IBA Insights

The Environmental Exit Plan After Covid-19

ICAO’s Carbon Offsetting Reduction Scheme for International Aviation (CORSIA), scheduled to commence in 2021, is a global market-based measure designed to complement a variety of governmental actions intended to secure carbon-neutral growth in aviation from 2021 onwards.

CORSIA applies only to international flights and requires airlines from participating states to monitor, report and verify their emissions. ICAO has developed a route-based approach and uses data for its calculations only from flights between participating states. Any emissions reported and verified above a baseline figure must be offset through the purchase of carbon credits and the scheme intended to use CO2 emissions data between 2019 and 2020 for this baseline.

Given the significant drop in air travel and aircraft emissions due to Covid-19, however, there will clearly be a sizeable reduction in the baseline emissions figure if 2020 data is used in its calculation. Airlines have argued that, as the industry cautiously rebuilds and begins to emerge from its financially stressed operating environment, a considerable distortion to the baseline figure would put increased and unnecessary financial pressure on their business models by imposing bigger offsetting requirements.

In response to these concerns and to added pressure from IATA, ICAO announced on Tuesday 30th June that it has agreed to disregard 2020’s emissions data and will use statistics only from 2019. ICAO is due to commence its periodic review of CORSIA in 2022 and adjustments to the scheme could possibly be applied. This does however raise further questions about its effectiveness in the short term when offsetting requirements are applicable from 2021.

CORSIA’s fundamental aim is to offset any emissions above the baseline figure from 2019 although, according to data from April 2020’s IATA Air Passenger Forecast, Global RPKs may recover to 2019 levels only by 2023. Furthermore, international RPKs are predicted to lag behind domestic air travel and may not reach 2019 numbers until as late as 2024, which places pressure on the integrity of CORSIA over the next few years since airlines will not have to purchase any offset credits for a considerable period: there will be a significant delay to meaningful implementation of a functional carbon trading scheme under the CORSIA framework.

Younger Fleets

Another factor in the distortion of aviation emissions recording is the paradigm shift away from the norm IBA has noticed when considering aircraft age against oil pricing. Traditionally, in periods during which the oil markets drop in price, the aviation industry moves towards using older, cheaper and less fuel-efficient aircraft as the benefit, or ‘premium,’ of operating a more fuel-efficient platform is typically discarded or seen as nominal.

In today’s ‘new normal’, we anticipate operators to shy away from such aircraft and instead favour younger, twin-engine widebodies for long haul routes such as the new generation Airbus A350 and Boeing 787 family aircraft to bolster cash reserves. The still relatively young Boeing 777-300ERs and Airbus A330-300s are also preferred.

Current Generation Aircraft Current In-Service Fleet Composition – As at June 2020

As a consequence of Covid-19, IBA has also witnessed accelerated retirements of large quad-engine widebodies which unfortunately do not make fiscal sense compared with their highly efficient, twin-engine replacements or competitors. The decision to remove A380s, 747s and A340s from international fleets and to continue storing aircraft such as A330-200s, 777-200ERs, 767-300ERs is also in part an exercise in minimising the higher associated maintenance and fuel costs that operating these aircraft would otherwise incur. Although, in some cases, during Covid-19 operators have temporarily converted their passenger aircraft into makeshift freighters or ‘preighters’ with supplementary type certifications.

According to IBA.iQ, the least affected aircraft in terms of active fleet percentage are the Airbus
A350-900 (37%), the Boeing 787-9 (49%), the Boeing 777-300ER (51%) and the Airbus A330-300 (29%). The aircraft in the graph above exhibit significant fuel burn advantage on transatlantic routes compared with previous generation aircraft according to a study conducted by the International Council on Clean Transportation (ICCT).

Transatlantic Airline Fuel Efficiency Ranking

Carbon Credits and ESG Finance for Aviation

The long-term repercussions of Covid-19 on the carbon markets is unclear. However, following the Global Financial Crisis (GFC) in 2008, the implementation of international carbon markets was severely impacted because momentum towards a carbon reduction policy was dented considerably during the period. The volatility in carbon pricing in the major carbon markets during the current global lockdown period is a similar scenario to the instability observed following the GFC. With the carbon output of aviation and wider industries being significantly lower now than in 2019, there is a strong possibility that carbon credits will flood the compliance markets and suppress demand for credits for the rest of 2020. Re-assessment of carbon budgets across global industry, and in particular aviation, is required to stimulate demand in the carbon markets and ensure offsetting is realigned with post Covid-19 market conditions.

Environmental, social and governance (ESG) finance has seen encouraging growth in sustainably-linked loans and green bonds over the last 12 to 18 months, 2019 witnessing impressive volumes. During Covid-19, however, there has been a significant reduction in new sustainably-linked loans, many airlines seeking financial support with no sustainability targets attached to bolster their short-term liquidity and weather the pandemic’s storm. It’s possible these loans will be refinanced over the next few years so they have ESG targets and meet airlines’ long-term sustainability strategies but will no doubt hinder any short term ESG criteria placed on existing loans.

In contrast, airlines seeking government bailouts have had strong sustainability targets set out by their administering governments. Air France/KLM have received €7bn in state aid which includes a €4bn state-backed bank loan and a €3bn direct loan. As part of the Air France side of the deal, French Finance ministers have insisted the airline permanently scraps all short-haul flights less than 2 ½ hours as they  ‘aren’t justified’ when TGV high-speed rail services can serve cities within France and the carbon cost of operating aircraft on these routes is unnecessarily high. In addition to the Air France/KLM state aid, Scandinavian Airline SAS has sought a US$ 536 million investment as part of a recapitalisation plan which stipulates it must meet ‘clear and quantifiable criteria’ on lower emissions. SAS’s fleet modernisation will be a focal point of the government recapitalisation plan with 35 Airbus A320neo and four Airbus A350-900s on order, according to IBA.iQ, as well as the Sustainable Aviation Fuel (SAF) strategy SAS announced in 2019 and has already implemented.

Aside from sustainably backed loans and bailouts, plans with strong backing for the prioritisation of carbon mitigation are already being implemented as part of the industry’s post Covid-19 exit strategy. In the UK for example, Sustainable Aviation, a long-term strategy coalition, delivered a letter to the UK Transport Secretary in early June calling for £500 million in support of early stage projects. They include sustainable aviation fuel projects, developing aircraft and engine technology, modernising UK airspace and further progressing carbon offset measures and carbon removal technologies.

Covid-19 has focused airlines’ attention largely on survival and, in the short-term, environmental sustainability for many will be somewhat of an afterthought. As we begin to emerge from the crisis, it is crucial we consider how Covid-19 has changed the way the world works. Many industries are looking to rebuild ‘better’ to achieve clear environmental benefits, estimates suggesting we will see a reduction of 5.5% in global emissions over the period. Further pressure will be placed on governments to adjust their environmental policies and on airlines to improve sustainability, many operators likely to accelerate their fleet renewal strategies and explore other sustainability initiatives.

For more information about this article or our Advisory services please contact Tim Boon.

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