The inclusion of aviation in the European Union Emission Trading Scheme

Table of Contents

II Table of Figures

III List of Abbreviations

1 Introduction
1.1 Background
1.2 Objective and limitations
1.3 Structure

2 Legal framework for climate change and emission trading
2.1 Demarcation of international and EU law for climate change
2.2 United Nations Framework Convention on Climate Change
2.3 Kyoto Protocol
2.4 European Union Emission Trading Scheme
2.4.1 Motivation and objectives
2.4.2 Scope and extensions
2.4.3 Allocation and cap system
2.4.4 Trading and price mechanisms
2.4.5 Timeline and structural changes

3 International aviation and climate change
3.1 International aviation industry and airline economics
3.1.1 Market evolution and competition
3.1.2 Market players
3.1.3 Price and demand mechanisms
3.1.4 Industry trends
3.2 Environmental policies in civil aviation
3.2.1 Convention on International Civil Aviation
3.2.2 Aviation Directive
3.2.2.1 Motivation and objectives
3.2.2.2 Major design elements
3.2.3 Current issues in climate policy for international aviation

4 Impact analysis of the EU-ETS on the aviation industry
4.1 Focus of analysis and research approach
4.2 Airline profitability
4.2.1 EU-ETS costs
4.2.2 Pricing behavior
4.2.3 Windfall profits
4.3 Industry competition
4.3.1 Distributional effects of allowance allocation
4.3.2 Airline type
4.3.3 European versus non-European airlines
4.4 Industry performance and development
4.4.1 Technological advancement
4.4.2 Operational improvement
4.4.3 Volume measures and modal shift

5 Analysis results and management implications

6 Conclusion and outlook

IV References

V Appendix

VI Eidesstattliche Erklärung

VII Curriculum Vitae

II Table of Figures

Figure 1: Evolution of world air traffic

Figure 2: Legal framework for climate policy

Figure 3: Carbon price evolution

Figure 4: Global CO2 emissions from aviation

Figure 5: Analysis perspectives

Figure 6: Research approach

Figure 7: Drivers of impact of the EU-ETS on the aviation industry

III List of Abbreviations

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1 Introduction

1.1 Background

Climate change has been a major concern in climate policy and has therefore regularly been on politicians agenda for a long time. For this reason, several scientific studies in climate research were conducted to detect main causes of this disturbing environmental development. It was determined that anthropogenic (i.e., human-induced) greenhouse gases (GHGs), such as nitrous oxide (N2O), methane (CH4), and carbon dioxide (CO2), have been major contributors of global warming.^[1] In particular, atmospheric CO2 concentration, which is caused by the combustion of carbon based fuels, has been declared as one of the major drivers of the greenhouse effect. Beyond that, records show a significant increase of atmospheric CO2 concentration compared to pre-industrial levels.^[2] In order to address these climate change challenges and mitigate global warming, international environmental treaties, such as the United Nations Framework Convention on Climate Change (UNFCCC) and later the Kyoto Protocol (KP), were established to enforce limitations on GHG emissions.^[3] As a result, the overall GHG emissions within the European Union (EU) were decreased by 5.5% between 1993 and 2003.^[4] Moreover, additional actions were taken through the creation of the European Union Emission Trading Scheme (EU-ETS) in 2003. This cap-and-trade scheme operates through the allocation and trade of emission allowances to reduce GHG emissions in a cost effective manner. Its original scope required only selected industries, such as energy, iron, and oil, to comply with the emission trading scheme (ETS).^[5] Aviation, as an industry whose CO2 emissions have risen in the EU by 95% since 1990, accounts nowadays for about 3.3% of the EU’s total CO2 emissions. However, it had never been subject to the KP nor included in the EU-ETS.^[6] In 2008, the European Commission (EC) proposed the inclusion of aviation in the EU-ETS as a response to the continuous air traffic growth which caused a constant increase of CO2 emissions from aviation. As a result, Directive 2008/101/EC (henceforth Aviation Directive), an amendment of the original EU-ETS legislation, was ratified and came into force in January 2012. Since then, all flights departing from and arriving at an airport located in the European Economic Area (EEA) have been subject to the EU-ETS.^[7] Figure 1 illustrates the long-term evolution of global air traffic between 1980 and 2007, including major events leading to some temporary variations of activity:

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Figure 1: Evolution of world air traffic (1980-2007) expressed in RTK (billions)^[8]

A significant volume of literature already exists concerning the inclusion of aviation in the EU-ETS. Most of the research laid its focus on specific industry levels such as the individual airline, the aviation industry in general or macroeconomic aspects. In this context, these studies tried to anticipate market reactions triggered by the EU-ETS by analyzing specific issues such as the financial impact on airlines, changes in competitive behavior or implications for the overall industry development.^[9] As a consequence, the existing studies took only a limited market view and made assumptions about expected developments in specific fields of the aviation industry. However, at the time of writing this thesis, conclusions about the scope of impact could hardly be drawn from existing impact assessments because of the wide range of issues that exceeded the scope of most impact studies. Hence, a broader research approach is needed which takes different analytical perspectives to describe the scope of impact of the EU-ETS and depict potential effects for the aviation industry.

1.2 Objective and limitations

The main objective of this thesis is to describe the scope of impact of the EU-ETS on aviation and to develop a detailed understanding of the effects for the aviation industry through its inclusion in the EU-ETS.

Facilitated by the following remarks, including a comprehensive impact analysis, this thesis will also help to understand:

- the potential chances and risks for airlines through the recent incorporation in the EU-ETS,
- the expected market development of the aviation industry in the future due to the imposition of an ETS for GHG emissions,
- the international legal framework for climate change and emission trading, and
- the distinct industry characteristics, including interrelations and dependencies between the legislation and the aviation industry.

Due to the complexity of the research topic, the presented analysis in this thesis is conducted under scope limitations. The focus of the analysis is to examine the impact of the EU-ETS on passenger airlines, excluding cargo airlines and other market participants such as airport operators, ground handlers or other service providers.^[10] Also, adjacent industries such as tourism and the oil industry are not subjects of the analysis.

1.3 Structure

This master thesis is structured into six main sections. After the introduction, section two provides the reader with an overview of the legal framework for climate policy in order to describe the legal scope of major climate policy treaties and explain how the EU-ETS is embedded in this legal environment. At first, international and national law is conceptualized by distinguishing between different environmental treaties. Later remarks refer to major climate change treaties such as the UNFCCC and the KP. Eventually, a detailed description of the EU-ETS, including its objectives, scope, and mechanisms, is given. Based on the preceding part, section three delves further into the EU-ETS by focusing on the aviation industry and its incorporation in the EU-ETS. In the beginning, a brief overview of key characteristics of the aviation industry is provided to achieve a sufficient understanding of the market players, the competitive situation, and major industry trends. Subsequently, the section elaborates on environmental policies in international aviation ending with a detailed description of the Aviation Directive including its objectives, design parameters, and latest amendments. Section four encompasses a comprehensive analysis of EU-ETS describing the scope of impact for the aviation industry. Different industry parameters that are potentially impacted through the inclusion in the EU-ETS are identified. Moreover, expected effects for the industry are highlighted and potential market reactions of airlines are discussed to provide support for future predictions on industry developments. In order to achieve an overall understanding of the scope of impact, the impact assessment takes three distinct analysis perspectives. The individual perspective focuses on the impact of the EU-ETS on airline profitability. Subsequently, the intra-industry perspective takes a broader view on the impact on competition between market players. Eventually, the collective industry perspective focuses on potential changes in market performance and development, and thereby examines effects for the overall aviation industry. Thereafter, section five outlines main results from the impact analysis, including main drivers of impact for aviation. Later, management implications for airlines to cope with the EU-ETS regulatory are discussed. Finally, section six concludes this thesis by recapitulating the key aspects of the research topic and providing a future outlook for potential developments regarding the EU-ETS and the aviation industry.

2 Legal framework for climate change and emission trading

2.1 Demarcation of international and EU law for climate change

In order to understand the legal framework for climate change and the embeddedness of the EU-ETS in this system, it is important to differentiate between international and EU treaties. Furthermore, it helps to clarify the legal scope of the respective treaties at the international and EU level.

The UNFCCC is an international environmental convention on climate change. It was negotiated at the United Nations Conference on Environment and Development in 1992 and has been effective since March 1994.^[11] At that time, GHGs were declared as a major driver of climate change which raised the awareness of the fact that human-induced emissions cause global warming. However, the UNFCCC did not contain any legal obligations for climate change prevention. Instead, as a multilateral environmental convention it provided the framework for negotiations about further, more specific, multilateral agreements to protect the climate system.^[12]

In later years, the UN adopted the KP, which has become the most prominent treaty established under the umbrella of the UNFCCC. As a multilateral treaty against climate change, it specifies the original objectives of the UNFCCC and sets legally binding and quantified emission targets. As to date, the UNFCCC has been ratified by 195 parties, including major economies such as the EU and the United States of America (USA).^[13] Article (art.) 4 of the KP entitles the EU member states to fulfill their KP emission targets collectively.^[14] Under this rule, which is often called the “EU Bubble”, the EU takes on a distinct role under the KP legislation since it allows for regional legal enforcements of emission mitigation measures within the community.

As a result, the EU-ETS was launched as part of the European Climate Change Program in October 2003. With the introduction of the EU-ETS, the EU decided to jointly fulfill the Kyoto targets, and thereby achieving its own environmental targets.^[15] Figure 2 depicts the previously described treaties and their inclusion within the legal framework of climate policy:

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Figure 2: Legal framework for climate policy^[16]

2.2 United Nations Framework Convention on Climate Change

The ultimate objective of the UNFCCC is the “stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system”.^[17] To achieve its objective, the UNFCCC demands from its parties to reduce their GHG emissions without setting legally binding quantified limitations on GHG emission levels.^[18] In order to account for the varying development stages and economical capabilities of the convention parties, the UNFCCC differentiates between developed (Annex I parties) and developing countries (non-Annex parties) regarding expected initiatives to combat climate change.^[19] Furthermore, the UNFCCC explicitly states to ensure equity between its parties and therefore applies “the principal of common but differentiated responsibilities” which imposes all parties to protect the climate system; however, developed countries ought to take the lead in implementing precautionary measures against climate change. Also, industrialized nations are required to support developing countries that bear a disproportional burden under the UNFCCC.^[20]

2.3 Kyoto Protocol

The KP is an international environmental agreement based on the UNFCCC which specifies the objective of preventing climate change by setting quantitative limitations on GHG emissions.^[21] Although the KP was originally adopted in December 1997, it did not enter into force until February 2005 because of the USA’s withdrawal from the protocol in 2000. In order to become effective, art. 25 KP requires the signing of not less than 55 countries, whose overall CO2 emissions total at least 55% of the global CO2 emissions for 1990.^[22] Since the USA withdrew from the protocol in 2000, the remaining KP parties had not fulfilled this requirement until Russia’s ratification in late 2004. Since then, 192 parties have been obliged to comply with the Kyoto emission targets.^[23] The KP follows a sequential timeline consisting of distinct commitment periods for which specific emission targets are set. The first commitment period ran from 2008 to 2012 whereas the second commitment period will span from 2013 to 2020 as recently decided at the UN Climate Change Conference in Doha. However, amendments concerning emission targets made on this conference are yet to be approved by the parties.^[24] For the first period, it was agreed to reduce overall GHG emissions by at least 5% compared to the base year.^[25] During these negotiations the EU was committed to a mutual emission reduction target of 8% which is known as the Burden Sharing Agreement.^[26]

Similar to the UNFCCC, the KP also acknowledges the different industrialized levels of its parties and therefore only requires developed nations listed in Annex I of the UNFCCC to comply with its quantified emission targets.^[27] In order to regulate emission levels, each Annex I party initially obtains so called Assigned Amount Units (AAUs) which are calculated by applying the party’s emission reduction target to the GHG emissions in the base year.^[28] If a KP party fails to meet the predetermined reduction targets, a penalty of 30% for each excess emission unit (hereinafter Kyoto unit) is enforced. This means that for each ton of GHG emissions, which exceeds the reduction target, 1.3 Kyoto units will be deducted from its AAUs for the subsequent commitment period.^[29] In order to increase the flexibility of the KP and increase cost efficiency to meet reduction targets, KP parties are allowed to add or subtract Kyoto units from their AAUs through the use of flexible mechanisms.^[30] The KP provides three flexible mechanisms which are widely known as Kyoto mechanisms. These are, Joint Implementation (JI), the Clean Development Mechanism (CDM), and International Emission Trading (IET).^[31]

JI is a project-based mechanism in which an Annex I party invests in an emission reduction project in another Annex I party.^[32] As a result, the investing party receives Emission Reduction Units (ERUs) in addition to its AAUs while deducting the same amount of Kyoto units from the beneficiary’s account. In this way, the total amount of Kyoto units does not increase but Kyoto units are only redistributed.^[33]

The CDM constitutes another project-based mechanism which enables KP parties to acquire additional Kyoto units. In contrast to JI projects, a CDM rewards Annex I parties after investing in emission reduction projects conducted in developing countries.^[34] In those projects, the funding party receives so called Certified Emission Reductions (CERs) which can be converted into Kyoto units. Since emissions from non-Annex parties are not subject to the KP, CDM projects increase the total amount of Kyoto units, and thereby allow for increased GHG emissions under the KP.^[35]

Unlike the preceding Kyoto mechanism, IET represents a market-based mechanism which creates the framework for international trade of Kyoto units between the KP parties.^[36] The IET gives KP parties, whose projected GHG emissions exceed the AAUs, the opportunity to acquire additional Kyoto units through trading activities on the carbon market. In turn, it enables KP parties, whose GHG emissions are lower than their AAUs, to gain profits through the sale of unused Kyoto units to high-emitting parties. Moreover, the trading opportunity of unused Kyoto units encourages KP parties to take domestic actions, and thereby reduce GHG emissions. To prevent future compliance issues with emission targets resulting from intensive trading of Kyoto units, KP parties are obliged to retain a certain number of Kyoto units to maintain a so called commitment period reserve.^[37] However, the IET does not prescribe any domestic or regional ETSs it rather constitutes the foundation on which other ETS can be established. Yet, all trading activities carried out under sub-ETSs are subject to the KP and need to comply with the KP emission targets.^[38] In the following, the EU-ETS as the most prominent regional sub-ETS of the KP is described.

2.4 European Union Emission Trading Scheme

2.4.1 Motivation and objectives

The EU had always been an advocate for the battle against climate change. Accordingly, the EU urged to take policy measures to prevent global warming. It was predicted that an increase of the global annual mean surface temperature by more than 2˚C above pre-industrial levels would cause irreversible catastrophic events.^[39] Also, it was obvious that the 8% decrease in CO2 emissions confirmed under the Burden Sharing Agreement would not be sufficient to achieve this target. Scientific findings by the Intergovernmental Panel on Climate Change (IPCC) had indicated that a sustainable global CO2 emission reduction of at least 50% below 1990 levels must be achieved by 2050 to avoid severe climate change events.^[40] For this reason, additional mitigation measures were needed to further curtail CO2 emissions. This led to the creation of the EU-ETS in October 2003. Since its launch in January 2005, it has been a cornerstone of European climate policy and presents the central instrument of the EU Climate and Energy Package from December 2008. Under this initiative, the EU pursues a 20% GHG emission reduction compared to 1990 emission levels by the year 2020.^[41]

2.4.2 Scope and extensions

As to date, the EU-ETS has been introduced in 31 countries including the 27 EU member states as well as neighboring countries such as Norway, Liechtenstein, Iceland, and Croatia. As an entity-based ETS, the EU-ETS covers some 11,000 installations across several high-emitting industries, including energy, oil, coke, metal ore, and steel.^[42] In its entirety the EU-ETS accounts for around half of the CO2 emissions released in the EU.^[43] This makes the EU-ETS the largest multinational ETS against climate change.^[44]

Since its launch, the EU-ETS has experienced several scope extensions as for instance the incorporation of N2O which results from the production of nitric acid.^[45] Also, extensions of the legal scope to non-EU countries such as Iceland, Liechtenstein, and Norway were accomplished.^[46] In addition, the international civil aviation industry, as the first segment of the transportation industry, was incorporated by adopting the Aviation Directive. Besides sectoral and GHG-specific extension plans, the EU pursues further geographical scope extension by promoting the EU-ETS beyond community borders. This also emphasizes the EU’s overall vision of developing an international network of ETSs and creating a global carbon market.^[47] Art. 25 of the EU-ETS explicitly states the openness to other compatible mandatory GHG ETSs. In this regard, officials from the EU and the Australian government recently reached an agreement on linking the schemes by 2018.^[48]

2.4.3 Allocation and cap system

The EU-ETS operates as a cap-and-trade scheme. This means that it sets a limit on the total amount of GHGs that are allowed to be released by the members under the scheme.^[49] The cap determines the total amount of emission allowances, so called EU Emission Allowances (EUAs), which the members receive to cover their emissions. If emissions from business operations exceed the amount of EUAs, members need to engage in trading activities to buy or sell EUAs on the carbon market. Also, as a sub-trading system of the KP, the EU-ETS entitles members to use Kyoto credits to cover emissions as agreed under the Linking Directive.^[50]

EUAs are allocated using a combination of auctioning and free allocation whereas the majority of EUAs are allocated free of cost by applying a benchmarking scheme. The quantity of EUAs that are freely allocated depends on the specific industry and its competitive situation on the global market to ensure competitiveness of the European economy. However, in order to achieve the ambitious emission reduction targets and generate revenues for EU mitigation measures, the EU intends to steadily increase the share of EUAs allocated under auctioning.^[51] The free allocation of EUAs to stationary installations, such as industrial plants, follows a product benchmark. This benchmark represents the 10% most efficient installations whose performance is compared to eligible installations to determine the number of free EUAs allocated to the members.^[52] At the end of every year, each member must surrender EUAs equivalent to the respective emission level of the year. If emissions exceed the quantity of EUAs, financial penalties are imposed by the regulatory authorities of the member states.^[53]

2.4.4 Trading and price mechanisms

As mentioned earlier, the EU-ETS is an entity-based ETS. As such, individual companies perform emission trading on a common carbon market.^[54] On the contrary, IET under the KP solely takes place between KP parties at a national level.^[55] It should be noted that emission trading refers to the trade of emission rights as opposed to trading of emissions themselves. In this context, an emission right is the permission to release a certain amount of CO2 within a specific period of time.^[56] Besides trading with EUAs, the EU decided to link the Kyoto project-based mechanisms to the EU-ETS. Since then, EU-ETS members are allowed to use a limited number of Kyoto credits to cover emissions under the EU-ETS and trade international credits (JI and CDM) on the carbon market.^[57] Beyond the general trade of EUAs, the EU-ETS legislation allows for inter-temporal trading which involves banking and borrowing of EUAs. Banking enables EU-ETS members to carry EUAs to future years whereas borrowing describes the use of future emission allowances to cover emissions from current operations. The inter-temporal trade gives members more flexibility to use EUAs under dynamic emission levels. However, to avoid compliance issues in future periods, the EU-ETS does not allow inter-period borrowing across compliance periods.^[58] In order to achieve emission reductions and stimulate emission mitigation actions, the EU imposes an emission cap based on historical emission levels which are lower than emissions released under current economic activities. This results in EUA scarcity and creates value for the emission allowances so that a market price can be established.^[59] Also emitters are encouraged to manage business operations more effectively and lower carbon emissions in order to ease the cost burden of emission charges.

2.4.5 Timeline and structural changes

The EU-ETS is periodically divided into consecutive trading phases. The first trading phase commenced in 2005 and spun over three years ending in 2007. It is often called the trial period as it was primarily pursued to gain experience in the operation of a multinational ETS, to establish an effective carbon price, and to provide seamless free trade of EUAs across the EU. Simultaneously, the implementation of a functioning infrastructure to perform reliable monitoring, reporting, and verification of emission data was a main objectives during the initial phase. Hence, significant CO2 emission reductions were not expected during this time period.^[60] Phase two ran from 2008 to 2012 coinciding with the first Kyoto commitment period. During this period, various changes of the community scheme were made to solve teething problems and ensure a more effective ETS against climate change. In this regard, allocation rules were changed, geographical scope extensions were conducted, and the Kyoto mechanisms were linked to the community scheme.^[61] As it can be seen, the EU-ETS as the largest multinational ETS requires constant revision by the policymakers to maintain an effective instrument against climate change. Especially, the size and complexity of the scheme has caused problems to implement a resilient scheme which does not require continuous modifications to achieve its objectives. Since its introduction, the EU-ETS has required various structural changes to improve its effectiveness and achieve its environmental goals. The EU-ETS has recently ended its second trading period. The EC proposes further structural changes for the current period which runs from 2013 to 2020. In the following, current developments regarding structural reforms of the EU-ETS are addressed.

In order to increase transparency and lower the complexity of several autonomous National Allocation Plans (NAPs), the EC decided to introduce a harmonized allocation methodology at EU level. Since 2013, EUAs have been centrally allocated applying a community-wide emission cap. This initiative promises to prevent member states from applying discriminatory measures, as they will no longer be able to favor their national industries under the NAPs.^[62] Moreover, the third period will experience a significant shift from free allocation to auctioning. In this regard, it is proposed to assign at least 50% of all EUAs through auctioning. In addition, a more stringent cap will be enforced which will decrease annually by 1.74%, reaching a 21% emission decrease compared to 2005 levels at the end of the period.^[63]

To raise environmental awareness outside the EEA and increase the international reach of its ETS, the EU has promoted the EU-ETS outside the EEA and has tried to establish links to other national or regional ETSs. As a first step towards a global network of carbon ETSs, officials from the EU and Australia recently announced to link their ETSs. Both countries agreed on establishing a full link between the two systems by 1 July 2018. This means that the free trade of emission allowances between Australian and European businesses will be possible. In addition, there are ongoing negotiations about linking the EU-ETS with the Swiss ETS. The merger of ETSs can potentially decrease system costs, increase market liquidity, and create a more stable carbon market.^[64]

There are currently debates about measures to ensure price stability on the carbon market. During the first and second trading period there have been system flaws that led to critical price falls on the carbon market. For instance, the former high level of decentralization made individual member states responsible to allocate EUAs to their national businesses. Under NAPs, large companies lobbied for a fair allocation of EUAs to prevent disadvantages in global competition. As a result, EUAs were distributed too generously at the national level which led to an oversupply of EUAs within the EU.^[65] In addition, companies were not allowed to bank excess EUAs for further use in future trading periods.^[66] As a consequence, the carbon price plummeted sharply in May 2006 reaching its low in 2007 at almost 0€/t CO2. The price recovered at the beginning of phase two, reaching its peak in August 2008 at 28€/t CO2 before falling again shortly after.^[67] This price collapse was predominantly indebted by the economic downturn during this period which led to a decline in demand for EUAs. Since mid 2009, the EUA price had been fairly stable at around 15 €/t CO2 before dropping again below 10 €/t in the second half of 2011 as outlined in figure 3:

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Figure 3: Carbon price evolution (data for front-year futures contracts with delivery in December)^[68]

As a result from a slowing economy over previous years, companies were able to build up a huge surplus of EUAs which was projected to reach some 1.5 to 2 billion EUAs in 2013.^[69] In order to prevent a repeated price fall and ease the impact of the EUA surplus on demand for emission allowances, the EC set out a range of measures to stabilize the carbon market. First, the EC refrained from the allocation of EUAs under NAPs and implemented a centralized EUA allocation at the EU level to prevent a further over-allocation of EUAs.^[70] Moreover, the EC plans to back-load some 900 million EUAs for the third trading period. This implies a deferral of EUA allocation to the end of the trading period. In this way, the current EUA surplus is expected to gradually decrease and EUAs are more evenly distributed over the individual years of the trading period.^[71] Furthermore, in a recent report the EC proposes the following measures to sustain an effective supply and demand relation and regain price stability in the carbon market:

- increasing the EU reduction target to 30% in 2020,
- retiring a number of EUAs in phase three permanently,
- revising the current annual linear reduction factor of 1.74% before 2020,
- extending the scope of the EU-ETS to other sectors,
- limiting the access to Kyoto credits, and
- establishing discretionary price management mechanisms such as a carbon price floor or an allowance reserve.^[72]

However, each of these proposed measures are still under debate and have yet to be passed by the EU legislative in order to be enforced.

3 International aviation and climate change

3.1 International aviation industry and airline economics

In order to understand the implications of emission charges for airlines, it is important to have general knowledge about specific characteristics of the aviation industry. This also helps to comprehend distorting effects on different airlines and to make projections for future industry developments. The following remarks highlight industry-specific parameters describing the overall industry, including the past evolution, current competitive situation, market players, and major industry trends, to provide relevant information for the later impact analysis.

3.1.1 Market evolution and competition

The aviation industry has experienced a dynamic development for a long time. In particular, several liberalization and deregulation measures have turned the aviation market from a formerly highly regulated industry into a truly globalized market. The Airline Deregulation Act which was passed by the US congress in 1978 is frequently mentioned as a pioneer for deregulation which triggered a move towards an open aviation market. The treaty phased out governmental regulations over air fares, flight routes, and barriers to enter the US aviation market for foreign airlines.^[73] Following this trend, similar efforts were made throughout the world, e.g. in Canada (1984), New Zealand (1986), Australia (1990) and Europe (1992-1997).^[74]

The deregulation instigated a reorganization and strategic realignment of airline business models which was supposed to meet global industry demand more effectively. As a result, the renowned hub-and-spoke system became widely the preferred network configuration since it enabled airlines to increase aircraft utilization while providing a larger route network for passengers.^[75] In contrast to the widespread hub-and-spoke model, Southwest Airlines has been a prominent exemption by following its low-cost strategy since its foundation in 1967. Today, Southwest Airlines is seen as the pioneer of the low-cost business model which offers passengers low-fare tickets by cutting down on services as for instance on-board meals, hub connectivity, and baggage transfer handling.^[76] Following Southwest Airlines, a large number of low-cost carriers (LCCs) were founded around the globe such as AirTran, jetBlue, Ryanair, and easyJet.^[77] Numerous market entries of LCCs intensified market competition and influenced price policies of many airlines. Air fares had to be decreased in order to stay competitive so that many airlines struggled to survive in the market.^[78] Also, an unprecedented trend of market consolidation was experienced in the industry.^[79]

In recent years, network carriers (NWCs), which traditionally provide passengers with comprehensive customer service, have more and more integrated the competitive low-cost business model in order to participate in this prospering market segment. NWCs have started to acquire existing LCCs (e.g. Lufthansa’s acquisition of Germanwings in 2009), or established own low-cost subsidiaries (e.g. BMI’s spin-off leading to the formation of bmibaby).^[80] A similar strategic convergence can be observed in the low-cost segment where LCCs increasingly provide passengers with improved service quality. Because of various market entries in the low-cost segment, competition has picked up and the market has become fairly saturated. As a result, formerly pure differentiators started to offer complementary services on flights. Also new aircraft layouts including business class seating is nowadays apparent.^[81] Correspondingly, the term “hybrid airlines”, which describes airlines whose strategy combines aspects from traditional and low-cost business models, can often be found in recent scientific literature.^[82]

In the course of increasing competition and intensifying price wars, the aviation industry has experienced a huge shift towards inter-organizational collaboration. This becomes evident in the fact that a large number of airlines have entered strategic alliances during the past decade. Today, members of the three airline alliances, namely Star Alliance, oneworld, and Sky Team, capture around 80% of the total market share.^[83] The trend towards the creation of alliance constellations can be seen as a response to increasing market dynamics caused by previous deregulation of the global aviation sector. In order to counter rising market volatility, lower uncertainty, and reduce reaction time for competitive moves, leading airlines engaged in strategic alliances, and thereby decreased their own vulnerability to unexpected market developments.^[84] Airline alliances often show a high degree of integration with alliance partners, including route coordination, revenue sharing, joint pricing, and marketing.^[85]

[...]

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^[1] See Grubb (2003), p. 147.

^[2] See Intergovernmental Panel on Climate Change (2007); Kiehl and Trenberth (1997).

^[3] See United Nations (1992); United Nations (1997).

^[4] See Wit et al. (2005), p. 1.

^[5] See European Commission (2003), Annex I.

^[6] See European Environment Agency (2012), pp. 293-294.

^[7] See European Commission (2008), preamble, par. 16; The EEA consists of the EU, Iceland, Liechtenstein, and Norway.

^[8] See Chèze et al. (2011), p. 5.

^[9] See Anger (2010); Lowe et al. (2007); Scheelhaase and Grimme (2007).

^[10] In this thesis, the terms “aviation industry” and “airline industry” are used interchangeably.

^[11] See United Nations Framework Convention on Climate Change (2013); United Nations (1992), art. 23 (1).

^[12] See United Nations (1992).

^[13] See United Nations Framework on Climate Change (2012b); In addition to each EU member state, the EU signed the KP collectively as a community of states; The last ratifying country was Andorra on 2 March 2011.

^[14] See United Nations (1997), art. 4.

^[15] See European Commission (2003), preamble, par. 5.

^[16] Own illustration.

^[17] See United Nations (1992), art. 2.

^[18] See United Nations (1992), art. 4 (2).

^[19] Annex I parties are developed countries and countries that are undergoing the process of transition to a market economy. Non-annex countries include all developing countries that have signed and ratified the KP.

^[20] See United Nations (1992), art. 3.

^[21] GHGs covered by the KP include CO2, CH4, N2O, HFCs, PFCs and SF6.

^[22] See United Nations (1997), art. 25; Freestone (2005), p. 9.

^[23] See United Nations Framework on Climate Change (2012a); United Nations Climate Change Secretariat (2004).

^[24] See United Nations Framework on Climate Change (2012c).

^[25] See United Nations (1997), art. 3 (1); The base year for most parties is 1990 except Bulgaria (1988),Hungary (average of 1985-1987), Poland (1988), Romania (1989), and Slovenia (1986).

^[26] See European Council (2002a).

^[27] See United Nations (1997), art. 3 (1).

^[28] See United Nations (1997), art. 3 (7).

^[29] See United Nations Framework on Climate Change (2008), p. 29.

^[30] See United Nations (1997), art. 3 (10-12).

^[31] Further EUAs can be acquired through land use, land use change, and forestry activities (LULUCF) which are not discussed in this thesis due to its low significance for the aviation industry.

^[32] See United Nations (1997), art. 6.

^[33] See United Nations Framework on Climate Change (2008), p. 17.

^[34] See United Nations (1997), art. 12.

^[35] See United Nations Framework on Climate Change (2008), p. 18.

^[36] See United Nations Framework on Climate Change (2012d); United Nations (1997), art.17; ERUs and CERs obtained through emission reduction projects are tradable emission units on the carbon market.

^[37] See United Nations Framework on Climate Change (2008), p. 58.

^[38] See United Nations Framework on Climate Change (2008), p. 16.

^[39] See European Commission (2005).

^[40] See Intergovernmental Panel on Climate Change (2007).

^[41] See European Council (2008).

^[42] Within an entity-based ETS emission allowances are traded between companies.

^[43] See European Commission (2013a).

^[44] See European Commission (2009b), p. 5.

^[45] See European Commission (2009b), p. 13.

^[46] Croatia joined the EU-ETS in January 2013 leading to 31 member states covered by the EU-ETS.

^[47] See European Commission (2003), art. 25.

^[48] See European Commission (2013e).

^[49] See European Commission (2013a).

^[50] See European Commission (2004).

^[51] See European Commission (2013a).

^[52] See European Commission (2011a).

^[53] See European Commission (2003), art. 16.

^[54] In the following the terms “companies” and “members” are used interchangeably.

^[55] See United Nations (1997), art. 3, 17.

^[56] See De Witt Wijnen (2005), p. 403; European Commission (2003), art. 3; Under the EU-ETS, an EUA represents the right to emit one metric ton of CO2 within a given year.

^[57] See European Commission (2004); For further details see also: Jepma (2003).

^[58] See Chevallier (2012), pp. 157-158.

^[59] See Faber and Brinke (2011), p. 3.

^[60] See Elleman and Joskow (2008), p. iii.

^[61] See European Commission (2013b).

^[62] See European Commission (2011a).

^[63] See European Commission (2009b), p. 12.

^[64] See European Commission (2013c).

^[65] See Egenhofer et al. (2011), p. ii.

^[66] See European Commission (2003), art. 13.

^[67] See European Energy Exchange (2013a).

^[68] See European Commission (2012b), p. 5.

^[69] See European Commission (2013d).

^[70] See European Commission (2011a).

^[71] See European Commission (2012a).

^[72] See European Commission (2012b).

^[73] See United States Congress (1978).

^[74] See Gillen (2006), p. 367.

^[75] See Gillen (2006), p. 368.

^[76] See Flenskow (2005), p. 102.

^[77] In May 2011 AirTran was acquired by Southwest Airlines.

^[78] See Goolsbee and Syverson (2008); Tan (2011).

^[79] See Gillen (2006), p. 368; Bermig (2005), p. 20; Delfmann et al. (2005), pp. 4-5.

^[80] bmibaby terminated its service in September 2012 after BMI’s takeover by IAG.

^[81] See Daraban (2012), p. 38; Klaas and Klein (2005), p. 138.

^[82] See Ehmer et al. (2008), p. 13; Bieger and Agosti (2005), p. 41.

^[83] See International Air Transport Association (2011), p. 1.

^[84] See Agusdinata and de Klein (2002), pp. 202-204.

^[85] See Bermig (2005), p. 28.