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Low EUAA liquidity jeopardises airline compliance

21 Feb 2013 14:31:34 | edcm

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The European Commission's decision to suspend international airlines from the EU emissions trading system (ETS) has hurt liquidity on the carbon market to the point of putting some airlines' ability to comply at risk, airline operators said on Wednesday. This scenario could worsen if a Commission U-turn on the suspension sparks a scramble for allowances at the end of 2013, they added.

Large commercial airlines such as Air France and Turkish Airlines, along with medium-sized Scandinavian Primera Air and TAG Aviation Europe, a group representing small aviation emitters, all agreed at a conference in London on Wednesday that the trade of EU aviation allowances (EUAAs) had dried up after the Commission decision in November 2012.

International impact

A source from another international airline, who did not want to be named, said that the operator had already put cash-settled derivatives in place to comply at the time that the EU announced the suspension.

"It was alarming to say the least," the source recalled, adding, "we were sitting with potentially large losses due to our hedges, including grey CERs (certified emission reductions) that we won't be able to use after this year."

An EU decision on whether to scrap the suspension is only due at the end of the year, meaning that the 'Stop the Clock' suspension continues to pose problems for airlines. "We are now effectively sitting on our hands, waiting for ICAO (International Civil Aviation Authority) and the EU," the source said.

International airlines fear that the EU may lift the suspension at the end of 2013.

The source slammed the EU's pledge to make a decision about whether to lift the suspension only after the autumn 2013 ICAO meeting as "irresponsible", adding that it could prompt "4,000 airlines to scramble to comply within a month or two".

S. Eyup Ozbay, purchasing manager at Turkish Airlines, echoed this as a representative of a non-EU based airline. The airline had set up a special unit, falling under its fuel department, to deal with the company's carbon requirements. When the suspension was announced, the airline had planned to buy mostly futures to meet its compliance needs. It has now postponed implementing its carbon strategy until late 2013 or even 2014.

EU airlines

Even European airlines, which still have to comply with the ETS under Stop the Clock, said that the unexpected suspension had complicated their compliance process.

Air France's Hubert Cropechot, who oversees the airlines fuel and carbon trading unit, said 'Stop the Clock' had lowered the airline's carbon costs, but only marginally so. The potential windfall was overshadowed by "more uncertainty and less willingness" to enter the market, he said. "We don't have a clue what will happen in 2013 and that is a really big deal for us." He pleaded for clear and stable rules to apply to the ETS and airlines inclusion in it. "[At the moment] I feel like I'm playing a game and the rules of the games change mid-game, but we're still expected to comply," he said.

Primera Air CFO Valdimar Bjornsson agreed that the current cost of carbon was difficult to assess for airlines, amid changing rules and market complexity, giving further credence to calls for a simpler system. "Even taxes are more transparent [than the carbon cost]," he said.

As carbon itself only made up "a small cost" of running an airplane, particularly at current low prices, fuel, amid high prices, made up the lion's share of airlines expenses. This makes it a much stronger driver for airlines to become more fuel efficient and invest in low-carbon technology than the ETS. However, if airlines fail to comply they face a fine of €100/tCO2e for each tonne of CO2 not covered by permits, which could see the associated carbon cost soar on airlines books.

Low liquidity raises compliance risk

The uncertainty arising from 'Stop the Clock', and the consequent postponement of many airlines' involvement in the carbon market, has driven down liquidity for the specially created EU airline allowances (EUAAs). This makes compliance hard particularly for small aviation emitters, who make up a large share of airlines covered by the ETS. It also adds to the potential compliance cost of all airlines, as EUAAs trade at a discount of around €0.75/tCO2e to the more liquid EUAs, which have to then be purchased instead.

Buying only small amounts of EUAAs was "almost impossible" in the aftermath of 'Stop the Clock', said Martina Becher, fuel manager Europe at TAG Aviation Europe, a view that was echoed by several of the other speakers.

Enric Arderiu, who is a carbon originator at BP, added that airlines may be tempted to use EUAAs as collateral, or working capital, as they will have received two phase III allocations (in February 2013 and February 2014), before the first phase III compliance deadline in April 2014 - or because, indeed, they no longer expected to report their emissions after Stop the Clock. However, the illiquidity of EUAA credits means that airlines sell the cheaper EUAAs but may then be forced to buy back the more expensive EUAs. This increases the potential risks and costs of the scheme for airlines, despite being allocated free allowances. Marie-Louise du Bois

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