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Vedder Thinking | Articles The European Union’s Emissions Trading Scheme

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Since its establishment in 2003,1 and in particular its expansion to aviation in 2008,2 the European Union’s Emission Trading Scheme (ETS) has attracted controversy. In the past year, with impending, and now effective, implementation, dissatisfaction, controversy and protest have grown exponentially.

By far the most controversial aspect of ETS is its extraterritorial reach, with covered operators required to monitor and surrender (and pay for, if necessary) allowances corresponding to CO2 emissions from every point of their flights to, from or within the European Union (EU) whether on the ground in, or over, non-EU territory or international water. Moreover, there is no requirement that the monies expended for compliance (or as a result of noncompliance) with ETS be reinvested in environmental causes or toward advancement of more ecofriendly technology. The potentially disproportionate burden on non-EU operators has provoked vociferous opposition from non-EU airlines and governments, who have decried ETS as an illegal tax, designed merely to line government coffers in the economically troubled Eurozone.3 The most prominent challenge to the ETS has been the lawsuit brought in December 2009 by United Airlines, American Airlines, Airlines For America, the National Airlines Council of Canada and the International Air Transport Association (IATA).4

On December 21, 2011, the European Court of Justice (ECJ), following the non-binding opinion issued in October 2011 by its advocate-general, upheld the validity of ETS and effectively struck down the lawsuit. Brought originally in the United Kingdom (UK) High Court and referred to the ECJ for interpretation of EU-wide treaty law, the lawsuit challenged the applicability of ETS to non-EU airlines on the grounds that it improperly infringes on the sovereignty of non-EU nations over their airspace and constitutes an unlawful charge or tax on fuel, in violation of the Chicago Convention and other aviation treaties. The ECJ held that the EU is not bound by the requirements of the Chicago Convention since it is not a party to the treaty, even though the member states comprising the EU are parties to the treaty.5 Nevertheless, the ECJ found no improper infringement of sovereignty (despite the fact that covered operators must account and pay for emissions during all points of flights to, from or within the EU) because the scheme applies to operators only when their aircraft are voluntarily in EU territory by having landed at, or taken off from, an EU airport.6 The ECJ also found that ETS was not an impermissible tax on fuel in breach of the U.S.-EU Open Skies Agreement (the "Open Skies Agreement") because there was (in the ECJ’s estimation) no direct link between the quantity of fuel consumed by an aircraft and the financial burden of its operator.7 Moreover, the ECJ held that the EU was not required to satisfy its Kyoto Protocol obligations exclusively through the International Civil Aviation Organization (ICAO).8 The EU has consistently justified the inclusion of airlines worldwide in ETS because a decade of talks at ICAO failed to produce a global solution to address the environmental harms posed by airline emissions. Lastly, the ECJ held that ETS did not improperly discriminate in violation of the Open Skies Agreement.9 While the case has been remanded to the UK High Court for final disposition, airlines from countries opposed to ETS are complying under protest, as the action shifts out of the courtroom and into the political arena.

The rallying cry of the ETS opposition is that emissions are a global environmental issue to be tackled globally through ICAO rather than unilaterally imposed by one market against the rest of the world. In response, the EU has consistently maintained that flights by operators from countries that have enacted "equivalent measures" to ETS within their own domestic systems would be exempt from ETS requirements. However, the EU Commission has never specified exactly what constitutes an "equivalent measure."10 Though the issue has been debated in ICAO for more than a decade, the 191-member organization has not yet readied an agreed position. ICAO is said to be considering several options, including a worldwide emissions trading system and levies assessed on airlines (likely to be passed along to consumers) based on fuel intake, passenger numbers and cargo weight.11 Some consideration has been given to initiating proceedings under ICAO’s dispute resolution mechanisms under Article 84 of the Chicago Convention; however, such actions rarely have been invoked, and on all but one occasion a mediated compromise was achieved without the need to resort to the full resolution process. The Secretary-General of ICAO has promised to have a proposed framework on the table by the end of 2012 for consideration and decision by ICAO in 2013, but at this point that is little more than an aspiration.

In light of the EU’s intractability, ICAO’s inactivity and the EJC’s decision, representatives of 26 countries (all of whom are ICAO members)12 have met twice, most recently in Moscow late last month. The Moscow meeting resulted in a "basket of measures" with each country free to adopt the measure(s) it deems necessary and most effective to counteract ETS.13 In the United States, Secretary of State Clinton and Transportation Secretary LaHood have written to the EU Commission and their counterparts in various EU member states, urging them to reconsider, delay or suspend the application of ETS and to engage with ICAO to address the aviation emissions issue. The FAA re-authorization bill signed into law last month reaffirms the U.S. opposition to ETS, favors a global consensus approach to greenhouse-gas emissions under ICAO auspices and calls for the federal government to use all political, diplomatic and legal means available to ensure that American aircraft operators are not subjected to ETS. Meanwhile, legislation prohibiting American aircraft operators from participating in ETS and authorizing the federal government to take any action necessary to keep American aircraft operators harmless from ETS was passed by the House in October 2011 and is now pending, with bipartisan support, in the Senate.14 If ETS is signed into law, American aircraft operators would be placed in the untenable position of violating either U.S. or EU law every time they fly to, from or within the EU.

On February 6, 2012, the Civil Aviation Administration of China (CAAC) took the most significant action to date against ETS, banning Chinese airlines (absent formal CAAC approval) from participating in the scheme and from raising fares or passenger charges to recover the cost of taking part in ETS. Absent participation by the world’s fastest-growing aviation market, and especially if Congress bans American operators from participating, it is very difficult to envision a sustainable system in its present form. Adding further tension to the situation is the Chinese government’s withholding of approval for new Airbus deliveries to Chinese airlines (presumably in favor of the competing Boeing models) as retaliation against ETS. Currently, Chinese airlines have as many as 45 A330 and A380 aircraft on order from Airbus (with a catalog value upwards of $12 billion), many of which are slated for delivery in 2013 and 2014. According to Airbus, the threat of losing these orders has temporarily halted plans to increase A330 production rates in order to meet customer demand, and it could result in billions of dollars and thousands of jobs being lost.15

As evidence of just how seriously this threat is being taken, European aviation leaders have written their own political leaders, calling for a change in course. In recent days, the chief executive officers of Airbus and eight major European airlines and engine manufacturers16 have written to European Commission President Barroso, British Prime Minister Cameron, German Chancellor Merkel, French Prime Minister Fillon and Spanish Prime Minister Rajoy, urging EU governments to delay enforcement of ETS until a global scheme can be implemented under ICAO, in the face of an "intolerable threat" of retaliatory trade measures jeopardizing all European aviation.17 Nevertheless, the EU has given no indication of backing down from ETS in its present form.

Conclusion

China’s response seems to be bringing the divisive matter of ETS to a political and economic head. Although covered operators are not required to surrender allocated or purchased allowances for 2012 emissions until April 30, 2013, the pressures being created by ETS have already risen to the highest levels of leadership worldwide. Many questions remain unanswered at this point. Will European operators cooperate even if their non-EU counterparts do not? How quickly can a global system be implemented (if at all)? How will rising jet fuel prices affect demand for tradable emissions allowances? Will airlines scale back (or discontinue) intercontinental routes to Europe? How will this affect traffic at airports in close proximity to Europe? Will an increase in traffic outside the EU actually cause an increase in global emissions? To what extent will EU economies be impacted as international traffic to and from the EU recedes and new hubs arise? Clearly, this issue will remain on the aviation industry’s front burner in the months (and years) to come.

1 Directive 2003/87/EC (October 13, 2003) (establishing a scheme for greenhouse gas (GHG) emission allowance trading within the EU and amending Council Directive 96/61/EC) (the 2003 Directive).
2 Directive 2008/101/EC (November 19, 2008) (amending the 2003 Directive to include aviation activities in the scheme for GHG emission allowance trading within the Community) (the 2008 Directive).
3 Estimates of the economic impact of ETS on the airline industry vary widely, ranging from €300 million to more than €500 million (according to one publication, IATA estimated the cost to be as high as $1.35 billion) for 2012 alone, and as much as $4.2 billion by 2020. See, e.g., "Airlines Face CO2 Bill of 300 Million Euros in 2012: Barcap," Reuters.com, February 17, 2012; "Airlines Can Profit from EU Carbon Tax," USAToday.com, February 21, 2012; "Airlines Shouldn’t Crater to the E.U. Carbon Caper," Forbes.com, February 28, 2012.
4 Case C-366/10, Air Transport Association of America and Others v. Secretary of State for Energy and Climate Change (Judgment of the Court dated 21 December 2011).
5 Id., at ¶¶ 52, 60, 63, 69 and 71. 
6 Id., at ¶¶ 116-118, 124-130 and 131-135. 
7 Id., at ¶¶ 137-147.
8 Id., at ¶¶ 76-78.
9 Id., at ¶¶ 152-157.
10 South Korea and Australia are at varying stages of development and implementation of emissions trading schemes for internal flights by their domestic carriers, but no official pronouncement has been made that these systems are sufficiently equivalent to pass muster.
11 "UN Aviation Body Says Emissions Proposal by Year-End," Reuters.com, March 2, 2012.
12 Argentina, Brazil, Burkina Faso, Cameroon, Chile, China, Colombia, Cuba, Egypt, India, Japan, Malaysia, Mexico, Nigeria, Paraguay, Peru, Qatar, Russia, Saudi Arabia, Singapore, South Africa, South Korea, Swaziland, Uganda, the United Arab Emirates and the United States of America.
13 These measures include the option for each country to bar its airlines from participating in ETS (which China has done and the US and Russia are considering or drafting legislation with similar impact) and submitting requested emissions data (as India has done), imposing retaliatory levies on EU-based airlines, renegotiating existing bilateral aviation treaties and ceasing talks about new routes with EU-based airlines (as India has threatened), initiating proceedings under Article 84 of the Chicago Convention, and reinstating territorial overflight restrictions on EU-based airlines (as Russia has threatened to do, despite previously agreeing to rescind such restrictions as a condition of its World Trade Organization accession).
14 See H.R. 2594 (an Act to prohibit operators of civil aircraft of the United States from participating in the European Union’s emissions trading scheme, and for other purposes); S.1956 (European Union Emissions Trading Scheme Prohibition Act of 2011).
15 See, e.g., "EADS Says A330 Boost Is Hostage to China Views on Carbon Tax," Bloomberg.com, March 8, 2012; "European Airlines Rally Against EU Carbon Tax: Source," ASDNews.com, March 12, 2012.
16 British Airways, Virgin Atlantic, Lufthansa, Air France, Air Berlin, Iberia, Safran and MTU Aero Engines.
17 See, e.g., "Aviation Chiefs Ask EU Leaders to Halt Carbon Row," Reuters.com, March 12, 2012; "Delay EU Carbon Levy, Says Air Industry," FT.com, March 12, 2012.

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