines “sustainable aviation” as the commitmentto meet the growing demand of passengers and shippers in a sustainable manner; maintaining an optimal balance betweeneconomic progress, social development and environmental responsibility”.2 ATAG (2000), The Economic Benefits of Air Transport. Air Transport Action Group.3 ATAG (2000) Resolution on Sustainable Aviation. Air Transport Action Group4 IPCC (1999) IPCC special report: aviation and the global atmosphere – summary for policymakers. Intergovernmental Panel onClimate Change.


Article 2.2 of the Kyoto Protocol is currently the only regulatory driver for the limitation ofgreenhouse gases (GHGs) from international aviation. The UNFCCC framework currently treatsdomestic and international aviation emissions separately. Emissions from domestic flights arerecorded in national inventories, using the 1996 revised IPCC Guidelines5 (see UNFCCC decision2/CP.3) and are included in Annex I Parties’ assigned amounts under the Kyoto Protocol. WhereAnnex I Parties’ domestic aviation emissions form a considerable proportion of the country’s totalGHG emissions, it can be expected that their programmes to implement the Kyoto Protocol willinclude measures to limit or reduce emissions from domestic flights.

Parties are required to report emissions from international flights separately, but the proceduresfor doing so (i.e. for establishing which country ‘owns’ which emissions for which flights) have notyet been established. International aviation emissions are thus not included in assigned amounts,and are not yet subject to Parties’ limitation or reduction commitments. Article 2.2 of the KyotoProtocol requests Annex I Parties to pursue aviation emission reductions or limitations throughICAO. It is generally understood that this relates to international aviation emissions – domesticaviation emissions being incorporated into Annex I Parties’ assigned amounts. Article 2.2 reads:

The Parties included in Annex I shall pursue limitation or reduction of emissions ofgreenhouse gases not controlled by the Montreal Protocol from aviation and marine bunkerfuels, working through the International Civil Aviation Authority and the InternationalMaritime Organization, respectively.

The UNFCCC Subsidiary Body for Scientific and Technological Advice (SBSTA) has been taskedwith providing advice on the merits of eight options6 for allocating international aviation emissionsto Parties. Three of the eight options have been discounted by Parties7, leaving five options on thetable8.

An initial assessment of the implications of these options for likely allocated emissions totals for 23Parties has been carried out for the Dutch Government9. With reference to the remaining options,it concluded10:

• allocation by country of aviation fuel sales would allocate a comparatively large share of globalinternational emissions to countries with a relatively well-developed aviation industry (in termsof number of departing flights), e.g. holiday countries such as Greece, Portugal and Spain;

• allocation by country of aircraft departure/destination and allocation by country of RTKdeparture or destination would give results similar to the allocation by country of fuel sales;

• allocation by airline nationality would allocate substantially more emissions to countries thanunder most other options.

5 J.T. Houghton, L.G. Meira Filho, B. Lim, K. Treanton, I. Mamaty, Y. Bonduki, D.J. Griggs and B.A. Callender, eds (1996) Revised

1996 IPCC Guidelines for National Greenhouse Gas Inventories. Intergovernmental Panel on Climate Change.6 UNFCCC (1996) Methodological issues: emissions resulting from fuel used for international transportation. Note by theSecretariat. Documents FCCC/SBSTA/1996/9/Add.1 and Add.2.7 UNFCCC (1999) FCCC/SBSTA/1999/20.8 The remaining options are: allocation to Parties where fuel sold; allocation to Parties according to country flag of operator;allocation to Parties according to country of departure/destination (or shared) of aircraft; allocation to Parties according to countryof departure/destination (or shared) of passenger/cargo; no allocation.9 A. Van Velzen and R.C.N. Wit (2000) National allocation of international aviation and marine CO2 emissions. Studycommissioned by the Dutch Civil Aviation Authority: Delft.10 The conclusions are subject to the caveat that they had been based on incomplete and frequently incompatible data sets.


The timing of any international aviation emissions commitment is uncertain. Article 2.2 does notspecify a timeframe for international aviation emissions. No target can be negotiated until theallocation mechanism (see preceding paragraph) has been resolved. The ICAO ExecutiveCommittee has recommended the ICAO 33rd Assembly adopt a resolution “aiming atimplementation in the first commitment period”11. However, there appears to be a general beliefthat time has probably run out to negotiate any specific commitment for 2008-12 (the firstcommitment period), given that negotiations for the second commitment period (probably 2013-2017) are due to commence in 2005. Any restriction on international aviation emissions wouldmost likely be incorporated into Parties’ targets for this second commitment period – providing theUNFCCC Subsidiary Body for Scientific and Technological Advice (SBSTA) has agreed itspreferred allocation mechanism ahead of 2005.

Some argue that no international aviation emissions commitment is likely, because the KyotoProtocol will not enter into force. To do so, the Protocol must be ratified by not less than 55countries which accounted for at least 55% of the carbon dioxide (CO2) emissions from thedeveloped (Annex 1) countries in 1990. Without the US, the Protocol’s entry into force will requireratification by the EU, its accession countries and Russia – plus either Japan or a groupcomprising Canada, Australia, New Zealand and the former Soviet countries. If both the US andRussia fail to ratify, the Protocol cannot enter into force.

Following the political agreement reached by 178 Parties at the resumed Sixth Conference of theParties to the UNFCCC (“CoP6bis”), the prospects for entry into force are far higher than earlier inthe year – when the Protocol was rejected by the United States as being “fatally flawed”. Althoughentry into force is far from certain, there have been several indications that the compromiseagreement12 may be sufficient for most Parties to ratify: the Canadian Prime Minister, the EUCommissioner and other EU officials, plus the Japanese Environment Minister have allsubsequently reiterated their intention to ratify in 2002. This has led the ICAO ExecutiveCommittee to consider that “it now appears likely that the Kyoto Protocol could enter into force in2002”13.

However, were the Protocol not to enter into force, it is unlikely that the driver for an internationalaviation emissions commitment would disappear. The UNFCCC’s commitments (see, e.g., Article4.2 above) would still be binding on Parties. There would be strong pressure for a wider, dominantagreement (perhaps a ‘son of Kyoto’) or regional (e.g. EU) initiatives driven by the spirit of Kyoto;such a scheme would drive aviation emissions trading rules in a similar way to theUNFCCC/Kyoto Protocol. There is likely to be increasing public pressure to assume acommitment; non-governmental organisations dedicated considerable attention to the issue atCoP6bis14. And there is still the potential for an international driver through ICAO (see section1.2).

11 ICAO (2001) Agenda item 14: environmental protection. Updating of resolution A32-8: consolidated statement of continuing

ICAO policies and practices related to environmental protection. Document A33-WP/43, for consideration by the ICAO Assembly33rd session, September 2001. The proposed ‘resolution framed by the Executive Committee and recommended for adoption bythe Assembly’ reads and Appendix I on Market-based measures regarding aircraft engine emissions): “Endorses the developmentof an open emissions trading system for international aviation aiming at implementation in the first commitment period (2008-12)subject to entry into force of the Kyoto Protocol”.12 Enshrined as UNFCCC document FCCC/CP/2001/L.713 ICAO (2001) Agenda item 14: environmental protection. Updating of resolution A32-8: consolidated statement of continuing

ICAO policies and practices related to environmental protection. Document A33-WP/43. Paragraph 2.2.14 see the article “Aviation emissions: fix the celestial loophole” in the influential Climate Action Network newsletter Eco volumeCVI, issue 9, circulated at Bonn.


1.3 ICAO

Through Article 2.2, ICAO has been mandated by the UNFCCC to pursue limitation or reduction ofGHG emissions from aviation bunker fuels that are not controlled by the Montreal Protocol.ICAO’s Committee on Aviation Environmental Protection (CAEP) has been addressing the issue.The findings presented at, and conclusions arising from,CAEP/5 (held in January 2001) wereaccepted by the ICAO Council in June 2001. Based on CAEP’s findings and conclusions, theCouncil presented its proposals – in the form of a draft Assembly Resolution - to the 33rd ICAOAssembly in September 2001. The UNFCCC Secretariat has subsequently invited Parties toprepare for “a detailed discussion at the fifteenth session of the SBSTA” 15 (October 2001).

Key elements of the draft Assembly Resolution – in relation to aviation emissions16 - include:

• acknowledgement of the “polluter pays principle”, balanced by a recognition of “an emissionstrading system or voluntary measures… in the context of controlling greenhouse gasemissions”;

• recognition of the “potential advantages of harmonizing treatment of domestic and internationalaviation emissions” and encouragement to [ICAO] States to “strive to take action in aconsistent manner to both domestic and international aviation emissions”;

• acknowledgement that “some [ICAO] States are already taking action to design options forreducing… domestic aviation emissions”;

• reiteration of the Council recommendation that any emissions-related levies be in the form ofcharges rather than taxes and that the funds collected “be applied in the first instance tomitigating the environmental impact of aircraft engine emissions”;

• recognition that CAEP has shown open emissions trading to be “a cost effective measure tolimit or reduce carbon dioxide emitted by civil aviation in the long-term and to respond to thecommitments of the Kyoto Protocol”;

• recognition that “in the short term, voluntary measures (industry initiatives and negotiatedagreements) could serve as a first step towards future actions to further reduce emissions”;

• a request that the Council provide advice to States on the application of market-basedmeasures;

• a request that the Council “develop concrete proposals… so that advice can be provided assoon as possible” to the UNFCCC CoP;

• a request to States to “refrain from unilateral action to introduce emissions-related leviesinconsistent with the current guidance”;

• endorsement of the development of an open emissions trading scheme for internationalaviation aiming at implementation in the first commitment period… subject to entry into force ofthe Kyoto Protocol”;

15 see UNFCCC document FCCC/SBSTA/2001/INF.116 ICAO (2001) Agenda item 14: environmental protection. Updating of resolution A32-8: consolidated statement of continuing

ICAO policies and practices related to environmental protection. Document A33-WP/43, for consideration by the ICAO Assembly33rd session, September 2001. Resolution framed by the Executive Committee and recommended for adoption by the Assembly’,Appendix H on the Environmental impact of civil aviation on the atmosphere and Appendix I on Market-based measures regardingaircraft engine emissions.


• a request that the Council “develop as a matter of priority the guidelines for open emissionstrading for international aviation focussing on establishing the structural and legal basis foraviation’s participation in an open trading system, and including key elements such asreporting, monitoring and compliance, while providing flexibility to the maximum extent possibleconsistent with the Kyoto mechanisms”

Pending the Assembly’s adoption of the new Resolution, the UNFCCC understands that ICAOintends to “play a leadership role, particularly regarding proposals for caps”, and that ICAO is“urged to consider possible targets for aviation”17. It is also likely to push for further work on thedevelopment of “key elements of an emissions trading system”, and consider pursuing voluntaryagreements as “a first stage to encourage near-term action, as a lead-in to a future regime”. Thereappears to be considerable momentum within ICAO to respond to the UNFCCC mandate.Although the draft Assembly Resolution identifies “entry into force of the Kyoto Protocol“ as aprerequisite for “implementation of an open emissions trading system for international aviation inthe first commitment period”18, this momentum might even be sufficient for ICAO to push aheadwith the emissions commitment process in the event that the Kyoto Protocol were to implode.

1.4 European Community

The European Union has become the main driving force for tougher international and regionalenvironmental regulation generally. The European Commission’s long-term policy target “is toachieve improvements to the environmental performance of air transport operations that outweighthe environmental impact of growth. This is a very ambitious target, notably in the field of CO2emissions”19. Against this background, there are three key areas to consider for the airlineindustry:

• The potential impact of EU initiatives such as the European Climate Change Programme andthe proposed EU emissions trading scheme;

• The potential for unilateral action by the EU, should international processes be perceived as‘dawdling’; and

• The potential impact on aviation of the EU’s burden-sharing agreement under the KyotoProtocol.

1.4.1 European initiatives

The European Commission has led the development of the European Climate ChangeProgramme (ECCP, expected to be presented to EU Ministers and the European Parliament inOctober 2001) including a Transport working group that has undertaken a cursory examination ofaviation emissions. A subgroup on Aviation and CO2 emissions has thus far done little more thanprepare the Member States for the CAEP process.

17 See FCCC/SBSTA/2001/INF.118 ICAO (2001) Agenda item 14: environmental protection. Updating of resolution A32-8: consolidated statement of continuing

ICAO policies and practices related to environmental protection. Document A33-WP/43. Appendix I.19 European Commission (1999) Air transport and the environment – towards meeting the challenges of sustainable development.Communication from the Commission to the Council, the European Parliament and ECOSOC, 30 November. COM (1999) 640.The Commission consider a fuel efficiency improvement of 4-5% pa (over 10-15 years) feasible, and intends to investigate thepossibility of a voluntary agreement with the aviation sector to achieve this.


As part of the ECCP, the European Commission has issued a draft Directive for an EU emissionstrading programme20. The current intention is to cap only large fixed point sources of CO2. Thissuggests that the aviation emissions may be exempt from the scheme’s obligations – but wouldalso not be able to benefit from its opportunities (e.g. access to emission reductions from othersectors).

However, the Commission has suggested the potential use of trading as an instrument to meetaviation emission commitments21 - so aviation could conceivably be introduced to an EU tradingscheme in the medium term. In the meantime, the European aviation industry might consider themerits of any voluntary ‘opt-in’ provision in the EU scheme, given that this should provide accessto a larger market for emission credits (under an ‘open’ trading system), thereby minimising thecost of compliance. Such a scenario is particularly likely if the Kyoto Protocol were to implode, butthe European Union chose to continue both with broader UNFCCC climate change commitments,and international aviation emission commitments. In such a scenario, relevant parts of the aviationindustry would be subject to the EU emissions trading rules.

Other European Government bodies are increasing pressure on aviation. In September 2001, theEuropean Environment Agency published a report22 which warned that current trends “point awayfrom achieving the EU’s recently-announced objective23 of breaking the link between economicgrowth and growth in transport”. It singles out air transport as “remaining the least energy efficientmode of transport despite technological advances”.

1.4.2 Unilateral European action

Particularly if no suitable international framework is agreed within a timescale deemed acceptableto European Ministers, there is significant potential for the European Union to take unilateralaction that would restrict international aviation emissions. Indeed the EU has already signalled thiswith respect to the ICAO process24. The perception of a weak outcome from the 33rd ICAOAssembly (e.g. recommending a combination of voluntary action and open emissions trading,without the support of a suitably detailed work programme) could prompt the EU to:

• push harder for an international fuel tax or emissions charge;

• introduce a unilateral EU fuel tax or emissions charge; or

• request the return of international aviation emissions from ICAO to the UNFCCC.

1.4.3 Implications of the ‘burden-sharing agreement’

The so-called “burden-sharing” agreement of Article 4 of the Kyoto Protocol – whereby theEuropean Community has distributed its 8% emission reduction commitment among its MemberStates – may have considerable implications for aviation.

20 European Commission (2001) Proposal for a Directive of the European Parliament and of the Council establishing a framework

for greenhouse gas emissions trading within the European Community. Brussels, 31 May 2001.21 European Commission (1999), supra 4; paragraph 36 suggests the Commission would be amenable to the introduction of an‘open’ emissions trading scheme including aviation.22 European Environment Agency (2001) Indicators tracking transport and environment integration in the European Union.European Environment Agency.23 This objective is contained in the EU’s Sustainable Development Strategy and revised Common Transport Policy24 The EU was the driver behind SBSTA agreement – at its 13th session in 2000 – to encourage ICAO “ to complete its work on thismatter as soon as possible” (see FCCC/SBSTA/2001/INF.1).


Intra-EU flights, while “international” from the aeropolitical perspective of individual MemberStates, could be “domestic” as concerns the European Community. If the sum of emissions of theParties participating in a ‘bubble’ arrangement is to be treated as from a single Party for thepurposes of compliance (and this has yet to be resolved at the UNFCCC level), then flightsbetween the Parties in that bubble would appear to have to be counted by those Parties asdomestic emissions.

Whether or not the EU will decide to count intra-EU flights as “domestic” is likely to be primarily apolitical decision that may, in part, depend on pressure from other UNFCCC Parties. Inclusionwould require action to be taken to mitigate the emissions from intra-EU flights regardless ofprogress on other international aviation emissions; this would be likely to impose considerablecosts for the industry.

1.5 National

It is currently unclear which drivers at a national level may affect international aviation emissions.To date, individual Governments appear to have paid relatively little attention to the issue. Forexample, Denmark’s national climate change strategy does not mention domestic aviationemissions and treats international emissions only schematically. The US Government foresees nospecific initiatives. The UK’s national climate change programme and consultation document onthe future of the country’s air transport industry present no specific recommendations. In the shortterm, domestic aviation emissions are not to be covered by the UK Emissions Trading Scheme(active from April 2002), although the Government has received policy recommendations thatoutline the benefits of their inclusion for the industry.

Such a low level of activity to date could present an opportunity for the industry (e.g. throughICAO) to take the lead in harmonising treatment of domestic and international aviation emissions.Different rules, different regimes and caps on different entities at national and international levelswould be unlikely to foster an efficient, feasible and consistent response to the common challengeof meeting aviation emission commitments. There may be benefit for countries and the industry ineither developing some form of ICAO guidance on how such commitments might suitably beimplemented or in pushing for ICAO’s remit to be extended to domestic aviation emissions.

1.6 Other international

Other intergovernmental fora have addressed issues relating to aviation emissions or broaderclimate change concerns. At the present time, they do not represent key drivers for the airtransport industry.

1.6.1 Organisation for Economic Co-operation and Development

The Organisation for Economic Co-operation and Development (OECD) agreed guidelines on“environmentally sustainable transport” in October 2001. Although not legally binding, two of thesecould form the basis for future drivers affecting the industry and its GHG emissions:

• Guideline 4 states that the transport industry should ‘set quantified, sector-specific targetsderived from environmental and health quality objectives…’; and

• Guideline 7 states that the industry should ‘construct packages of measures and instrumentsfor reaching the milestones and targets of EST’.


In May 2001, the OECD urged its members to make “changes aimed at decoupling a range ofenvironmental pressures from economic growth, so as to ensure that continued economic growthdoes not result in further environmental degradation”25. It also highlighted “aviation air pollution” asa grave environmental concern.

1.6.2 UN Commission on Sustainable Development

The UN Commission on Sustainable Development (CSD) oversees the implementation of Agenda21, the action plan adopted at the Rio Summit in 1992. The 9th session of CSD (April 2001)included discussion on the transport sector (resulting in decision 9/3)26 and the global atmosphere(decision 9/2)27. There was consistent endorsement of Principle 7 of Agenda 21 – that of “commonbut differentiated responsibilities”. This is code for commitments being expected of developedcountries before they are assumed by developing countries – a key issue both in the KyotoProtocol discussions and in the international aviation emissions debate.

However, decisions 9/2 and 9/3 contained little of direct relevance to aviation, with only weakreferences to the need to mitigate climate change and to the work of ICAO. Decision 9/3“encourages international organizations, such as the International Civil Aviation Organization(ICAO) … in fostering transport systems that are affordable and do improve safety and reducepollution and other negative impacts on the environment”. Moreover, CSD decisions are notlegally binding and are therefore unlikely to have a direct impact on the aviation sector.

1.6.3 World Health Organisation

Decisions taken thus far by the World Health Organisation (WHO) in relation to climate change(e.g. through its participation in “Climate Agenda”) do not directly impact on aviation, and theorganisation does not therefore currently provide a key driver.

25 OECD (2001) An environmental outlook for the 21st century. Organisation for Economic Co-operation and Development.26 Commission on Sustainable Development (2001) Decision 9/3: Transport.27 Commission on Sustainable Development (2001) Decision 9/2: Protection of the Atmosphere.


2 Emissions trading as a tool to meet aviation emissions commitments

2.1 Possible options for achieving an emissions commitment

ICAO, as part of its mandate from Article 2.2 of the Kyoto Protocol, has been examining a range ofoptions potentially available to reduce the impact of aviation emissions and meet any futureemissions reduction commitment. CAEP and its working groups have been focusing on threebroad categories - technology and standards, operational measures, and market-based options28.This resulted in two reports discussed at CAEP/529, which formed the basis of the resultingconclusions and draft elements for an Assembly Resolution30.

2.1.1 Technology and standards

CAEP continuously monitors and assesses technological advances and evaluates the need forupdating existing or introducing new emissions standards. CAEP/5, however, considered itundesirable to pursue the possibility of developing a CO2 emissions standard. It recognised thatmarket pressures were sufficient to minimise these emissions.

Furthermore, new aviation technology is rolled-out over a long time-scale, often taking 10 to 15years from conception to market place, and the replacement of a fleet would take severaldecades. This would make it very difficult to make substantial improvements in time for amandatory commitment as early as 2013.

2.1.2 Operational measures

The ICAO Assembly is expected to adopt an ICAO Circular on operational measures to minimisefuel use and emissions. It provides guidance for its member states identifying operational bestpractices including, for example, the implementation of new satellite-based Communications,Navigation, Surveillance and Air Traffic Management (CNS/ATM) systems, eliminating non-essential aircraft weight, carrying more passengers and freight per aircraft, optimising aircraftspeed, limiting auxiliary power unit (APU) use and reducing taxiing times of aircraft. Althoughthese measures could reduce the amount of fuel burned by 8-18%, the IPCC recognise thatoperational measures, like technical measures, “will not fully offset the effects of increasedemission resulting from the projected growth in aviation”31.

2.1.3 Market-based options

ICAO CAEP/5 considered two types of market-based options - environmental levies andemissions trading schemes. Three forms of environmental levy were considered: a fuel tax, an

28 ICAO (1999) Statement from the ICAO to the 10th Session of the UNFCCC Subsidiary Body for Scientific and TechnologicalAdvice (SBSTA).29 CAEP Working Group 5 (2001) Market-based measures: report from Working Group 5 to the fifth meeting of the Committee on

Aviation Environmental Protection. Document CAEP/5-IP/22; CAEP Forecasting and Economic Support Group (2001) economic

analysis of potential market-based options for the reduction of CO2 emissions from aviation. Document CAEP/5-WP/24.30 CAEP/5 (2001) Historical. Document CAEP/5 – WP/86.31 IPCC (1999) IPCC Special Report: aviation and the global atmosphere – summary for policymakers. Intergovernmental Panel onClimate Change.


‘en-route emissions charge’, and a ‘revenue-neutral emissions charge’. Potential problems wereidentified for each of these levies, including issues of equity and competition, legal feasibility andcomplexity. Several different designs for emission trading schemes were considered. Thesecomprised permutations of open and closed systems, with different permit distribution methods(e.g. grandfathering and auctioning). An open system was favoured, as it would allow the majorityof reductions to occur in other industry sectors at a lower cost, thus minimising the scheme-widecosts of compliance. The key disadvantage identified was the potential difficulty involved inincorporating the rules of an aviation emissions trading scheme into those of a future Kyotoregime.

The ICAO Council’s draft Assembly Resolution endorses the development of an open emissionstrading system for international aviation aiming at implementation in the first commitment period(2008 – 2012), subject to entry into force of the Kyoto Protocol and requests the Council todevelop urgently the guidelines for such a system.

2.1.4 Voluntary initiatives

Voluntary mechanisms are seen primarily as a means of achieving near-term action by theaviation sector. The main options considered by ICAO are: an industry initiative, under whichindustry would propose a set of actions and / or targets that it voluntarily commits to meet; anegotiated agreement between government and industry to achieve specific reductions; or ahybrid of these two. CAEP concluded that a voluntary mechanism alone could not achieve anambitious emission reduction target in the absence of a legally enforceable compliancemechanism. This view is supported by many environmental pressure groups, which have beensceptical about the robustness of voluntary agreements. The EU has also voiced its opposition tovoluntary agreements alone.

2.2 What is emissions trading?

Emissions trading is a market-based approach to achieving environmental objectives that allowsthose reducing GHG emissions below what is required to trade the excess reductions to offsetemissions at another source. Article 17 of the Kyoto Protocol provides the legal basis for tradingof GHG allowances between Annex B countries with an emissions reduction commitment underthe Protocol. The unofficial UNFCCC negotiating text released at the end of CoP6 bis in July 2001suggests that there is likely to be agreement (at CoP7 in November 2001) that legal entities maytrade, providing they have the authorisation of a Party, and providing that Party is not ineligible toparticipate in the mechanisms32.

Ahead of this agreement, several emissions trading schemes have been designed and someimplemented. Denmark launched a scheme in January 2001, and the UK scheme is to belaunched in April 2002. A draft directive on an EU emissions trading system has been developedfor adoption by the European Commission, and is to be considered by EU Governments inOctober 2001. Furthermore, corporations such as BP and Shell have developed andimplemented internal trading schemes to meet voluntary emissions reduction targets, and a groupof corporates have formed the Chicago Climate Exchange.

32 Anon (2001) Mechanisms pursuant to Articles 6, 12 and 17 of the Kyoto Protocol. Non-paper by the Co-Chairmen. Seeparagraph 5 of the Annex to the draft decision on Article 17.


2.3 The benefits of emissions trading

• It enables emissions reductions to be made at the lowest cost

Participants in an emissions trading scheme have the flexibility to make emissions reductionswhere it is economically viable to do so, and to buy emissions reductions where necessary, or sellwhere possible. In this way, and subject to certain assumptions about the world, competitivenessissues and transaction costs, the trading scheme community makes emissions reductions at thelowest overall cost.

• It offers the potential to make emissions reductions outside of the aviation industry in order tomeet commitments

To achieve more stringent emissions reduction commitments at reasonable costs, the aviationindustry would require access to credits and permits from outside the industry. Open emissionstrading provides access to such credits and permits and offers maximum flexibility in meeting anemission reduction commitment.

• It allows greater certainty over the achievement of environmental objectives

Emissions trading involves the allocation of allowances by States to entities corresponding to atotal volume of greenhouse gas emissions (the basic “cap-and-trade” model). These allowances,or credits, can be traded within an emissions trading scheme to assist entities in meeting theiremissions reduction targets. States can reduce the amount of allowances within the market overtime, thereby controlling the overall amount of greenhouse gases emitted. This allows greaterprobability that the emission reduction commitment will be met.


3 Designing an Emissions Trading Scheme suitable for aviation

3.1 Overview of the project

Aware that there was much support for emissions trading as a tool to help meet any futureaviation emissions commitment, IATA invited Andersen to investigate options for the design of anemissions trading scheme for aviation.

The Andersen project, as agreed with IATA, was comprised of three Workstreams. These weresuccessive and cumulative, with the first laying a foundation for the second, and the first andsecond forming the basis of the third. The agreed steps are shown in the following figure.

Option evolutionand design

Strategic, Policy, Financial and Economicanalysis

Strategic challengeand formulation

Detailed report onemissions trading

options

Recommendations for mostappropriate emissions

trading scheme

c. 10 - 12 weeks

Expertpanel

review

Workstream 2: Evaluating emissions trading options

Workshop

Design andpreparation ofa stakeholders

workshop

Confirming thescope anddirection

Backgroundreport

Workshopmaterials

Feedbackreport

c. 4 - 6 weeks

Workstream 1: Development of policy options and analysis of stakeholders

Discussions with IATAmanagement

Synopsis of policy andtrading direction

Positioning Report

c. 2 - 3 weeks

Workstream 3: Key findings and conclusions

Expertpanel

review


3.2 Analysing emissions trading schemes

Firstly, various emerging and existing emissions trading schemes and relevant academic paperswere examined in order to identify the core components intrinsic to any emissions trading scheme.A division was made into primary and secondary ‘design elements’, to reflect the impact that eachwould have on the overall scheme design. In addition, ‘critical success factors’ were identifiedwhich served as objectives that an emissions trading scheme for aviation would aim to achieve aswell as criteria against which design elements could be assessed. These design elements andcritical success factors were agreed with IATA and the “Expert Panel” (see section 3.3).

3.3 Consultation with industry and emissions trading experts

The project included the close involvement of stakeholders (see section 3.4) and other relevantexperts. With IATA’s input and agreement, an Expert Panel was formed to provide a ‘filterprocedure’ to aid decision-making and to provide insight and feedback on the acceptability ofdesign choices and trade-offs. The experts were involved and consulted in Workstreams one andtwo, reviewing the material to be used for the stakeholder workshop, and the economic analysis ofdesign options. They also had access to the background report produced during Workstream 1.

Expert panel members were as follows:

Name Organisation, positionHugh Somerville British Airways, Head of Sustainable Aviation Business UnitJohn Begin Northwest Airlines, Director Operational Safety and Environmental AffairsShigeyuki Ooka Japan Airlines (JAL), Director, Secretariat Environmental CommitteeMalcolm Thompson Australian Department of Transport and Regional Services, Assistant Secretary

Environment GroupBrian MacLean US Environment Protection Agency, Head of SO2 programmeErik Haites Margaree consultants, climate change consultantJurgen Lefevere FIELD, Legal expertMartin Bartlam Jones,Day, Reavis & Pogue, Corporate Finance LawyerDuncan Eggar Air BP, Environmental Leader

Specialist input was additionally sought, in an expert capacity, from Andrew Sentance (BritishAirways, Chief Economist) and Bryan Beudeker (Ansett New Zealand. Environmental PolicyAdviser).

3.4 Assessing the background to the scheme design

To provide a sound basis for the project, a review was undertaken of aviation issues relevant toemissions trading. As agreed with IATA, this drew principally on relevant publications anddiscussions with stakeholders and experts. A background report was produced comprising threechapters:

• Chapter 1: The Challenge: Sustainable Aviation

• Chapter 2: Designing an Emissions Trading Scheme

• Chapter 3: Emissions Trading for Aviation

Chapter 1 examines air transport policy issues relevant to emissions trading, drawing fromrelevant policy and academic papers, scientific assessments and the work of internationalorganisations. In particular, this involved:


• researching issues related to the predicted growth of the aviation industry, and its futuresustainability;

• identifying and assessing the drivers for an aviation emissions commitment, both internationaland regional; and

• identifying the tools for addressing emissions from aviation and their limitations; and detailingspecial considerations for the air transport industry.

Chapter 2 seeks to consolidate the experience of some existing and emerging trading schemes33

in order to provide a basis of understanding for the choices that the air transport industry mightmake. It comprised an analysis of the design choices made in such schemes against the criticalsuccess factors, and an assessment of the lessons learnt.

Chapter 3 provides a comparison and evaluation of current opinion on suitable emission tradingscheme designs for aviation. Several authorities have expounded such views, in addition to thework of ICAO. This involved examining how the developing international rules may impact uponthe design of an emissions trading scheme for the aviation industry, and relating the particularneeds of the aviation industry to the design elements. It also includes a discussion of transitionoptions and implications.

3.5 Obtaining stakeholder perspectives: the stakeholder workshop

Following the assessment of the background to the scheme design, a workshop was held tofurther analyse the design options in the context of the aviation industry and to determine possibledesign choices for an aviation emissions trading scheme. The workshop was developed jointlywith IATA, and Expert Panel members contributed to the production of workshop inputs. Theworkshop aimed to:

• obtain an understanding of stakeholders’ preferences and concerns related to scheme design;

• obtain stakeholder views on suitability of design choices; and

• provide a context in which to understand the acceptability of trade-offs, for example betweeneconomics and policy requirements.

A number of stakeholders representing a wide range of perspectives were invited to attend theworkshops, but some were unable to attend. The 12 eventual participants includedrepresentatives of:

• Medium- and large developed country airlines;

• Other key industry sectors (manufacturer, fuel provider);

• Government policy makers and negotiators in aviation and climate change;

33 The schemes used for this analysis were primarily the UK emissions trading scheme, the US SO2 trading scheme, the emissionstrading schemes in Ontario, and the BP internal scheme. We also drew lessons from the directive for the proposed EuropeanUnion emissions trading scheme, the Denmark electricity producers’ emissions trading scheme, the Chicago Climate Exchangeinitiative, the Norwegian emissions trading scheme, the Californian Electricity Trading Market, the Transferable Quotas scheme forCommercial Fisheries in New Zealand, and greenhouse gas emissions simulations undertaken by companies in the electricityindustry (GETS 2) and the Queensland Emissions Trading Forum (QETF).


• International organisations (UNFCCC and WTO);

• Aviation NGO; and a

• Legal adviser.

The workshop started with scene-setting presentations which ensured a common level ofunderstanding of emissions trading issues. This was followed by a breakout activity. Participantswere divided into three groups; each was given the mandate to draw up a core emissions tradingscheme design that would be suitable for aviation. Groups assessed potential options for keyscheme design elements against critical success factors. Groups reported back on their chosenscheme design, their rationale, and issues raised during discussions.

A report was produced detailing findings from the workshop. This described various themes andareas of agreement that emerged during discussions and breakout activities. Key findingsincluded the following:

1. there was support for trading as a potential tool to meet any emissions commitment;

2. this was coupled with awareness that the issues surrounding the design of an emissionstrading scheme are complex and need further consideration;

3. emissions trading was thought to need a regulatory driver. If the Kyoto Protocol were not toenter into force, there would be no clear immediate regulatory driver;

4. this was balanced with the recognition of the value in starting in the absence of a driver, solong as a regulatory driver was anticipated (it was acknowledged that another agreement –probably through ICAO, the UNFCCC or unilateral action by the EU – could influence aviationemissions in a similar way to the Kyoto Protocol);

5. open trading was considered essential. The use of the Kyoto mechanisms would helpparticipants meet emissions targets at minimum economic cost. Any trading scheme adoptedby the aviation industry would need ultimately to have access to credits from, and becompatible with, a trading scheme under the Kyoto Protocol (or, indeed, under any otherwider, overarching or “dominant” scheme);

6. there was no clear preference for a particular type of scheme although an absolute cap wasseen as the most suitable way of ensuring the environmental integrity of a trading scheme. Acap was not seen as being incompatible with minimising economic cost, providing access tothe Kyoto mechanisms were granted;

7. any trading scheme should begin with what is technically feasible and scientifically reliable. Inthe short term, this would mean that any trading system would be restricted to carbon dioxide.Other gases could perhaps be added at a later date when their impact was more widelyunderstood and dependable measurement techniques had been developed;

8. institutional costs should be minimised by using existing or emerging ICAO, UNFCCC orother bodies and capabilities where appropriate and acceptable;

9. developing countries should be involved in the process of limiting or reducing internationalaviation emissions. However, at this stage the imposition of targets was thought to bepolitically unacceptable and would conflict with the principle of common but differentiatedresponsibilities, as reflected in the Kyoto Protocol (which imposes commitments, in the shortterm, on developed countries only). The scope of participation and coverage might be


expanded between commitment periods (just as the list of UNFCCC Parties with legallybinding commitments is thought likely to lengthen);

10. following allocation of allowances to Governments, airlines would seem the best positioned totake on emissions commitments as they were most able to control their emissions throughthe application of different operational measures and technologies. Inclusion of other industryplayers (e.g. airports and ATC providers) would have potential merit in order to reflect thereality that not all aircraft emissions are controlled by airlines.

11. on permit distribution, some form of grandfathering was thought the simplest, most cost-effective and equitable way for permits to be allocated to legal entities;

12. further work might be needed to assess the relative costs and benefits of various types oftrading schemes (e.g. cap and trade v baseline and credit); and

13. the equitable treatment of airlines on the same route was considered important to minimisecompetitive distortions as a result of the introduction of an emissions commitment.

3.6 Economic analysis of design options

Economic analysis formed the second workstream of the project. Its key results are integrated intosections 4 and 5.

Main issues identified in the first workstream were analysed from an economic perspective, asagreed with IATA. The analysis included review of existing analysis, application of economicprinciples to analysis of issues and modelling work. The analysis took into account previous workon aviation emissions trading, seeking to extend, for example, the ICAO CAEP Forecasting andEconomic Support Group work34. The work also used the AERO model, a tool developed forassessing policy options for emission reductions in the air transport industry; major conclusionswere supported by Andersen’s own analyses35.

The main topics analysed were:

• The integration of permit trading in the air transport sector with permit trading in other sectorsor under other schemes;

• The effect of coverage of the trading scheme on competition between airlines;

• The effect of different extents of scheme coverage on the quantity of emissions reduction; and

• The method of allocation of permits, in particular whether permits are issued free or sold, andhow any revenue raised from sale is used.

The analysis was based on certain key assumptions about the regulatory framework36, althoughmost of the conclusions were valid for a variety of regulatory frameworks. Analysis was also

34 See, e.g., CAEP FESG (2001) Economic analysis of potential market-based options for reduction of CO2 emissions from

aviation. Document CAEP/5-WP/24.35 Use of FESG work and the AERO model were at IATA’s request. MVA, one of the AERO licensees, carried out runs of theAERO model for this work; Andersen did not validate the accuracy of the data input to the model, or the validity of the assumptionswithin the model, and takes no responsibility for its accuracy.36 These assumptions were: carriers must hold permits in proportion to fuel used; the emissions trading scheme would be limited toCO2; and that the Kyoto mechanisms are potentially available for trading.


largely based on the assumption that the industry as a whole is largely competitive37, but identifiedkey differences in results were the industry (or parts of it) less competitive.

An economic analysis report was produced covering each of the main areas of analysis and alsoproviding background on general principles of permit trading. The report provided conclusions onthe relative economic advantages of the different scheme designs to inform the Workstream 3analysis.

The analysis concluded that there were strong advantages to an open scheme, which was definedas one that gives the air transport sector access to permits from sources with lower costs ofabatement than the air transport sector, such as other sector or sinks. These sources could beaccessed via Kyoto mechanisms or via other international trading mechanisms, depending on theregulatory environment.

The analysis also concluded that the distortions arising from imposing obligations to hold permitson some airlines on a route but not others are potentially severe. This applies both when routesare highly competitive and when they are less so. In contrast the distortions arising from imposingobligations on some routes although not on others may be less severe (although potentially severin some cases). However limiting coverage of the scheme, and thus the extent of any cap, riskedlimiting the scale of emissions reductions achieved.

The initial allocation of permits was also examined. Auctioning of permits was found to haveadvantages in terms of economic efficiency, for example because revenue from permits sales mayallow other taxes, such as those on value added or income, to be reduced. Alternatively suchrevenue could be used to correct other market failures, including any in the air transport sector.Revenues could also be used to incentivise extensions to scheme coverage, such as the inclusionof non-Annex 1 countries in a scheme.

The effect of free allocation of permits depends on the basis on which they are issued. Issuing ona fixed basis, for example in relation to a 1990 baseline, may create revenue gains to the sectorbut does not weaken incentives to abate emissions with optimal patterns of consumption. Issuingpermits in proportion to present emissions risks weakening incentives because it reduces themarginal cost of permits for additional flights, although it is not clear that this effect will be large inpractice. Direct incentives for increased efficiency can be provided by allocation based on anefficiency standard.

37 The analysis assumed that the sector can be described as effectively competitive where: there is free entry and exit; there aremany carriers; costs of increasing production are similar for all carriers; and products are close substitutes.


4 Key Policy Findings

This section seeks to identify the guiding principles that have come out of the analysis provided byWorkstream 1 in particular. These principles are likely to provide the framework for thedevelopment of an industry position regarding any aviation emissions trading scheme.

4.1 The Kyoto Protocol is currently the only regulatory driver for an aviation emissionslimitation; but if the Protocol were to collapse, UNFCCC - and perhaps otherframeworks - would remain

Article 2.2 of the Kyoto Protocol sets the ground for an international aviation emissionscommitment, requesting UNFCCC Parties to work through ICAO to limit or reduce their emissionsfrom aviation bunker fuels. Were the Kyoto Protocol not to enter into force – e.g. if the US andRussia were not to ratify – this regulatory driver would disappear. However, UNFCCCcommitments – including the commitment to develop national policies that limit GHG emissions -would remain valid. Most likely, these would form the basis for the development of a newinternational emissions commitment, which could include international aviation emissions from theoutset.

4.2 International aviation is very likely to be required to limit or reduce its greenhousegas emissions, most probably from 2013, but possibly from 2008. The industry willneed to agree its position by the 34th ICAO Assembly in 2004, given that negotiationsfor the second commitment period (2013-2017) start in 2005.

The lack of agreement on how to identify – or allocate - ‘ownership’ of international aviationemissions prevented their inclusion in UNFCCC Parties’ assigned amounts under the KyotoProtocol (i.e. for the first commitment period, 2008-12). Once allocation methods are agreed, theappropriate total of emissions can be added to Parties’ assigned amounts (under a UNFCCCframework), or allocated as “aviation assigned amounts” to ICAO member states and anappropriate limitation or reduction commitment could in principle be negotiated (under an ICAOframework). Either way, the industry could then be subject to an emissions reduction or limitationcommitment.

Presuming a scenario whereby the Kyoto Protocol enters into force, there appears to be a generalbelief among negotiators that time has probably run out to agree any specific commitment for2008-12 (the first Kyoto commitment period): negotiations for the second commitment period(probably 2013-1017) are due to commence in 2005. Although a drive (e.g. from the EU or fromNGOs) for a commitment in 2008-12 cannot be ruled out (particularly given the ICAO ExecutiveCommittee’s recognition of this possibility38 and the likely prominence given to the issue at

38 ICAO (2001) Agenda item 14: environmental protection. Updating of resolution A32-8: consolidated statement of continuing

ICAO policies and practices related to environmental protection. Document A33-WP/43, for consideration by the ICAO Assembly33rd session, September 2001. Resolution framed by the Executive Committee and recommended for adoption by the Assembly’,Appendix I on Market-based measures regarding aircraft engine emissions, proposes that the Assembly “aim at implementation [ofan open aviation emissions trading system] in the first commitment period (2008-12), subject to entry into force of the KyotoProtocol”.


CoP739), international aviation emissions would be more likely to be incorporated into Parties’targets for this second commitment period.

This has three key implications. First, the international aviation industry is relatively unlikely to facea mandatory emissions cap for over ten years40. Second, if the industry avoids a commitment in2008-12, it would be less likely that the industry as a whole will face a specific, internationallyproscribed emissions commitment (a stand-alone target or ‘industry bubble’). It would be morelikely that international aviation emissions would be incorporated into Parties assigned amounts -and it would be at Parties’ discretion whether to allocate a proportion of their commitment toaviation41. Third, there is a growing belief that increasing pressure on developing countries in theUNFCCC process could result in them assuming emissions commitments for the third commitmentperiod (2018-25?), with possibly some provision for voluntary participation in the secondcommitment period. Such a commitment would be likely to include international aviationemissions. Fears of inequity between the aviation industries of developed and developingcountries, as a result of differing GHG emissions commitments, could thus conceivably be limitedto the second commitment period.

4.3 The European Community is likely to provide a regulatory driver, but otherinternational processes are less potent forces

The European Union has become the main driving force for tougher international and regionalenvironmental regulation generally. There are three main ‘threats’ to the industry, all of whichcould happen in the short to medium term (i.e. before the second commitment period andprobably by 2008). First, the European Climate Change Programme could push for commitments,yet there is no current indication that aviation emissions will be incorporated into the proposed EUemissions trading scheme. Second, the EU may take unilateral action – including the imposition ofa fuel tax or emissions charge - should it perceive international processes to be ‘dawdling’. Third,there may be pressure for the emissions from intra-EU flights to be captured under theCommunity’s burden-sharing agreement, and thus subject to 2008-12 commitments.

Currently, other intergovernmental processes (e.g. OECD, CSD) are not significant drivers for anaviation emissions commitment. However, outside ICAO and the UNFCCC, the OECD is the mostlikely forum in which the EU might pursue agreement to such a commitment. The aviation industrymay wish to keep an eye on developments there.

4.4 Retaining the international aviation emissions framework within ICAO may enhanceindustry influence, but risks jeopardising access to the Kyoto mechanisms

Considering that the UNFCCC would be unlikely to hand over to ICAO its responsibility fordomestic aviation emissions, and that domestic issues and activities are outside ICAO’s(international) jurisdiction, ICAO’s emissions work is likely to be restricted to internationalemissions. In doing so, ICAO has two broad options:

• it could explore the issue, achieve consensus among Member States and makerecommendations to the UNFCCC Conference of the Parties; or

39 Document FCCC/SBSTA/2001/INF.1, presented by the UNFCCC Secretariat at CoP6bis, suggests (paragraph 9) that “theSBSTA may wish to take note of the information contained in this document in the preparation of a detailed discussion at thefifteenth session of the SBSTA” [concurrent with CoP7].40 Indeed, if the industry is pressed to assume a commitment during 2008-12, it could argue that it has had fewer years to preparefor implementation than other industries (listed in Annex A of the Kyoto Protocol).41 This issue is considered in more detail in section 4.8.


• it could, in theory (and presumably only with the agreement of the UNFCCC42) claim ownershipof the international aviation emissions commitment concept and its implementation.

There are advantages for the industry in retaining the issue within ICAO. First, ICAO is more likelyto be receptive to industry needs – and the industry has greater influence within it. Second, therewould be the potential for wider geographical participation – i.e. by all ICAO Member States ratherthan Annex I UNFCCC Parties (although see 4.8). This would address a key industry concern,supported by economic analysis and derived from the unique nature of international air transport:that an aviation emissions commitment imposed only on developed countries would significantlydistort competitiveness patterns. Third, it would be easier to introduce a harmonising frameworkthat sought to eliminate differences between countries’ implementation (and thus minimisecompetitive distortions). Fourth, there would be the potential for ICAO to develop its own eligibilitycriteria regarding sources and sinks projects – thus increasing potential supply of permits.

However, there are disadvantages of pressing for a permanent ICAO framework. Instead, it maybe less risky to press for a second option: using ICAO as the vehicle to present recommendationsto the UNFCCC, prior to incorporation into the UNFCCC system. First, having mandated ICAO,the UNFCCC is the ultimate arbiter of any ICAO decisions. UNFCCC dissatisfaction with ICAOdecisions could prompt it to reclaim the international aviation emissions remit. Some Parties mightalso fear that establishing an emissions framework outside Kyoto could set an unhelpful precedentthat might be followed on a national scale by non-Parties to the Protocol, which could potentiallyundermine the Protocol’s provisions and effectiveness.

Second, the industry would need UNFCCC approval to access credits and allowances from theKyoto (or equivalent UNFCCC) mechanisms: introducing its own ‘definitions’ of sources and sinks(e.g. allowing credits from ‘avoided deforestation’ projects, currently ineligible for the CleanDevelopment Mechanism during the first commitment period) might jeopardise this access.Supporting incorporation into the UNFCCC system would mean that the air transport industrywould be a player like any other in that system – with guaranteed access to the same creditsupply, and with no need for either a specific aviation emissions commitment or a specific aviationemissions trading scheme.

Third, an aviation-specific system, with its own compliance and crediting provisions might incurobjections from competitor international transport modes (road and rail) which would not havesuch flexibilities. Fourth, a system under ICAO could prompt objections from developing countries,which could challenge the legal basis of any commitment imposed on them. Fifth, it would becheaper – as there would be no need for the industry to develop and pay for emissions-relatedinfrastructure. Sixth, incorporation into the UNFCCC assigned amounts would permit compatibletreatment with domestic emissions (which are already covered in the Kyoto Protocol’s assignedamounts for 2008-12). It would reduce or remove inconsistencies (and encourage synergies) inthe division in treatment and responsibility between domestic and international emissions. It couldthus avoid potential fragmentation of entities’ carbon budget management strategies. While theremay be advantages for the industry in initiating proceedings with a push for ICAO ownership, it isquite conceivable that a UNFCCC framework may be a better long term bet for the industry.

42 The idea that the UNFCCC is the ultimate arbiter of ICAO recommendations or decisions on international aviation emissions isborne out by the reassertion of control evident in the document FCCC/SBSTA/2001/INF.1, discussed briefly at CoP6bis.


4.5 There are good reasons to grant industry special consideration, but not all wouldjustify lenient treatment, and they would risk the removal of access to Kyoto credits

There is frequent discussion of the ‘special nature’ of the air transport industry, which has beenlinked to the special considerations that it could potentially be given within the context of the globaleffort to limit or reduce GHG emissions.

There is considerable justification for the claims to special status. There are legal reasons (theindustry was singled out in the Kyoto Protocol, and there is no agreement yet on how to allocateemissions in international territories to individual countries). There are economic reasons (anemissions commitment could jeopardise the industry’s significant contribution to the worldeconomy – and one that is made on narrow margins). There are technological reasons (aviationhas few available to make significant technological shifts). And there are scientific reasons(considerable uncertainties exist about the real contribution of aviation to global warming). Thesefour sets of reasons might justify lenient treatment compared to other industrial sectors and couldstrengthen calls for greater flexibility. But such a position might also pose risks.

There are also environmental reasons – and these might support claims for more oneroustreatment for aviation compared to other industries. First, aviation’s CO2 emissions (at 2% of theworld’s total anthropogenic CO2 emissions in 199243) were only slightly less than those of theU.K.44, one of the world’s most industrialised countries. Second, the fact that emissions at altitudeare thought to have a greater radiative forcing (and thus a greater contribution to climate change)than those at ground level could strengthen calls for the industry to account for its full radiativeforcing effect or to accept more onerous commitments. Presumably, it could even prevent or limitaccess to the credits/allowances under the Kyoto mechanisms – perhaps with a differentialapplied such that a tonne of CO2 emitted at altitude needs to be offset by, e.g., a greaterdifferential of tonnes of CO2 reduced or removed at ground level.

Third, while CO2 is the most abundant greenhouse gas emitted at ground level, it accounts foronly 37% of aviation GHGs45. The other 63% of aviation GHG emissions relate to gases notcovered by the Kyoto Protocol (i.e. nitrous oxides, water vapour, sulphate and soot aerosols). Thismeans that a GHG emissions commitment under the Kyoto Protocol could only relate to just overa third of the industry’s contribution to global warming. Some adverse reaction to this might beenvisaged. It is conceivable that the aviation industry might (in the medium term at least) berequired to assume a commitment relating to the other GHGs – possibly under a subsidiary orsuccessor legal instrument.

4.6 Any commitment is likely to be on Governments (probably UNFCCC Parties, butpossibly ICAO Member States), who then have the option to devolve thiscommitment to aviation entities (probably principally to airlines)

The two international bodies with a mandate to explore an international aviation emissionscommitment are the UNFCCC and ICAO. Both are intergovernmental bodies, whose jurisdictiononly extends to their signatories/members. These bodies’ signatories (UNFCCC) or MemberStates (ICAO) are sovereign governments. A commitment orchestrated through the UNFCCC orICAO can thus only be on governments. There is no legal basis for legal entities (e.g. airlines)

43 IPCC (1999) IPCC Special Report: Aviation and the global atmosphere. IPCC. CO2 emissions from aircraft (international anddomestic aviation) were 0.14 GtC/year in 1992.44 DETR (2000) UK Climate Change Strategy. [Annex B: emission projections.] UK CO2 emissions were 0.168 GtC/year in 1990.45 D. Lee and R. Sausen (2000) New directions: assessing the real impact of CO2 emissions trading by the aviation industry.Atmospheric Environment 34: 5337-5338.


themselves to be capped directly by an intergovernmental body. It will be up to sovereigngovernments to decide whether (and, if so, how) to devolve their commitments to the entity level.

If Governments wish to devolve international aviation commitments to an entity level, they willneed to decide which sectors should receive targets. The general view seems to be that the airlinesector would be the most likely recipient, as airlines are ‘demandeurs’ for both fuel-efficientequipment design (from engine and aircraft manufacturers) and fuel (from fuel providers; section5.3 discusses the possibility of a “permit-paid fuel” system) and thus have a certain degree ofcontrol over actual emissions. In turn, airlines would be likely to pass on the cost of their obligationto customers, who stand at the apex of the demand pyramid.

Air Traffic Control (ATC) providers could in principle also receive a commitment. This woulddepend, in part, on how flight emissions were calculated for the purpose of the overallcommitment. Options include:

• restricting the commitment to actual emissions, which are increased by emissions due to ATCdelays and sub-optimal routing; or

• a process similar to that of Air Navigation Charges, whereby fixed proxy emissions totals foreach fixed route length are developed, based on standard fuel consumption rates per km foreach type of aircraft. This might be easier and less costly to administrate, but would lower bothenvironmental integrity of and market confidence in an aviation emissions system.

If the Kyoto Protocol enters into force, commitments are more likely to be placed on UNFCCCParties than ICAO Member States. As noted in section 4.4, there may be benefits for the industryin pressing for retention of the process of developing, undertaking and administering internationalaviation emission commitments under ICAO. However, as the instigator and managementauthority of the intergovernmental climate change mitigation system, the UNFCCC is more likelythan ICAO to administer any international aviation emissions commitments.

4.7 The industry ought to consider whether it prefers a stand-alone target or a targetintegrated into national assigned amounts. A resulting variety of implementation ofan international aviation emissions commitment would call for an overarchingstructure or guidance, e.g. through ICAO

The current format of any aviation emissions commitment is uncertain. The key options are astand-alone target (an ‘industry bubble’, the first of its kind) or integration into assigned amount. Astand-alone target (e.g. which could be a limited increase above 1990 emissions by 2010 ratherthan an absolute reduction46) would be allocated among individual governments (see section 4.6)via whatever UNFCCC allocation mechanism is agreed (see section 1.247). It could then beretained separately, retained separately but with a gateway into domestic assigned amounts, orfully integrated into assigned amounts.

The choice depends, in part, on timing (first or second commitment period), locus of framework(ICAO or UNFCCC)48 and the extent to which the industry claims special treatment. A stand-alone

46 Not all emissions commitments are reductions; they may also be limitations. This is explicit in the Kyoto Protocol term “quantifiedemission limitation or reduction commitments”. For example, should it ratify the Kyoto Protocol, Australia will have agreed to limit itsGHG emissions to 108% of 1990 levels by 2010 – i.e. to allow for an 8% increase in emissions.47 See also document UNFCCC (1996) Methodological issues: emissions resulting from fuel used for international transportation.Note by the Secretariat. Documents FCCC/SBSTA/1996/9/Add.1 and Add.2; and document UNFCCC (1999) FCCC/SBSTA/1999/20.48 The pros and cons of an ICAO framework versus a UNFCCC framework are discussed in section 4.4.


target would be most likely in an ICAO framework, in the first commitment period (as assignedamounts will already have been identified) and if the industry presses for special consideration.Integration into assigned amounts would be most likely in a UNFCCC framework, in the secondcommitment period and where industry does not seek special consideration.

A stand-alone target would focus attention on the air transport industry. It would require specificcompliance provisions – with government compliance assessed separately to compliance withtheir UNFCCC/Kyoto Protocol commitments. It would require the development of specificinfrastructure and institutions. Negotiators and industry representatives should consider assessingwhether the industry is a sufficiently significant contributor to climate change (at 2% of globalemissions) to justify conducting a time- and resource-intensive parallel set of negotiations –potentially for each commitment period. If this route is chosen, adoption of a stand-alonecommitment during 2008-12 should not preclude integration into assigned amounts duringsubsequent commitment periods.

The alternative is to press for integration into assigned amounts. This would ‘disperse’ theinternational aviation commitment, perhaps diminishing its profile. The manner of implementationwould be up to individual governments – some might choose to ‘spare’ their aviation industry,covering its emissions target with carbon savings made elsewhere.

The latter scenario could create potential for vastly different trading systems to be implemented,with different airlines or routes subject to entirely different commitments and with access toentirely different tools. This would provide major disruption to competitiveness patterns that wouldnot be in the wider interest of the international aviation community.

Under this scenario there would thus seem to be considerable benefit in ICAO – as the principalindustry forum and authority – adopting recommended guidance on principles and procedures forimplementing aviation emissions commitments. This could for example encompass theidentification of best practice for:

• selecting sectoral recipients of commitments and involving other sectors;

• minimising competitiveness issues;

• selecting emissions allowance allocation methods; and

• recommending appropriate options for other trading scheme design elements.

• harmonising the treatment of international and domestic aviation emissions;

ICAO could conceivably adopt additional roles. These could include:

• providing the forum for discussion (or negotiation) of allocation methods and commitmentlevels; and

• presenting well reasoned argumentation and recommendations on aviation emissions foradoption by the UNFCCC CoP.

4.8 Although from an equity and environmental perspective it is desirable to have globalparticipation, it may be politically difficult to achieve this

The wider the geographical scope of emissions commitments (i.e. to developing as well asdeveloped countries), the greater the potential contribution to mitigating climate change and the


less the disruption to competition. Clearly then, global participation would be desirable. But it maybe politically difficult to achieve.

Given that only developed countries currently have commitments under the Kyoto Protocol, it willprobably be very difficult, under a UNFCCC framework, to persuade developing countries to dolikewise for international aviation. It would perhaps be less difficult to do so under an ICAOframework, given that there is no explicit differentiation in commitments on developed anddeveloping country ICAO member states – other than the ICAO practice that recognises theparticular situation of developing countries. However, such an outcome would still be ratherunlikely as developing countries would be likely to try to press the Kyoto (and Rio Earth Summit)principle of “common but differentiated responsibilities”

This likely differentiation between developed and developing country commitments may last onlythe duration of the second commitment period (probably 2013-17), given the tacit assumptionsthat: (a) there will be no international aviation emissions commitment before 201349; and (b)developing countries will accept some form of UNFCCC emissions commitments for the thirdcommitment period (probably 2018-25). Moreover, given that perhaps 77% of aviation emissionsreputedly come from flights between Annex I countries, the limitation on environmentaleffectiveness would not be too significant. This is particularly apparent when one considers thegeneral acceptance that aviation emissions commitments should be limited to CO2 in the shortterm, when this gas contributes just 37% of aviation’s global warming impact. Developed countriesthat feared significant distortion to the competitiveness of their aviation industry could potentiallyseek remedy through individual Bilateral Air Service Agreements, and their provisions relating to‘fair and equal opportunity’.

4.9 Given the industry’s marginal returns and high growth expectations, emissionstrading is likely to be an appropriate tool to help meet emissions reductioncommitments

The ICAO CAEP analysis has shown that the aviation industry has limited technological andoperational opportunities to limit or reduce its emissions in the short to medium term; the rate ofefficiency improvements through these is unlikely to match the rate of industry growth. There isthus a real possibility that emissions commitments could only be met if industry growth werereduced; particularly given the industry’s marginal returns, this prospect is clearly undesirable.Emissions trading is one tool that could help the industry meet its commitments, while minimisingthe impact on growth. Trading offers participants the flexibility to source lowest cost abatementopportunities from outside its own activities. It has the potential to maximise gain, and minimisepain.

4.10 An “open” system is a ‘no brainer’, but being open to trade with other sectors meansaccepting relevant trading rules

Available evidence and stakeholder perspectives concur that any trading scheme involvingaviation must be open to trade with other sectors. Within a UNFCCC context this is generallyunderstood to mean full access to the allowances and credits available from eligible sources andsinks through the three Kyoto mechanisms (international emissions trading, Joint Implementationand the Clean Development Mechanism) within the definitions and eligibility criteria agreed by theUNFCCC. Within an ICAO emissions framework, this might mean being open to a variety of offsetoptions (for which definitions could follow the UNFCCC or, in theory, could be derived fromunilateral ICAO decisions).

49 see section 4.2


However, this approach would risk losing access to the supply side offered by the KyotoProtocol/UNFCCC (or another “dominant” scheme, should one emerge). Access to UNFCCCcredits and allowances will almost certainly mean accepting UNFCCC definitions, rules andprovisions. In deciding between developing its own framework under ICAO and integrating itselfinto the UNFCCC, the industry should consider weighing up the potential total supply of creditsand allowances from each side, as well as political acceptability and legal feasibility issues.

4.11 There are advantages in preparing for a mandatory commitment with a voluntarytrading scheme

Particularly if there is unlikely to be a mandatory emissions commitment for ten years, the industrymay face increasing pressure to adopt an effective voluntary initiative – an approach alreadyrecognised by ICAO50. A voluntary trading programme could perhaps be useful in this context –and would be likely to attract political approval. It would also offer additional benefits.

It would give the industry the opportunity to explore the potential effectiveness of emissionstrading as a tool to meet commitments. It would present an opportunity for a smooth transitionbetween a short term voluntary initiative and what is likely to be a key (market-based) mechanismfor meeting emissions commitments in the longer term. Participants would be able to trial differenttrading strategies without fear of stringent non-compliance penalties. It would also give theaviation industry the opportunity to ‘catch up’ on other energy-intensive industries who will alreadybe trading as a way of meeting emissions commitments; UK companies, for example, will have theopportunity to hone their emissions management and trading skills as soon as April 2002, whenthe country’s national scheme unrolls.

The exact approach for a voluntary scheme would be open for discussion. One possibility wouldbe that participants accept an absolute limit on emissions. This need not be an absolute reductionin emissions, but could be tailored to reflect expected industry growth; in a similar fashion, forexample, Australia’s Kyoto Protocol commitment allows the country an 8% increase in itsemissions relative to 1990. Another possibility would be some form of performance standardbased approach, which would reward entities that had already taken action to improve fleetefficiency. Yet another possibility would be to focus on offsetting (in part or in their entirety) ‘new’emissions above an agreed baseline (e.g. 2000); in this way, only additional growth would betargeted rather than existing activities. Whatever scheme is chosen, it should have the politicaland public perception of being ‘credible’. Such ‘credibility’ would need to be carefully determined.One potential measure might be the successful negotiation of recognition (by Governments) ofearly action.

There may be merits in prefacing any voluntary trading scheme with an electronic tradingsimulation.

50 see, e.g., ICAO (2001) Agenda item 14: environmental protection. Updating of resolution A32-8: consolidated statement of

continuing ICAO policies and practices related to environmental protection. Document A33-WP/43, for consideration by the ICAOAssembly 33rd session, September 2001. This includes recognition that “in the short term, voluntary measures (industry initiativesand negotiated agreements) could serve as a first step towards future actions to further reduce emissions”.


5 Assessment of Options for Scheme Designs – by Design Element

Emissions trading schemes can be deconstructed into individual design elements (see Appendix).Workstreams 1 (policy assessment) and 2 (economic analysis) provide the basis for the followingassessment of options for each design element – in the international aviation context.

5.1 Open vs. Closed

An open system has wide support among relevant aviation authorities, climate change authorities,and environmental NGOs. An open system will therefore be politically acceptable, and wouldfacilitate compatibility with future international rules and other emissions trading schemes. It isrecognised as the most cost-effective option in reducing greenhouse gas emissions in the longterm. An open system for aviation is generally understood to be a system that allows creditsupplies derived from activities under the UNFCCC/Kyoto Protocol.

The economic analysis has confirmed that an open scheme is a far more economically effectiveway of meeting an emissions commitment. In terms of economic efficiency, the essential featureof any trading scheme should be that most reductions in emissions are made outside the aviationsector, because emissions in the sector are of high value and expensive to abate. Under an openscheme, aviation would be expected to be a net buyer51 – as its internal abatement costs are likelyto be higher than the expected market price. Buying in permits would allow the air transport sectorto continue to grow. In contrast, under a closed scheme, the supply of permits would be restrictedand the price would be high; air transport growth would correspondingly be curtailed.

Economic analysis also indicated that permit prices under a closed scheme may be some 10 to 20times higher than under an open scheme if the sector is subject to a cap imposing a reduction inemissions relative to 1990 levels. Prices may be $600/tonne of CO2 under a closed scheme52

compared with $25-50/tonne of CO2 under an open scheme. Correspondingly volumes of trafficare likely to be greatly reduced under a closed scheme compared with an open scheme and thosepassengers who continue to fly would face large fare increases as a result from high permit prices.The reduction in traffic would mean that total airline profits would be reduced. A less stringenttarget would reduce the severity of these effects but they would remain large with any targetrequiring a significant reduction in the rate of growth of the sector.

The price of permits is likely to be reflected in increased fares; the higher the permit price thegreater the increase in fares. For a permit price in the range $25 to $50/tonne of CO2, which ispotentially typical under an open scheme, the average price of a London to New York ticket mightrise by some $11/ticket to $21/ticket. Higher permit prices would lead to correspondingly greaterincreases.

51 Indeed, the economic analysis suggests that the industry might buy some 90% of its required reductions from outside.52 Calculations derived from the tables in the Appendix to the AERO-model indicate that fuel costs are of the order of 10% ofaverage costs (an approximate average, with inevitable variations between routes and carriers), and demand for air travel isrelatively inelastic, with a 10% rise in fares leading to only a 7% reduction in demand on average. A 100% rise in the fuel prices(taken here to including the price of permits) thus leads to only a 7% reduction in demand. This means that the rise in costs (andreflected in a rise in fares) needs to be large to counteract the rise in demand expected by 2010. To reduce emissions in 2010 to95% of 1992 levels entirely by increases in fuel prices would require a 770% rise in fuel prices, equivalent to a levy of $2000 pertonne of fuel or $634 per tonne of CO2, compared with a base fuel price in the model of $220/tonne of fuel.


Not all carriers will have their profitability affected equally. Relatively fuel efficient airlines may tosome extent gain if there are fare increases which are greater than their cost increases. This mayhappen if fare increases in the market are driven by the costs of less fuel efficient airlines.

Economic analysis has also indicated that the price volatility within a closed scheme is likely to behigher than in an open scheme, even in a transitional arrangement before moving to a full closedscheme. For these reasons, an open system would be the preferred option for the aviationindustry, even in a transitional scheme.

However, one specific alternative to open trading might be feasible – an essentially closed system(for example based on a performance standard; see section 5.2) but with access to offsetmeasures (notably sinks) or to other forms of low cost permits. This could be conceivable underthree scenarios:

• If the Kyoto Protocol were to implode (and, with it, the regulatory driver of Article 2.2), to bereplaced by a similar commitment under ICAO (see section 1.2);

• If ICAO member states agree that ICAO retains full control over international aviationemissions, and remove it from the UNFCCC realm;

• In the case of a voluntary scheme ahead of mandatory commitments under the UNFCCC.

In the first scenario, ICAO would be entirely free to develop whatever system was acceptable to itsMember States. But there are issues to consider with the second and third scenarios. The industryshould carefully consider whether the second scenario would be in its best interests (see section4.8 for a synopsis of the arguments). In the third scenario, participants would probably be requiredto use UNFCCC definitions (e.g. of eligible sinks) – agreed intergovernmentally on the basis ofinternationally developed scientific research – if it were to receive credit during the mandatorycommitment period for its early action. Just as projects under the UNFCCC Activities ImplementedJointly scheme are to stand a chance of getting credits usable to meet Kyoto Protocolcommitments only if they meet (ex post) the rules for Joint Implementation or Clean DevelopmentMechanism projects, it would seem unreasonable to expect that Parties would accept giving creditfor particular activities that were not eligible under the UNFCCC.

If residual opposition to an open scheme strengthened, one potential compromise would be tohave the scheme open to domestic aviation emissions only. This would facilitate entities’ coherentcentral management of their whole (domestic and international) emissions budget.

5.2 Type of scheme

There is no unequivocal choice between a classic ‘cap and trade’ model, the more ad hoc‘baseline and credit’ approach, the hybrid ‘cap, credit and trade’ model or the “carbon intensity”approach inherent in a performance standard.

Cap and trade would impose an absolute limit on emissions: this would be compatible with (andwould facilitate integration with) the underlying principle of the Kyoto Protocol (trading below acap). It would also give the greatest environmental certainty as to the level of emissions.Presuming that aviation would be able to buy in credits from outside its industrial sector (see 5.1),it would effectively be a ‘cap, credit and trade’ scheme – so all participants have the potential tomeet their commitment. Careful consideration should be given to the baseline year, so as not topenalise companies that had taken early action, e.g. by purchasing more efficient aircraft, nor toreward those that operated older, less efficient fleets.


For a mandatory scheme under the auspices of the UNFCCC (i.e. if and when a formal emissionscommitment is agreed for the second and/or subsequent commitment period) and for the sake ofsimplicity, cap and trade would seem the most appropriate approach. But it may be too rigorous toencourage participation in any precursor voluntary scheme.

Baseline and credit would probably give reasonably good assurance over the achievement ofenvironmental objectives, as the baseline can be lowered over time towards a defined target.However, it would be less conducive to promoting liquidity, as the market would be ‘thinner’,because most of the emissions commitments would be accounted for by the baseline, with onlysurpluses or deficits traded.

An industry-wide performance standard (or “unit”) approach, with permits allocated on the basis offuel efficiency per unit of activity, would present a considerable challenge for negotiation,particularly given that proper benchmarking of individual performance against an industry standardwould require a case-by-case approach of take account of all individual circumstances.

However, there may be some merit in considering such an approach, particularly for a voluntaryscheme ahead of mandatory requirements53. Being based on a ‘carbon intensity’ parameter (i.e.amount of carbon emitted per unit of output), a performance standard would allow the continuationof industry growth, while providing an incentive for improving energy efficiency. The potential formore energy-efficient airlines to become net sellers would increase market liquidity, and providethe potential for supply even in a closed trading system. It would presumably enable easyparticipation for new entrants – who could compete on the same terms as existing participants(and may even benefit from using newer, more efficient aircraft).

Moreover, economic analysis shows that allocating free permits on the basis of present fuelefficiency would increase incentives for abatement, which may or may not be economicallyefficient, depending on whether emissions reduction targets have been set at the optimal level. Aperformance target approach would tend to increase both the quantity of flights and fuel efficiencyrelative to the case where fixed amounts are ‘grandfathered’ or permits are ‘auctioned’ (seesection 5.4).

The approach is not without its drawbacks, but even these can be countered. There is noguarantee that a unit approach will make any contribution to limiting absolute emissions, norprovide any incentive for it to do so. It would be more complicated to administer than a systembased on absolute emissions, as the unit-based approach is not immediately compatible with theabsolute approach of the Kyoto Protocol – the unit of trade would be quite different. It would beimportant to establish a direct relationship between an efficiency standard expressed in, forexample, gallons/RTK and a ‘carbon currency’ expressed in tonnes of CO2 equivalent. Theresulting conversion factor would then enable ‘absolute permits’ to be bought from outside thesystem and converted into the unit efficiency parameter, and would prevent entities with domesticaviation emission commitments from having to manage these separately (as these would bequantified in absolute terms).

As the performance standard approach would allow for the continuation of industry growth – albeitcleaner growth – there might be particular merit in considering it for the basis of a voluntary

53 A. Sentance and H. Pulles (2001) Discussion paper on the initial allocation of permits at the beginning of each year:

“benchmarked allocation”. Paper for CAEP WG 5 (market based options). CAEP 5/WG5 WP5-5/3. The authors agree with thisconcept, suggesting that one could “define the benchmarked initial allocation as an efficiency target for each airline (defined interms of emissions per RTK). Airlines that met their target would not need to buy or sell permits. Airlines which were more efficientthan the target level would be net sellers of permits to airlines which did not meet their target. The first step in developing thissystem could therefore be the development of a system of efficiency targets which formed the basis of a voluntary commitment byairlines to curb emissions.“


scheme open to all entities. An energy efficiency-based commitment might also increaseincentives for non-airline members of the industry to participate in emissions-related activities (i.e.they could benefit from crediting for more efficiency fuel/equipment).

Finally, it could perhaps also provide the basis for the voluntary participation of developingcountries, assuming that any mandatory (absolute) commitment will bite first on developedcountries (see 5.3) and would thus be more effectively addressed through cap and trade. A similarproposal – binding caps on developed countries complemented by voluntary energy efficiencytargets for developing countries – has been tentatively mooted as a possibility in the broaderUNFCCC context, as the first (second commitment period) step towards full developing countryparticipation54.

5.3 Extent of scheme

There are several issues involved in this category:

• Whether commitments should be imposed on countries or industry entities;

• Which countries should face commitments (developed v developing; ICAO member states vUNFCCC Parties), and whether others can participate voluntarily;

• Which entities might expect to face commitments in some form.

Whether directly or indirectly, the burden of limiting international aviation emissions is likely to fallon the industry. Some have argued for imposing an emissions commitment directly on emittingentities (e.g. airlines). However, the only current legal basis under an intergovernmentalframework (such as UNFCCC or ICAO) is for commitments to be allocated to sovereign states (i.e.countries that are signatories or member states of the relevant agreement). Thereafter,governments are entitled to devolve such commitments to legal entities, and it can be expectedthat many authorities will do so. A voluntary initiative, on the other hand, would more likely beindustry-led.

From an aviation industry perspective, there are arguments both ways for any such commitmentto be imposed on ICAO member states or UNFCCC Parties. Both are feasible routes; while ICAOhas been delegated responsibility for pursuing options to limit or reduce (international) aviationemissions, the UNFCCC does retain ultimate authority. A framework within ICAO might give theindustry the greatest potential influence. And – not incorporating the UNFCCC’s explicit splitbetween developed and developing country members – it might be environmentally beneficial,giving the opportunity to cover the entire global total of international aviation emissions. An ICAOscheme might also open coverage to developed countries that are not Parties to the KyotoProtocol (most likely including the United States). But an ICAO-based commitment might alsoreduce the prospects of having access to credits and allowances through the Kyoto mechanisms(which are under the UNFCCC framework and subject to UNFCCC rules). Acceptance of theUNFCCC framework (i.e. imposition of any commitment on Kyoto Protocol signatories) may thus,in the longer run, be a more beneficial position for the industry to take.

54 B. Müller, A. Michaelowa and C. Vrolijk (2001) Rejecting Kyoto: a study of proposed alternatives to the Kyoto Protocol. Climate

Strategies, July 2001 (pre-publication copy for general distribution). While rejecting the feasibility of permanent global commitmentsbased on emission intensity, the authors consider that “…emission intensity considerations might form useful input to exploringways of quantifying commitments for some developing countries, perhaps in the form of voluntary second-period commitmentsunder Kyoto”. However, they premise this on being able to resolve the “considerable inequities between developing countries” thatsuch an approach might exacerbate.


However, these issues might not need to pose excessive problems. First, the environmentalperspective. A large majority of international aviation emissions are thought to come from flightsbetween Annex I countries. Removing developing countries from the commitments equation wouldhave less of an effect on environmental integrity than excluding non-CO2 aviation GHGs (CO2accounts for just 37% of aviation radiative forcing55).

Second, the competitiveness issue. At present, the imposition of a mandatory internationalaviation emissions commitment before 2013-17 (the expected duration of the 2nd commitmentperiod) seems unlikely. Some form of GHG emissions commitment on developing countries couldcome into effect by the 3rd commitment period (expected to be 2018-25). Such a commitmentcould be expected to relate to international aviation emissions as well as all domestic GHGemissions. So in the end there may only be a five year time lag (2013-17, the likely duration of thesecond commitment period) when the developed v developing country competitiveness issuewould exist.

On the issue of geographical coverage, universal participation (i.e. by developing as well asdeveloped countries) is clearly advantageous for both the environment and to mitigate competitivedistortions between countries’ air transport industries. A wider geographical scope increases thelevel of aviation emissions subject to a commitment. Moreover, economic analysis has raisedcompetitiveness concerns. Obligations based on carrier nationality may introduce distortions tocompetition on some routes because different carriers flying on the same route may have differentobligations. If the route is highly competitive this could drive some carriers (e.g. from developedcountries) with an obligation to hold permits off routes, because they may not be able to competeon price with those carriers (e.g. from developing countries) who do not have a similar obligation.Additionally, there may be knock-on effects to other routes due to the presence of joint costs andthe network nature of the industry56. A route-based scheme (i.e. with equivalent commitments onall airlines flying that route) would avoid introducing competitive distortions on individual routes57.

However, it is politically unrealistic to expect developing countries to accept an internationalaviation emissions commitment in the short term. Not only would it contravene the principleenshrined in the “Rio Declaration” (Earth Summit, 1992, principle 16) of “common butdifferentiated responsibilities”, but it would be impossible to disassociate international aviationemissions from the UNFCCC timescale for the adoption of developing country commitments. It isunlikely that a developing country Government would accept a climate change commitment simplybecause this commitment was orchestrated by ICAO rather than the UNFCCC. The same mightdoubt also apply to the United States, which might be considered unlikely to take action oninternational aviation emissions, unless similar schemes were introduced for other transportsectors.

The geographical coverage issue also influences the economics of options for assigninginternational aviation emissions to individual countries (a consideration akin to SBSTA’s

55 D. Lee and R. Sausen (2000) New directions: assessing the real impact of CO2 emissions trading by the aviation industry.Atmospheric Environment 34: 5337-5338.56 If the market were less competitive the effects on market share might be more limited because carriers are able to absorb someof their permits costs in existing profits. Changes in market share might be further reduced if airlines are perceived as offeringdifferent services, e.g. due to loyalty to a national flag carrier. Nevertheless, analysis suggests that the distortions to competitionwould remain potentially significant relative to the route-based permit scheme.57 On a route-based scheme, some switching between destinations by carriers and customers is conceivable, but this would beunlikely unless passengers view routes as close substitutes. However, introducing new stop-overs to create new routes which areclose substitutes and distortions of competition between rival hubs which offer similar services may lead to more significant effects.Moreover, some potentially important routes would be excluded because they involve non-Annex I stop-over points, e.g. mostroutes between Europe and Australia, via Bangkok, Kuala Lumpur and Singapore. Non-inclusion of these routes wouldcompromise environmental effectiveness.


contemplation of UNFCCC-level allocation options). From an economic perspective, allocation byaircraft nationality (i.e. to airlines registered in developed country) exacerbates thecompetitiveness issues outlined above. Analysis shows that there are potentially seriouscompetitive distortions arising from imposing additional costs on one airline on a route and not theother, irrespective of whether the route is fully competitive or not. This applies even at relativelymodest permit prices, for example $25-50/tonne. One option – with support from the economicanalysis - is to allocate emissions either on the basis of routes flown or on the basis of take-offand landing point. These do not present the same level of concern relating to competitiveness. Butimplementation would involve either:

• all airlines (i.e. including those from non-Annex I countries) taking on the same commitmentson the whatever routes were selected for commitments (e.g. all flights to/from or betweenAnnex I countries); or

• a restriction of routes covered to those on which airlines from non-Annex I countries did not fly(this would need to be confirmed, but would most probably be the vast majority of intra-Annex Iflights.

There has been some consideration of which sector(s) within the air transport industry should bethe recipients of a commitment. Options include: airlines, manufacturers, fuel providers, and AirTraffic Control (ATC) providers. There appears to be a general presumption – including withinCAEP and at the IATA Stakeholder workshop in April 2001 - that airlines would be best positionedto receive commitments. Airlines are generally considered to have the greatest control over bothtechnology deployment and aircraft operations.

However, it is too early to exclude discussion of commitments on other industry sectors; evenCAEP suggested that ICAO might provide guidance on how to engage airports, manufacturersand ATC. The most likely participants would seem to be fuel- and ATC-providers.

In the first scenario, fuel providers would handle the emissions permits (either financing offsetprojects or buying/being allocated permits from the system authority), and would reprice their fuelaccordingly; airlines would buy permit-paid fuel and would presumably need no furtherinvolvement in the emissions system. Such a system offers several advantages. It would probablybe efficient to administer, centralising the emissions allowance system, rather than dispersing itamong numerous players. Certain fuel providers are affiliated to entities (e.g. bp, Royal DutchShell) that are already leaders in the carbon market – which might increase system efficiency. Itmight be less expensive overall for airlines, as there would be no need to develop theinfrastructure, institutions and capabilities related to emissions trading. The system wouldprobably benefit smaller airlines (e.g. charter operations) which might not have the purchasingpower or infrastructure to compete on a global carbon market. It might also facilitate developingcountry participation; with developing countries perhaps being encouraged to make a certainproportion of their fuel requirements permit paid.

However, this nature of commitment also has several disadvantages. It would appear to take theform of a levy (i.e. ‘permit-paid fuel’), a market-based approach on which the aviation industry(and ICAO) has well established views. It would be hard (if not counterproductive) to integratepermit-paid fuel (a commitment on fuel providers) with airline-level emissions trading. It couldmean that airlines are subject to price risk on the permits which they would be unable to hedgeuntil financial instruments were developed to manage this risk. If all fuel had to be purchased withpermits it would reduce the opportunity for the airlines to make emissions reductions themselveswhich they may find are at a lower cost than those which they purchase. Finally, and inevitably,fuel providers would be very reluctant to assume the commitment themselves, perhaps arguingthat they have no control over the actual demand for fuel.


The second scenario envisages ATC providers taking some responsibility for the emissionsliability associated with ATC delays and indirect routing; both contribute to increasing emissionsrelative to a direct A to B route – an increase that is outside the control of airline operators(‘excess’ emissions).

There are two potential ways to deal with this. First, airlines could, for example, be heldresponsible only for the emissions resulting from a direct route between two points – regardless ofthe actual distance flown and actual tonnage of emissions. This approach is analogous to thesystem for air navigation charges. This would require standard emissions levels to be developedfor each route, based on parameters such as distance, weight load and aircraft type. This wouldenable airlines to calculate their liability in advance – but would reduce environmental integrity (asthis system would not account for all emissions) and might limit market confidence (as the unittraded would bear no relation to the ‘actual’ commodity).

Second, Governments – which frequently control ATC – could allocate a stock of permits to ATCproviders. ATC providers could then assume responsibility for ‘excess’ emissions – and agree‘service level agreements’ (or equivalents) which would ensure that airlines are recompensed fortheir ‘excess’ emissions. As the ATC stock would be limited, this would provide financial incentivesto reduce the delays. Eurocontrol’s Central Office for Delay Analysis currently attributes causes todelays – and could potentially form the basis of a framework for a ATC commitment in Europe atleast. A similar alternative would be for Governments themselves to assume responsibility for‘excess’ emissions related to indirect routings and other forms of inefficient airspace use due toaeropolitical reasons.

5.4 Permit distribution method

There is no clear choice for permit distribution. Both grandfathering and auctioning have theiradvantages. While some form of grandfathering would seem the more logical choice from a policyperspective, economic analysis58 shows a preference for auctioning. There are several potentialmechanisms for enabling the participation of new entrants.

Grandfathering forms the basis of most existing emissions trading schemes, principally because itis premised on gratis allocation59, and thus is more likely to win industry buy-in. Caps are basedon historical data or present activity levels, so are equitable to participants and relatively efficientto administer.

However, it is hard to integrate new entrants equitably (as they have no historic data on which toallocate). There is a potential for ‘gaming’ (keeping emissions high to make it easier to reducethem), reducing the incentive for early action. Similarly, there is the potential for inefficient airlinesto receive a generous allocation60. Free allocation of a greater number of permits than isnecessary to achieve the objectives would possibly contravene ‘state aid’-regulations, e.g. underEU law, as it would effectively amount to a subsidy.

58 The economic analysis encompassed both economic efficiency (the extent to which economically efficient price signals aremaintained, and the extent to which fares reflect the full price of permits) and distributional effects (which result from differingallocation of funds among airlines, governments, consumers and other parties).59 Free allocation of permits to existing carriers may have the potential to create distortions in less competitive market sectorsbecause of the potential use of grandfathered funds to deter entry, for example by the threat of predatory pricing. Conversely freeallocation of permits to carriers facing competition on a route from those without obligations may mitigate competitive distortions.60 A recent CAEP Working Group 5 paper suggests that this problem can be surmounted by grandfathering on the basis of aproduction level: A. Sentance and H. Pulles (2001) Discussion paper on the initial allocation of permits at the beginning of each

year: “benchmarked allocation”. Paper for CAEP WG 5 (market based options). CAEP 5/WG5 WP5-5/3.


There are two types of grandfathering: allocation based on present levels of flight activity (e.g.RTKs) or fixed allocation according to historic levels of activity (e.g. based on 1990 emissions).

The former could be linked to the schedule that airlines have filed for the coming year61. It wouldreduce incentives for abatement because it means that carriers do not pay the full cost of permitsfor additional activity. It may thus increase levels of activity above the optimal signalled bypermits, although it is not clear how great this effect will be in practice.

Allocation based on historic activity levels does not have the same effect of weakening incentivesbecause changes in activity do not change the allocation of permits. Carriers thus bear the fullcost of emissions from any additional activity. This is likely to be reflected in fares, which tend toinclude the full price of permits for all emissions from a flight. Consequently economic efficiencyshould not be reduced relative to the case where permits are auctioned, provided that the marketfor air transport is competitive, because the decisions of carriers in respect of which flights andfares to offer are unchanged from the case where permits are auctioned62.

Were grandfathering based on historical data adopted, there should be careful consideration ofthe choice of baseline year. For a voluntary programme, it could be appropriate to select the mostrecent years for which reliable quality data were available (e.g. the three years to 2000 for the UKtrading scheme). To implement a mandatory commitment, there may be greater benefit inselecting the same base year as for the commitment (e.g. 1990 in the case of the Kyoto Protocolfirst commitment period, or 1992 as used by IPCC63).

Auctioning has advantages from an economic perspective, notably that it allocates permits on anon-discriminatory basis and the revenue raised could in theory be used, for example, to reducetaxes elsewhere or finance other climate change initiatives. It forces participants to focus on theiractual needs and attaches a value to these needs (i.e. auctioning effectively sets the quantity andprice of the commodity, as participants will seek to avoid overpaying or overbuying).

An auction would enable equitable participation of all – including new entrants. It would avoid theimmediate need for data availability, quality and consistency in order to be grandfather allowances(an airline, however, would still benefit from forward estimating its RTK and CO2 emissions inorder to determine its permit purchasing requirements). However, auctioning imposes animmediate cost on the entity which is likely to deter industry participation. This would beparticularly true if the air transport industry were required to pay for permits which would beallocated free to other industrial sectors (particularly direct competitors, such as international roadand rail transport). It could also pose intra-industry competitiveness issues, as the purchasingpower of large entities may force small entities into non-compliance. Auctioning is alsoadministratively complex – requiring institutions to act as auctioneer and revenue holder/disburser.

Auctioning raises revenues. This is consistent with the ‘polluter pays principle’, but does begquestions about how that revenue is utilised. If retained by Governments, it amounts to a tax. Ifrecycled to the industry, it effectively becomes a revenue-neutral charge. Revenues could besubstantial. Economic analysis suggests that with a permit price of $50/tCO2, auction revenues in2010 could amount to some $17 billion pa.

61 A. Sentance and H. Pulles (2001), as above.62 Such a scheme could conceivably lead to windfall gains to carriers. They might receive increased revenue commensurate withfares reflecting the full price of permits, without themselves being subject to this price for all of their permit requirements. Thesewindfall gains could potentially be of the order of $15 billion p.a. with a $50/tonne CO2 permit price. However any gains may beabsorbed, at least partially, in increased costs, e.g. because other participants in the value chains are able to appropriate therevenues.63 IPCC (1999) IPCC special report: aviation and the global atmosphere – summary for policymakers. Intergovernmental Panel onClimate Change.


Suitable options for the recycling of revenues might include:

• Recycling for projects in the air transport sector (e.g. scrapping aircraft purchased more than20 years before 201064);

• Reducing other environmental impacts (e.g. noise and NOx);

• Investing in fuel efficiency in the air transport sector (e.g. R&D into emissions-reducingtechnology);

• Funding improvements in ATC service provision;

• Funding environmental projects outside the air transport sector.

It is important to design the allocation method such that it enables the participation of new entrantson a fair and equally competitive basis. Permits cannot be grandfathered (in classic fashion) tonew entrants, as they have no historical emissions levels on which to base an allowance.However, they could in theory be grandfathered on the basis of predicted future emissions (i.e.activity levels apparent in schedule filed for the forthcoming year). Conversely the adoption of aperformance standard approach to grandfathering could facilitate new entrant participation (seesection 5.2). One option would not be appropriate, namely to require new entrants to purchaseemissions allowances (e.g. through an auction) if existing participants were grandfatheredallowances for free. This would likely contravene trade law regulations, including EU law.

For a country to be in a position to have sufficient emissions allowances to allocate to newentrants, it will have to have managed its national ‘carbon budget’ to not allocating the entirety ofits emissions allowances at the outset, instead retaining a ‘bank’ of allowances. In a rapidlygrowing and diversifying industry such as international aviation (witness the rapid recent growth ofthe number of low cost short-haul airlines), there is considerable benefit for Governments to retaina ‘credit reserve’ to serve both as a source for new entrants and a buffer to cover unforeseeneventualities. The level of this credit reserve would require careful determination, but could becombined with either grandfathering or auctioning. One option would be to grandfather themajority of permits, but retain a credit reserve for new entrants and perhaps for ATC (see section4.3), and to auction for ‘over-emitters’ (this sending a price signal, promoting liquidity, and raisingrevenue).

5.5 Coverage of gases

Emissions trading schemes generally target specific gases, or groups of gases, for reduction. Foraviation, three broad options can be considered:

- Restriction to CO2, as the only ‘direct’ greenhouse gas (GHG) emission from aircraft aboutwhich there is a sufficient degree of certainty about the impact;

- Inclusion of the “Kyoto basket” of 6 GHGs, although only one of these (CO2) is emitted byaircraft; or

- Inclusion of all GHGs emitted by aircraft (CO2, NOX, H2O) whether listed in the Kyoto Protocolor not, and whether direct or indirect

To date, emissions trading schemes developing under the Kyoto Protocol are tending to berestricted to CO2, in the short term at least. In part this is due to simplicity, in part due to residual

64 Estimated by FESG to cost $1 billion: FESG (2001) Economic analysis of potential market-based options for reduction of CO2

emissions from aviation. Document CAEP/5-WP/24.


difficulty in measuring and verifying GHGs other than CO2. The latter is even more true for aviationemissions of NOx and water vapour for which there are considerable scientific uncertainties abouttheir ‘global warming potential’ (GWP) – and which are Parties to the Kyoto Protocol would nototherwise be required to limit (as they are not listed in Annex A of the Kyoto Protocol). Without aGWP, it will be impossible to convert emissions reductions of such gases into CO2-equivalent (theestablished unit of exchange within the GHG emissions trading framework), and thus impossibleto trade freely through the Kyoto mechanisms.

These provide a strong rationale for restricting an aviation emissions trading commitment (andthus trading) to CO2, in the short term at least. CAEP, authorities who have proposed aviationemissions trading schemes, and stakeholders at IATA’s ‘stakeholder workshop’ concur on thispoint. However, there is also general recognition that other gases could be added at a later datewhen their impact was more widely understood and dependable measurement techniques hadbeen developed. Once GWPs have been determined for other aviation GHGs, they too could besubject to emission commitments, and available for trading purposes. This may be particularlyappropriate given that a scheme limited to a gas (CO2) that forms just 37% of aviation GHGs65 issomewhat limited in environmental effectiveness. Moreover, it would give the aviation industryaccess the potential flexibilities of a multi-gas system (e.g. the opportunity to balance an increasein NOx emissions with reductions in CO2, or vice versa).

5.6 Liability rules

To instil confidence in the market, participants prefer to understand their liability with regards tocredits purchased from another participant who subsequently defaults on the terms of the scheme.In general, individual emissions trading schemes have seen industry support for seller liability.Seller liability is generally accepted as being the most feasible and cost-effective liability regime,and has been adopted in most emerging and existing emissions trading schemes. Participants atthe IATA ‘stakeholder workshop’ also favoured seller liability from an aviation perspective,although they were aware that neither CAEP nor any other commentators had addressed theissue. A system of seller liability would probably be of most benefit to the aviation industry, as alikely net buyer of emissions. It would also facilitate compatibility with the wider carbon market.

5.7 Monitoring, verification and reporting

Unless participants’ emissions are monitored and verified in a way that is accurate, standardisedand universally accepted, the environmental and market credentials of the trading scheme will notbe secure. It would be in the best interests of the aviation industry to adopt an internationallyaccepted monitoring, verification and reporting protocol, such as the developing WRI/WBCSDGHG Protocol, and complement this with aviation-specific requirements. The standards could beapplied by independent verifiers, accredited as such by relevant national emissions tradingschemes or for relevant international mechanisms (i.e. Joint Implementation and the CleanDevelopment Mechanism), providing they could demonstrate proficiency with the aviation-specificrequirements.

This path would increase market confidence in the validity of emissions reductions from theaviation sector and enable compatibility within the wider carbon market. It would also have theadditional advantage of being carefully tailored so as to be compatible with emerging UNFCCCprovisions (thus facilitating access to credits and allowances from the Kyoto Protocol). Use of anexisting standard would be more cost-effective than the development of a new protocol, although

65 D. Lee and R. Sausen (2000) New directions: assessing the real impact of CO2 emissions trading by the aviation industry.Atmospheric Environment 34: 5337-5338.


it may be need to be supplemented with specific provisions relating to the aviation industry. Itwould also allow airlines to manage their domestic and international emissions within the sameframework, which would presumably be cheaper and easier than managing them under differentprotocols.

5.8 Institutional implications

Whoever establishes the scheme, and however it is established, a variety of institutional forms areneeded to facilitate and regulate the market. These include a body (or bodies) to: monitor andreport emissions; act as a trading platform/exchange; provide a registry; regulate the scheme andpenalise non-compliance. To date, institutional issues have been relatively sidelined indiscussions on aviation emissions trading. Yet they represent a significant cost, and requiresuitable infrastructure and knowledge.

If a mandatory commitment is imposed through the UNFCCC (e.g. international aviation emissionsbecome integrated into Parties’ assigned amounts from the second commitment period), theninternational aviation will become a player in the Kyoto mechanisms like any other sector. Theindustry would be able to use the institutions that would be developed anyway – both nationallyand internationally - to facilitate international emissions trading. In this scenario, there would be noneed for the industry (e.g. through ICAO) to develop specific infrastructure or institutions. Suchaviation-specific institutions would incur significant costs, yet bring no added value. If, however, itshould be decided that industry specific compliance provisions are required, ICAO, as the bodyresponsible for setting international standards and recommended practices for aviation, would bein a good position to take responsibility for their management.

But such an approach will not suffice for a short-term voluntary scheme or a mid-term mandatoryscheme wholly under the ICAO banner. In these scenarios, ICAO and other industry bodies willneed to establish their own infrastructure.

In the first scenario (which envisages transition to a mandatory arrangement under the UNFCCC),the institutions will have a short shelf life so costs should be minimised. The key new institutionsrequired will be: a registry to track movement of allowances between participants’ accounts; apseudo regulatory body (“emissions trading authority”) to allocate allowances, assimilate theemissions totals reported by participants, and ‘penalise’ non-compliance (see section 5.11). In avoluntary airline-based initiative, IATA could conceivably perform these functions – but should notunderestimate the costs involved. In a wider voluntary initiative, there could be call for ICAO to doso. Emissions could be verified by accredited verifiers (e.g. those accredited to verify nationaltrading schemes or CDM/JI activities) without needing to establish a separate accreditationprocess.

In the second scenario, institutions would have a longer shelf life, and may merit greaterinvestment. However, the industry would need to weigh up these considerable additional costsagainst the uncertain additional benefit that an industry-specific scheme might bring. Wherepossible, and where permitted (if ICAO “goes its own way”, it may not be allowed access to Kyotomechanisms credits, allowances or infrastructures), there may still be advantages in“piggybacking” onto institutions that are developed for the wider carbon market (e.g. using thesame, or very similar, trading platform).

5.9 Banking protocol

Participants in a trading scheme may – in principle – save or “bank” unused or excess emissionsallowances or credits from one commitment period for use in a subsequent commitment period. Atrading system may elect to: have full banking (i.e. no restrictions); have limited banking (i.e. a


quantitative ceiling on the number of permits that may be banked, or a qualitative restriction on thetypes of permits that may be banked); or prohibit banking (i.e. surplus allowances are retired fromthe system). The basic decision to weigh up is the flexibility and incentive for early action providedby banking versus its potential for hoarding which can led to market price distortions. Noauthorities have yet commented on options for banking within an aviation emissions tradingscheme.

If a mandatory commitment is imposed through the UNFCCC (e.g. international aviation emissionsbecome integrated into Parties’ assigned amounts from the second commitment period), theninternational aviation will become a player in the Kyoto mechanisms like any other sector. Theindustry will thus be subject to the same banking provisions at the international level – which arelikely to be reflected at the national level, where compliance will be assessed.

In either a voluntary scheme (which could eventually lead into the above UNFCCC scheme) or apermanent ICAO-managed scheme, the industry may develop its own banking provisions. Theindustry would benefit from weighing up the advantages of full, unlimited banking (flexibility ontiming of emission reductions; making the most of early cheap abatement opportunities) against itsdisadvantages (could promote hoarding of early, cheap emission reductions and thus reducemarket liquidity – as demonstrated by the SO2 market in the US).

Unlimited banking is likely to be preferable, particularly in the early stages. It is the most cost-effective solution, offering entities flexibility in the timing of emission reductions, and allowing themto take advantage of earlier (and likely cheaper) abatement opportunities. Moreover, unlimitedbanking is likely to be the norm in the UNFCCC world – thus facilitating parity and (potential)transition between the systems. It is unlikely that the aviation emissions market – presuming it isopen to flows of credits and allowances from outside (see section 5.1) – would be stifled byhoarding; to date, this seems to occur only in small schemes such as for US SO2. Were hoardingto occur, the system management body (“emissions trading authority”) could consider the case forsome form of self-imposed limitation on the percentage of allowances that may be banked.

5.10 The permit or unit of exchange

‘CO2-equivalent’ is the most widely recognised permit denomination, and has been generallyadopted in emerging and existing schemes. Use of this unit within an aviation emissions tradingscheme seems sensible from the perspectives of both commodity trading and compliance. First, itwould therefore enable compatibility with the wider carbon market; there are evident efficiencies inhaving a single ‘currency’ for the entire emissions trading system. Second, it would also provideflexibility for incorporation of other aviation greenhouse gases in the future, through theirconversion to ‘CO2-equivalents’ once Global Warming Potentials would have been developed.Third, international trades will require Government recognition of allowances from otherjurisdictions – suggesting that Governments might not accept a unit of exchange other than thatagreed internationally. So an entity might risk non-compliance if it sought to achieve complianceusing units (e.g. from ineligible activities, gases, non-GHG trading schemes) that were notacceptable to the relevant jurisdiction.

5.11 Trading rules

All trading systems require clearly defined rules of conduct for its participants to abide by. If amandatory commitment were imposed through the UNFCCC, then international aviation wouldbecome a player in the Kyoto mechanisms like any other sector. The industry would be subject tointernational trading rules and those specific to relevant jurisdictions (e.g. EU and nationalschemes).


In either a voluntary scheme or a permanent ICAO-managed scheme, the industry may developits own trading rules. In either scenario, it is not worth rushing ahead into developing rules. Themost appropriate course of action should become clearer once certain fundamental decisionshave been made (e.g. the relationship to the Kyoto mechanisms; the similarity of monitoring,verification and reporting provisions to those under the UNFCCC). In the former case, there couldbe considerable advantage in ensuring that these are compatible with relevant UNFCCCprovisions (and regional/national derivations thereof). In the second scenario, the industry wouldhave greater freedom. However, developing detailed rules is a complex, lengthy and costlyprocess. There may be merit in learning from the experience of Kyoto Protocol-derived schemes.

5.12 Penalties for non-compliance

If a mandatory commitment is imposed through the UNFCCC and orchestrated through nationalGovernments, international aviation would be subject to whatever non-compliance provisions areagreed for all trading scheme participants in each jurisdiction. Participants in a trading schemecould then expect to be penalised if they breach the scheme’s rules, or default on theircommitments.

In either a voluntary scheme or a permanent ICAO-managed scheme, the industry may developits own system of penalties. In the second scenario, penalties should be sufficiently rigorous toensure that they substantially exceed the benefits of non-compliance. Weak penalties and/or laxenforcement would reward free-riders at the expense of entities that comply with their obligations– raising relative compliance costs for the latter and creating competitiveness distortions. Suitableoptions include: financial penalties (a standard fine per tonne of emissions in excess of thenumber of allowances held as the year-end); forfeiture of future allowances at a higher ratio; andexclusion from trading for a predetermined duration. Given potential competitiveness issues withother international transport modes, there would be benefits in making the nature and level ofpenalties compatible with those faced by those competitors.

In a voluntary scheme – where participants are accepting to incur abatement costs that they wouldnot otherwise face – penalties should be very modest or even absent. The aim should be topromote participation, rather than punish non-compliance. Direct financial penalties would beinappropriate. Suspension from the trading scheme would be counterproductive to the goal ofencouraging participation. Forfeiture of allowances at a ration slightly higher than 1:1 wouldperhaps be more suitable, as would the withdrawal of any incentives.

5.13 Incentives

In theory, companies may benefit from financial or other incentives to engage in often unfamiliaremissions trading schemes where participation is not mandatory or where alternative methods ofcompliance are available. Judging by available evidence, however, external financial incentivesappear to be having minimal impact in encouraging participation (e.g. the UK, where a totalincentive of £215m over five years has not yet enticed any confirmed participants). Given the likelyhigh abatement costs, any financial incentive for a voluntary aviation emissions trading schemewould probably have to be extremely high if it were to elicit participation from entities who wouldnot otherwise be interested. More important appears to be the possible impact of strategic,reputational, or operational incentives on potential participants’ performance and shareholdervalue.


Appendix 1: Analysing emissions trading schemes

Design Elements of an Emissions Trading Scheme

Primary Design Elements

Integration of schemeThis refers to the extent to which participants within a scheme have access to emissionreduction opportunities from outside it. In a ‘closed’ scheme permits are created by,distributed to, and traded between the scheme members alone. In an ‘open’ scheme,permits can be obtained from emission reductions projects ‘external’ to the scheme to beused to offset emissions of those participants within the scheme. In an intermediatescheme, there could be some limitation on the quantity or type of permits that may bepurchased from outside the scheme.

Type of schemeThis refers to the basic model of the trading scheme.

The implicit model of the allocation of permits to emit GHGs, to (Annex B) countries underthe Kyoto Protocol, is one of trading beneath an absolute maximum level (‘cap and trade’).Under a ‘cap and trade’ scheme, the total emissions levels for a jurisdiction (e.g. country orindustry sector) are distributed as absolute amounts of permitted emissions for eachparticipant.

‘Baseline and Credit’ is an alternative model, in which emission baselines are determinedfor all participants on the basis of a ‘business as usual’ scenario. Trading can occur to theextent that participants deviate from that baseline. i.e. credits accrue when participants emitless than their baseline, and are in deficit when participants emit above their baseline.

‘Cap, Credit and Trade’ is a hybrid of the two models above. Certain participants arecapped, but additional supply is achieved through other participants adopting a baselineand credit approach.

‘Performance standard or ‘unit’ approach’ is where the efficiency target is expressed as anumber per unit of output (e.g. tCO2 per passenger-km), and absolute emissions can growprovided the relative efficiency has kept within limits. Performance standards can be usedas part of the allocation rule for ‘cap and trade’ or to define the baseline for ‘baseline andcredit’.

Extent of schemeThis refers to the spatial or sectoral distribution of a scheme’s participants and/or theactivities covered. It affects: the activities for which emissions must be reduced orotherwise offset (and thus require permits); the sectors (e.g. airlines, manufacturers or fuelsuppliers); the participants in trading (e.g. only those with emission reduction commitmentsor others as well); the countries involved (e.g. developed countries only).

Permit distribution mechanismThe permit distribution mechanism is the method used to allocate allowances to participantsof the scheme. It is usually used with a cap and trade scheme, although the principlescould be applied to other types of scheme. The two main methods of permit distribution are‘grandfathering’, whereby permits to emit are allocated in proportion to a baseline reflectingemissions at a previously agreed point in time, or ‘auctioning’, in which participants are


required to bid for allowances. A hybrid of these two mechanisms may be chosen, e.g. witha permit reserve held back for excess emitters, new entrants or as a buffer. Less frequentlyconsidered options are a lottery whereby slots are allocated, and tendering.

Secondary design elements

Coverage of gasesThis design element states which gases are covered by the scheme. Schemes generallytarget specific gases, or groups of gases for reduction.

Liability rulesThe issue of liability is concerned with responsibility for the accuracy and validity ofemissions reductions associated with a particular allowance. To instil confidence in themarket, participants must understand their liability with regards to credits purchased fromother participants who subsequently default on the terms of the scheme. The two optionsfor design generally considered are buyer liability and seller liability.

Monitoring, verification and reportingIn order to ensure the environmental credibility of the scheme, and to enable participants tobe assured of the validity of credits purchased within the scheme, there needs to be astandard and accepted method of monitoring, verification and reporting emissions. Toassess the overall environmental impact of a trading scheme, combined results of emissionreductions and transactions should be accurately reported.

Institutional implicationsA variety of institutional forms are required to facilitate and regulate the market, and inparticular to monitor and report the emissions of the participants, to monitor and report theallocation and trade in permits between participants, and to regulate the scheme andpenalise non-compliance.

Banking protocolThis refers to the saving or ‘banking’ of excess emission allowances or credits from oneperiod to use in a subsequent period. The system authority may place restrictions onbanking. “Borrowing” is the opposite of banking (i.e. the utilisation of allowances from asubsequent commitment period).

The ‘permit’ or unit of exchangeThe ‘permit’ is the unit of exchange. It is a financial instrument that has value,fundamentally, in its nature as a compliance tool. Differing units of exchange in differentjurisdictions will have implications for cross-border trading. Different legal definitions indifferent jurisdictions may have implications for tax treatment, regulation and audittreatment. These may impact cross-border trades.

Trading rulesAll trading systems require clearly defined rules of conduct for its participants to abide by.These typically detail the nature and behaviour of the commodity being traded, the entitiesto whom the scheme is open, penalties for non-compliance, levy issues (e.g. akin to‘adaptation levy’ under the Clean Development Mechanism), and registry/reporting issues.

The key decision to be made is whether or not these rules are designed to be compatiblewith the emerging rules for international trading.

Penalties for non-complianceIt is important that the rules of any emissions trading scheme be enforced in order to ensurethat the scheme is equitable to all participants and achieves its objectives. Options of


enforcement methods differ widely in their ease of implementation and their degree ofstrictness.

IncentivesAn incentive to trade needs to exist to ensure maximum liquidity, and thus economicefficiency within the trading market. In a mandatory scheme incentive comes through thedesire to avoid penalties and also to optimise financial performance through trading. In avoluntary scheme, or where alternative methods of compliance are available, companiesshould benefit from another form of incentive (financial or otherwise) in order to encourageparticipants to join the scheme and to stimulate trading.

Critical Success Factors of an Emissions Trading Scheme (from chapter 2)

Environmental effectivenessEnvironmental effectiveness relates to the contribution of the scheme to the slowing ofclimate change. This factor determines whether the environmental goals will be achievedand with what degree of certainty.

Economic efficiencyEmissions trading schemes seek to achieve the greatest possible reduction in emissions forthe lowest possible financial abatement cost, by providing flexibility and motivation forreductions to occur where they are least expensive. This is important for the air transportindustry, which seeks to protect its ability to continue to grow.

Equity and competitivenessTrading schemes can potentially have differential impacts on different sources (in thiscontext, both on companies and countries). It is important to evaluate the scale of the costsimposed on key affected parties, in order to manage the possible issues of equity andcompetition.

Legal feasibilityIt is important to address legal issues relevant to international, regional and national legalframeworks under which any emissions trading scheme would be implemented. It isimportant to evaluate whether the options are compatible with (among others) the ChicagoConvention, bilateral Air Service Agreements, WTO trade/environment rules, specificregional rules (e.g. EU competition laws) and the emerging Kyoto trading rules.

Technical and administrative feasibilityTechnical feasibility comprises the suitability, compatibility, user-friendliness and the easeof implementation of IT systems. Administrative feasibility concerns the need for newinstitutions, and implications for levels of bureaucracy. The technical and administrativefeasibility of the scheme directly impacts upon transaction costs, and would therefore affectparticipation in an emissions trading scheme.

Industry acceptance and participationStakeholder engagement in a participatory process is fundamental to minimising conflict,establishing trade-offs acceptable to industry, and gaining support from key playersincluding potential participants. Maximum participation promotes market liquidity and isimportant to the success of an emissions trading scheme.

Political acceptanceTo succeed, the scheme must gain political support at both a national and regional level.Political support relates to Government, non-Governmental Organisation (NGO) andinternational levels (e.g. UNFCCC).


Accepted science and measurement methodologiesFor trade to occur, the market must have confidence in the value of the commodity beingtraded. This requires rigorous and standardised definition of a permit, and acceptedverification of its environmental credentials

Compatibility with voluntary initiatives and other market-based optionsA number of nascent voluntary and market-based initiatives are in place as industries andgovernments prepare for ratification of the Kyoto Protocol. In the design of a civil aviationemissions trading scheme, interaction with these other initiatives should be considered, andaction that may reduce or remove compatibility with, and accessibility to, these otherregimes (“inescapable traps”) should be avoided.

Wider environmental implicationsIt is important to consider ‘at what cost’ a trading scheme is implemented - whether thereare any trade-offs with other objectives (e.g. reducing local noise and NOX emissions), andpossible means of mitigating any adverse repercussions.


Appendix 2 Selected bibliography

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UNFCCC (2001) Reports on intersessional activities. Emissions resulting from fuel used forinternational transportation. Document FCCC/SBSTA/2001/INF.1

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emissions. Study commissioned by the Dutch Civil Aviation Authority: Delft.

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Vrolijk, C. (2001) Meeting Report: President Bush might have done Kyoto a favour, Royal Institute ofInternational Affairs, London.

Whitelegg, J. and N. Williams (2000) The Plane Truth: Aviation and the Environment. The AshdenTrust


Whitelegg, J. (2000) Aviation: a briefing document. Published in association with Transport 2000;London.

Wit, R.C.N. (1996) How to control greenhouse gas emissions from international aviation? Options forallocation. Centre for Energy Conservation and Environmental Technology (CE): Delft.

World Health Organisation (2000) Climate Change and Human Health: Impact and Adaptation. WHO

Relevant websites

Boeing, www.boeing.com

GERT, Canada www.gert.org

International Petroleum Exchange, www.ipe.uk.com

IATA website (2001), www.iata.org

North American Free Trade Agreement, see http://www.nafta-sec-alena.org/

UNFCCC climate change information kit: on website http://www.unfccc.int/resource/iuckit/fact03.html

2001 IATA Arthur Andersen

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