EXECUTIVE EDUCATION

EU ETS impacts on Airlines’ business model

HEC – Advanced Certificate in Aviation & Aerospace Pierre Bontems, Johann Panier, Franco Lanza,

Jorge Caro, Julien Gebel

EXECUTIVE

EDUCATION

Agenda

• Introduction: context & scope

– History: climate change & path towards “green aviation”

– Scope of the study and approach overview

• EU ETS applied to aviation overview

• EU ETS impacts analysis

– The airlines’ business model framework

– Impacts identification & overview

• Way forward: possible airlines strategy

– A 3-stream strategy to face EU ETS challenges

– Zoom on Stream 1: Direct transfer to customer

– Zoom on Stream 2: Structural changes implementation

– Team 1 recommendations

• Latest developments

• Q&A

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EXECUTIVE

EDUCATION

Agenda

• Introduction: context & scope

– History: climate change & path towards “green aviation”

– Scope of the study and approach overview

• EU ETS applied to aviation overview

• EU ETS impacts analysis

– The airlines’ business model framework

– Impacts identification & overview

• Way forward: possible airlines strategy

– A 3-stream strategy to face EU ETS challenges

– Zoom on Stream 1: Direct transfer to customer

– Zoom on Stream 2: Structural changes implementation

– Team 1 recommendations

• Latest developments

• Q&A

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EXECUTIVE

EDUCATION

Kyoto Protocol

Introduction: context & scope History: climate change & path towards “green aviation”

• The climate change is not a new concept: first alarms were raised in the early 60’s • In 2007, the EU endorse the “Climate & Energy Package” having aggressive targets regarding

emissions reduction. The EU ETS is one of the enablers used to reach the targets • In 2008, the EU has decided to impose a cap on CO2 emissions to aviation, leveraging on EU ETS

mechanism

Aviation accounts for only 2% of total global CO2 emissions,

but these emissions have increased by 87% since 1990

Time 1992

“Earth Summit” 1997 Kyoto

2012 2009 Copenhagen

2020

EU Climate & Energy Package

2007 “20-20-20”

ETS to Aviation

2008

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EXECUTIVE

EDUCATION

Introduction: context & scope Scope of study and approach overview

• Study objective is the analysis of the EU ETS impact on major European PAX airlines’ business model

• To reach this objective, a 3-step approach has been used, going from the understanding of the EU ETS mechanism towards the presentation of possible airlines’ strategic answer

• Information gathering has been performed through research and stakeholders’ interviews

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EXECUTIVE

EDUCATION

Agenda

• Introduction: context & scope

– History: climate change & path towards “green aviation”

– Scope of the study and approach overview

• EU ETS applied to aviation overview

• EU ETS impacts analysis

– The airlines’ business model framework

– Impacts identification & overview

• Way forward: possible airlines strategy

– A 3-stream strategy to face EU ETS challenges

– Zoom on Stream 1: Direct transfer to customer

– Zoom on Stream 2: Structural changes implementation

– Team 1 recommendations

• Latest developments

• Q&A

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EXECUTIVE

EDUCATION

EU ETS Overview Overview of EU ETS applied to aviation

Item Description Item #1 The maximum allowed industry CO2 emission is determined based on the average fuel consumption 2004-2006 on all flights to and from

Europe

Item #2 The industry emission allowance (“cap”) is allocated among airlines by means of emission rights, based on their 2010 RTK share. The free allowance benchmark should be published by 30th September 2011

Item #3 The start of the ETS is set at 1st of January 2012

Item #4 The number of aviation allowance to be created in 2012 is equal to 97% of 2004-2006 historic aviation emission (around 213 MT) and 95% of 2004-2006 historic aviation emission in 2013 (around 208 MT).

Item #5 82% of the cap will be offered as allowed free emissions until 2020. The remaining 3% will be allocated to a reserve for fast growing airlines and new entrant to the market

Item #6 15% of the cap will be provided by auctioning

Item #7 For all emission exceeding the cap, emission rights have to be purchased on the market (CDM / JI / Airline industry / Other sectors)

Sources: Scheme is property of Mr. Albano, Head of Environment within Air France 7

EXECUTIVE

EDUCATION

Agenda

• Introduction: context & scope

– History: climate change & path towards “green aviation”

– Scope of the study and approach overview

• EU ETS applied to aviation overview

• EU ETS impacts analysis

– The airlines’ business model framework

– Impacts identification & overview

• Way forward: possible airlines strategy

– A 3-stream strategy to face EU ETS challenges

– Zoom on Stream 1: Direct transfer to customer

– Zoom on Stream 2: Structural changes implementation

– Team 1 recommendations

• Latest developments

• Q&A

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EXECUTIVE

EDUCATION

EU ETS Impact Analysis The airlines’ business model framework

• A business model can be defined as a tool used to describe the rationale of how an organization creates, delivers and captures value

• Proposed business model framework provides a structured way to represent the core aspects of the airline business, from a high level perspective

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EXECUTIVE

EDUCATION

EU ETS Impact Analysis Impacts identification & overview

• Interviews and research activity show that implementation of EU ETS induces several changes that have been mapped on proposed airline business model framework

• Impacted areas are “Key Partners”, “Key Resources”, “ Activities & Value Proposition”, “Cost Structure”, and “Revenue Structure”

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EXECUTIVE

EDUCATION

EU ETS Impact Analysis Impacts identification & overview

Area #1 – Key Partners • Setup of new Joint

Ventures or Partnerships • Increased collaboration

between Airports and Ground Suppliers

Area #2 – Key Resources • Optimized fleet

management to match resource & requirement

• Fuel efficiency, biofuels, and other alternative energies

• Airport slots usage optimization

Area #3 – Cost Structure • Increasing aircraft unitary cost • New charges as “Emission Allowance

Acquisition”, “MRV & Trading costs”, and “Non compliance penalties”

Area #5 – Revenue Structure • Additional revenues generated from the

increase of PAX ticket prices • Additional revenues coming from on-board

services • Missed revenues due to increase competition

from non-EU airlines and traffic distortions

Area #4 – Activities & Value Proposition • Distortion of traffic and

carbon leakage • Change on airline

geographic coverage coming from the optimization of network structure

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EXECUTIVE

EDUCATION

Agenda

• Introduction: context & scope

– History: climate change & path towards “green aviation”

– Scope of the study and approach overview

• EU ETS applied to aviation overview

• EU ETS impacts analysis

– The airlines’ business model framework

– Impacts identification & overview

• Way forward: possible airlines strategy

– A 3-stream strategy to face EU ETS challenges

– Zoom on Stream 1: Direct transfer to customer

– Zoom on Stream 2: Structural changes implementation

– Team 1 recommendations

• Latest developments

• Q&A

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EXECUTIVE

EDUCATION

Way forward: possible airlines strategy A 3-stream strategy to face EU ETS challenges

• The stream 1 “Direct Transfer To Customer” corresponds to a short-term solution to face EU ETS challenge

• The stream 2 “Structural Changes Implementation” aims at, on medium-term, mitigating the risk related to revenue leakage due to air travel price increase

• The stream 3 “EU ETS principles generalization” aims at ensuring long-term sustainability

• Based on analysis results, Major European airlines will probably launch three different streams of actions in order to mitigate the EU ETS implementation impacts:

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EXECUTIVE

EDUCATION

Way forward: possible airlines strategy Zoom on Stream 1: Direct transfer to customer

• Major European airlines will most probably transfer directly the EU ETS-related costs on the customer

• As, as of today, carbon represent a very low portion of airlines’ costs (compared to fuel), the price increase will not be perceived by the customer on the short term

• Thus, a clear understating of air travel price elasticity of demand is required

• it appears clearly that cost retransfer to customer must be focused in priority on business travelers (“Long-haul international business” and “Short-haul business”) as the demand is less elastic to price

• As carbon represents low portion of costs compared to fuel, airlines will consider transferring EU ETS costs to customers

• Analysis of price elasticity of demand allow better targeting of customer segments to be charged • This retransfer of costs must not be considered as definitive as air travel price will increase with

carbon costs and customers will start looking for alternative solutions

Sources: Department of Finance Canada: “Air Travel Demand Elasticities: Concepts, Issues and Measurement” 14

EXECUTIVE

EDUCATION

• On the medium term, to mitigate the risk related to revenue leakage due to air travel price increase, major European airlines will have to identify and launch key programs:

Way forward: possible airlines strategy Zoom on Stream 2: Structural changes implementation

• Based on the detailed analysis of the impacts performed in the previous sections, the following three categories of actions can be considered by major European airlines: Actions related to carbon reduction Actions related to carbon compensation Other actions

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EXECUTIVE

EDUCATION

Way forward: possible airlines strategy Team 1 recommendations

• Mitigation actions can be mapped on the below quadrant after quick qualitative analysis:

• European airlines must address EU ETS considering cost retransfer (short-term) , “quick wins” & “must dos” (medium-term)

• European airlines must work closely with international organizations to ensure that EU ETS mechanism (or equivalent) is agreed and applied globally for long-term sustainability

• Overall industry must require transparency on the way funds from carbon credits are used (invested in R&T projects that will benefit to the industry)

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EXECUTIVE

EDUCATION

Agenda

• Introduction: context & scope

– History: climate change & path towards “green aviation”

– Scope of the study and approach overview

• EU ETS applied to aviation overview

• EU ETS impacts analysis

– The airlines’ business model framework

– Impacts identification & overview

• Way forward: possible airlines strategy

– A 3-stream strategy to face EU ETS challenges

– Zoom on Stream 1: Direct transfer to customer

– Zoom on Stream 2: Structural changes implementation

– Team 1 recommendations

• Latest developments

• Q&A

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EXECUTIVE

EDUCATION

Latest development

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European Level

• The EU ETS is fully compatible with international law, response issued by the EU highest court on the 6th of October 2011: no breach of sovereignty, no discrimination

The train is on its rail and will not move, according to Mr. Haas (EU)

Worldwide

• Airlines are urging the Federal Aviation Administration to accelerate the use of on-board satellite-based for benefits of air-traffic control in order trim fuel costs, reduce pollution and alleviate airport congestion

• NASA launched a prize for an electric plane capable of a 7000 miles range at mach 0,85, target : 2025

• Air France launched its first eco flight with 50% biofuel from Paris to Toulouse

Changes in the industry seem to happened

EXECUTIVE

EDUCATION

Agenda

• Introduction: context & scope

– History: climate change & path towards “green aviation”

– Scope of the study and approach overview

• EU ETS applied to aviation overview

• EU ETS impacts analysis

– The airlines’ business model framework

– Impacts identification & overview

• Way forward: possible airlines strategy

– A 3-stream strategy to face EU ETS challenges

– Zoom on Stream 1: Direct transfer to customer

– Zoom on Stream 2: Structural changes implementation

– Team 1 recommendations

• Latest developments

• Q&A

19

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EDUCATION

Q&A

Thank You!

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EU ETS impacts on Airlines’ business model

HEC – Advanced Certificate in Aviation & Aerospace Pierre Bontems, Johann Panier, Franco Lanza, Jorge Caro, Julien Gebel