As European skies become less friendly for global airlines, carriers fear their profitability will come under pressure as the airline industry struggles to wriggle out of the multiple shocks it suffered in 2011.
The dreaded carbon tax was imposed by the European Union starting January 1, which means that airlines worldwide are now required to pay the carbon fee for flying in and out of Europe under the Emissions Trading Scheme (ETS), which is effectively intended to pare pollution.
While Gulf airlines and some others globally have already started paying the fee, the EU move has faced stiff resistance from the airlines of some countries such as the US, China and India.
Following last year's events such the Arab Spring, natural disasters in Japan, spiralling oil prices and the Eurozone debt crisis, emission fees are one more nail in the airline's profit coffins.
And airlines, unfortunately, have no escape route. As aviation analyst Ernest S Arvai, President and CEO of aviation consultancy The Arvai Group, says: "Airlines will be forced to pass on higher costs, or face financial ruin."
Profitability under pressure
Global aviation body the International Air Transport Association, which represents 240 airlines comprising 84 per cent of global air traffic, estimates the carbon emissions taxes will result in airlines losing up to €900 million (Dh4.32 billion) this year alone, and up to €2.8 billion in 2020.
It also forecasts a 49 per cent fall in 2012 industry-wide profit to $3.5 billion owing to a weak global economy and high fuel prices.
"It is difficult to predict how the ETS will affect airline profitability in 2012 and beyond, because the carbon price is extremely volatile. Airline profits are expected to fall in 2012 and the profit margin will be only 0.6 per cent, so any additional costs will be a burden to the industry," Paul Steele, Director of Environment at IATA, told Gulf News.
He added that looking ahead it is even more difficult to predict as both the carbon price and the structure of the scheme (such as the number of free allowances) are likely to change.
"However, we can be certain that the costs to airlines will continue to rise throughout the decade," Steele said.
Tony Tyler, director-general and CEO of IATA, said recently that the industry will "not generally be able to pass this on to consumers because the market is too weak".
Gulf carriers, like many other global airlines, stand to lose hefty sums. Emirates has said it expects to lose over €40 million to purchase additional emission allowances in 2012 alone and well over half-a-billion euros in the nine-year period to 2020.
Similarly, Etihad Airways stated it will end up spending an extra €310 million (Dh1.48 billion) over the next nine years on carbon taxes.
However, neither of the UAE airlines has started passing on the costs to passengers.
"Unfortunately, while we always try to make our fares as competitive as possible, the additional costs of the EU ETS programme will almost certainly have to be passed on to customers but how this will be done has not yet been determined," Emirates President Tim Clark recently told Gulf News.
Echoing similar views, Linden Coppell, Etihad's Head of Environment, said it is inevitable that such a cost would have an impact on fare levels.
US airlines have estimated the carbon tax will take at least $3.1 billion (Dh11.4 billion) from their pockets by 2020, with travellers worldwide expected to pay an additional $22.9 billion in the same period, eating into a sizeable portion of airline profits. The country's carriers such as Delta, United, American Airlines and US Airways have already added a $3 surcharge for flights between the US and Europe.
Meanwhile, the China Air Transport Association (CATA) estimates Chinese carriers will have to pay 800 million yuan (Dh464 million) in carbon taxes in the initial year and more than three times of that by 2020.
Indian carriers together could pay more than Rs3 billion (Dh214 million) in 2012. Air India, Jet Airways (India) and Kingfisher Airlines currently operate to Europe from India, and would have to make carbon tax payments at the end of the year.
Germany's largest carrier, Deutsche Lufthansa AG, said on January 1 — the same day the emissions tax came into effect — that it will pass on to its customers an expected €130 million (Dh616.79 million of costs for carbon permits it needs this year under the EU ETS.
Although the airlines pressed the panic button when the EU imposed the ETS scheme, one market expert is of the opinion that ETS is not as high as it is made out to be.
Andrew Charlton, Managing Director of the Europe-based strategic advisory, government and public affairs firm Aviation Advocacy, told Gulf News: "Particularly in the first few years, the cost of the ETS is not as high as has been made out. This is because 85 per cent of the ETS certificates are distributed to the commercial airlines for free, and because the price of the 15 per cent of ETS certificates that are needed to be purchased has collapsed."
He said that as the amount of flying done next year is likely to be reduced because of the European economic crisis, the impact will be further lessened.
"The certificates allocated are fixed, so less flying will mean fewer required to be purchased. That said, this is an additional cost that will need to be absorbed."
Negative impact
Arguing Charlton's view is Arvai of The Arvai Group who says that the EU tax will cost passengers about $20-$30 additional per head on their tickets, "which, given price elasticity in the industry, will decrease demand and have a negative impact on both airline load factors and profitability".
"I would expect the cost globally to be more than $2 billion in direct and indirect losses from this new tax, with several carriers in the EU becoming unable to further compete," he told Gulf News.
The industry has seen a few fallouts already, as Charlton points out, including Lufthansa's announcement about passing costs directly to passengers; and UK carriers such as British Airways and Virgin Atlantic besides others demanding ("with no success so far") that this cost replaces existing taxes - so that it remains neutral from a cost perspective.
Potential escape routes
"In competitive terms, all European carriers will have to participate in the ETS on almost all their operations; while their competitors, such as Emirates and Etihad, will only have to do so on their flights to and from European airports," said Charlton.
In order to manage costs better, some airlines will exploit the fare differential by offering routes outside Europe, according to Arvai. "And this could be a boon for Gulf carriers to the US flying non-stop and avoiding Europe," he points out, adding that it could mean Emirates A380s flying to more cities in the US, and their pricing forcing European airlines to match, causing financial difficulties for Europe and US-based carriers.
"Expect a few more non-stops by US carriers to the Gulf as well," said Arvai.
Gulf carriers, however, do not intend to make changes in their European operations. Asked if Emirates, for instance, would consider scaling down its European operations, Clark told Gulf News: "While we argue this programme will hurt and impact European aviation and those serving their markets, we have no plans to alter operations."
Meanwhile, there is still time to alter the ETS scheme, according to IATA's Steele. "In 2013 there will be a review for the next reporting period, which will run for the rest of the decade. So there is still a lot to play for," he said.
And then there are others who are taking drastic steps to combat the tax. AirAsia X, the long-haul arm of Asia's biggest budget carrier, said on January 12 that it will stop flying to London and Paris as a result of the tax, as well as other factors such as the UK's tax increase and waning demand. The carrier's CEO, Azran Osman Rani, reportedly said that the carbon charge and the planned April tax rise "forced the airline's decision to withdraw its services".
Steele, however, said the aviation body is not in favour of airlines retaliating. "IATA does not wish to see retaliatory measures as this would create exactly the kind of inefficient patchwork of taxes that we have been working hard to avoid. Likewise, other kinds of retaliatory measures (such as switching aircraft orders) might risk a trade war which would benefit nobody."
A silver lining?
Ironically, the US carriers may actually post windfall gains of as much as $2.6 billion after their inclusion in the EU emissions trading system, Bloomberg reported recently, quoting an academic study that contradicts the aviation industry's cost estimates.
According to a study by scientists at the Massachusetts Institute of Technology and Muenster University in Germany, the ETS would only have a small impact on US carriers.
"If carriers pass on all additional costs, including the opportunity costs associated with free allowances, to consumers, profits for US carriers will increase," it said, adding that windfall gains from free allowances may be substantial as under current allocation rules, airlines would only have to purchase about a third of the required allowances.
"An increase in the proportion of allowances auctioned would reduce windfall gains and profits for US airlines may decline," the report said.
