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In addition to higher fuel prices, airlines are facing the prospect of rising costs as a result of the EU’s emissions trading scheme, according to Standard & Poor’s.

Selected excerpts from Airline Carbon Costs Take Off As EU Emissions Regulations Reach For The Skies

Airlines worldwide are bracing themselves for the start, in 2012, of a new phase of Europe’s greenhouse gas (GHG) emissions trading scheme (the EU ETS). Besides curbing the industry’s projected growth in emissions, the scheme will likely increase costs. Furthermore, in Standard & Poor’s Ratings Services opinion, these costs could, if not passed through to passengers or mitigated in other ways, impact the carriers’ credit quality over time.

We estimate that in 2012-2013 alone–the first year of trading for airlines under the EU ETS–the industry will likely incur an additional cost of approximately €1.125 billion, based on the current carbon price of about €15 per tonne of carbon dioxide (€/tCO2).

This additional cost burden on airlines is, at least initially, marginal in our view compared with existing fuel expenses and aircraft lease payments or depreciation charges. Nevertheless, it will add further cost pressure to a cyclical, capital-intensive, and highly competitive industry already subject to volatile fuel prices, and may further differentiate aircraft operators. Moreover, we believe that EU-based airlines may be more severely affected than non-EU based carriers, which could create a competitive mismatch and introduce the risk of carbon leakage (that is, the transfer of airline activities to non-EU operators or to routes not covered by the EU ETS).

While the medium- and longer-term price of carbon is uncertain, we do not think that the EU ETS will have a significant impact on rated European airlines such as British Airways PLC (OTC:BAIRY) (BB-/Stable/–), Deutsche Lufthansa AG (OTCQX:DLAKY) (BBB-/Stable/A-3), and SAS AB (B-/Negative/–) in the short term. CO2 emissions are directly related to fuel efficiency, and airlines already have an incentive to improve fuel efficiency because fuel costs represent as much as 40% of their total costs.

In the longer term, we think an aircraft operator’s ability to pass on the additional carbon cost will be a key differentiator, one that is likely to vary from operator to operator.

Overall, we think that the global network carriers are best-placed to cope with the introduction of the EU ETS. Conversely, we think that low-cost and short-haul airlines that have lower premium revenues, and particularly those with older aircraft fleets, may be somewhat more adversely affected.

[Latest updates via Alacra Pulse: International Airlines Group (IAG), formed by the merger of British Airways and Iberia, said it was concerned that political instability in the Middle East would hit fuel prices this year, as it reported a swing back into profit in 2010.(Reuters) Charles Stanley upgraded its recommendation and target price for IAG as its market value has now factored in the rising prices of crude oil. (Sharecast)]

Source: EU Emissions Trading Scheme Will Boost Airlines' Carbon Costs