An Emission Trading System (ETS) or cap-and-trade system is a carbon pricing mechanism for reducing CO2 emissions, which can be applied to aviation. Unlike a direct carbon tax, where the unit price of CO2 is fixed, under an emissions trading scheme the price per tonne of CO2 varies. The overall amount of emissions is fixed for a given period of time (e.g. annually). Entities are allocated a set amount of CO2 emissions allowances, or quotas, and trade emissions with one another: those able to reduce their emissions below their allowance level can trade them with those emitting in excess of their allowance. Such systems require management and enforcement to ensure efficacy. This requires the monitoring, reporting and verification of emissions and the tracking of allowances and trading.
The first and largest ETS was launched in the European Union (EU) in 2005. The EU-wide cap has been gradually reduced to further encourage emissions reductions in the industries covered. Varying shares of allowances are allocated by auction and for free, depending on the industry. 85% of aviation allowances were allocated for free during the scheme’s third phase (2013-2020). Intra-EEA flights have been included in the EU ETS since 2012.
Carbon pricing makes fossil fuels more expensive, encouraging more efficient aircraft operations and incentivising the use of sustainable alternative fuels with lower emissions. A successful ETS requires the price of carbon to be high enough. If the resulting increase in airlines’ operating costs are passed on to passengers, passenger demand growth for aviation would likely decline.
The World Bank reported that the average price per tonne of carbon in the EU ETS was EUR 25 (nominal figure from 1 April 2019). The ITF’s (2019) Transport Outlook assumed a carbon price of USD 100 per tonne of CO2 by 2050 based on current commitments, as part of a range of assumptions. Under this scenario, emissions from international passenger aviation are projected to grow by 82%. Under more ambitious scenario assumptions, which include electric aircraft being operational for short-haul flights, a price of USD 500 per tonne is assumed. This package of measures sees a 19% fall in international aviation emissions.
The EU predicted that emissions from sectors covered by the EU ETS will be reduced by 43% between 2005 and 2030.
The enforcing authority needs the capacity to monitor and verify emissions reporting (which must be done by the entities in the regulated sector). This may present upfront costs when setting up the ETS. Recurring overhead costs linked to the scheme’s day-to-day administration should also be taken into account.
Emissions trading across sectors reduces emissions in the most cost-effective way by allowing entities with the lowest abatement costs to reduce their emissions and sell surplus allowances to those with higher abatement costs.
When implemented in one or a group of countries, carbon pricing mechanisms - including ETS – can cause carbon leakage, i.e. the shift of polluting activity to countries with no carbon pricing. This leads to an emissions reduction in the country or countries with carbon pricing but an increase in emissions elsewhere. Carbon leakage is often thought to be highly likely in the case of international aviation, and a global approach would be the most efficient option. However, carbon leakage in international aviation may be overestimated: a carbon tax on flights departing the UK could in fact be associated with negative leakage (Dray et al., 2018). Airline responses to an increased carbon price in one country (e.g. fleet swapping, fuel tankering), which lead to higher network-wide emissions, could be offset by reduced passenger demand due to the increase in the price of air transport.
Similarly, an ETS implemented in one or several countries could lead to a decrease in the number of carriers serving the country or countries, which could have undesirable competition impacts.
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