The past few weeks have seen the airline industry suffer from regulatory issues both in the U.S. and abroad.
In the United States, the proposed merger of American Airlines and U.S. Airways is causing a headache. Officially bankrupt since 2011, American Airlines’ bankruptcy exit plan was approved by a federal judge in late September of this year, such plan being contingent upon its merger with U.S. Airways going ahead successfully.
However, and to the frustration of American Airlines, the U.S. Department of Justice (DOJ), filed a motion in August to block the proposed merger and continues to resist it on antitrust grounds, arguing that the deal would harm competition and passengers. A trial date has been set for November in which American Airlines and U.S. Airways will fight the DOJ’s decision. If unsuccessful, American Airlines will remain under bankruptcy protection and will need to come up with a revised bankruptcy exit plan without the benefit of the proposed merger.
The airline industry in the United States has historically had a rough time compared to other regions around the world, with airlines frequently drifting in and out of bankruptcy. This makes the question of what is actually in the best interests of competition and passengers a more difficult one. Passengers, it seems, are faced with a least-worst option scenario: keep an airline slowly going bankrupt on life-support so as to preserve valuable competitiveness within the market, or allow it to regain strength at the expense of a merger which will reduce competition. Relaxing the protectionist measures prohibiting foreign airlines from operating freely in the U.S. domestic market may be the real solution.
Over in Europe, the airline industry is facing a different headache as the debate over the future of the European Union Emission Trading Scheme (EU ETS) comes to a head.
At their latest meeting in Montreal a couple of weeks ago, members of the International Civil Aviation Organization (ICAO) declined to approve the expansion of EU ETS into the aviation industry. This is a blow that, as explained below, puts Europe’s response to carbon emissions in the aviation industry at odds with that desired by the wider international aviation community.
The E.U.’s regional “cap and trade” scheme works by imposing an annual cap on the amount of carbon emissions which may be emitted by carriers on all flights departing from or arriving in an E.U. member state. “Carbon allowances,” allocated to each airline in decreasing amounts annually, can then be traded on an open “carbon” market. Not only are financial penalties for non-compliance severe, but other consequences include detention by the national authorities of any aircraft in the defaulting airline’s fleet, regardless of whether leased to or owned by the airline and—in the most drastic of cases in some E.U. member states (such as the U.K.)—sale of those aircraft in order to satisfy the penalties owed.
The expansion of EU ETS is generally unpopular within the aviation industry, because of the additional business costs it imposes on the aviation industry. These fall into several categories. First, there are costs associated with monitoring its carbon emissions and otherwise ensuring compliance on a day-to-day basis. Second, while each airline will initially be allocated a certain amount of carbon allowances “free of charge,” if one emits more carbon that its allocated credits allow, it will have to buy additional credits from other airlines (that is, from the “carbon allowance market” set up by the scheme). Third, with the overall cap on the total number of allowances decreasing annually, airlines will be forced into improving the efficiency of their fleet, either by upgrading or by replacing their aircraft. Lastly, as mentioned above, penalties for non-compliance are high.
Higher cost of business means either lower profits for an industry whose profit margins are notoriously slim, or passing the costs onto passengers. Assuming the latter, the estimated increase to ticket prices, at least according to the International Centre for Trade and Sustainable Development’s November 2011 report, are estimated to be a maximum of €30 (~$40) added to the cost of a ticket for a long haul (4,000 mile) flight, and as little as €2 (~$3) being added to the price of a short haul flight.
The European scheme, which has already become law in Europe, is currently subject to a 12-month moratorium ending April 2014 rushed through the European Parliament to allow for the outcome of the recent ICAO conference. The E.U. had proposed, as a compromise and for consideration at the conference, that the scheme be limited to apply only to those sectors of flights over E.U. Member States’ airspace. However, this was rejected with ICAO members voting instead for an ICAO-led scheme, unlikely to come to any fruition until 2020 to the dismay of environmental campaigners. Europe had previously complained that the ICAO has been too slow to act, a sentiment apparently justified by the recent ICAO promise.
The E.U. regional scheme has already been challenged, unsuccessfully, by the United States and other governments at the European Court of Justice (ECJ) in December 2011, The challengers argued that the E.U. plan breaches sovereignty rules because some of the carbon dioxide emitted during the flights to and from Europe is emitted in United States or international airspace. In response the ECJ’s ruling, the United States Congress passed the European Union Emissions Trading Scheme Prohibition Act into law in late 2012, permitting the U.S. Secretary of Transportation to compel U.S. airlines to defy compliance with the European scheme if he deems it to be in the public interest to do so.
The U.S. Act provides for recompense to airlines from the United States government, but U.S. airlines nevertheless may face a difficult choice if the issue is not resolved: comply with European law and breach U.S. law, or do not comply and risk financial penalties, serious disruption to commercial operations, or worse—aircraft being detained.
More subtly, many aircraft on lease to such airlines will contain provisions requiring the airlines to comply with EU ETS legislation or more generally with all “applicable laws,” risking default if they do not, and worse for the aircraft lessor, unauthorized liens over or detention of the lessor’s aircraft. Absent amendment, renegotiation or waiver, aircraft lessors may therefore be in a position to terminate such leases early, leading to further costs and disruption for the U.S. airline industry.
Where this leaves the future of EU ETS in the aviation industry is unclear. On October 16, the E.U. re-proposed its compromise rejected by the ICAO that it may limit the scheme only to those sectors of the flight that are over the airspace of E.U. member states. This compromise is and always has been to the dismay of low-cost European carriers who operate predominantly within Europe. Under such compromise, they believe that they will be disproportionately and unfairly penalized.
Whatever the fate of the EU ETS scheme, because it has already been passed into European law it can now only be repealed or amended by a further act of the European Parliament, which will have to act fast. Follow-up amendment legislation may also be required by each member state’s national legislature.
Free trade, both between the E.U. and the U.S. and worldwide seems to be the unfortunate victim in all of this. Airline passengers may be in for a rough and more expensive ride.
Dominic Pearson is an attorney (solicitor) admitted to practice in England and Wales. Before pursuing an LL.M. degree at Berkeley, he practiced for a number of years in the area of aviation finance and leasing at two major law firms in London.