Q+A-What issues are at stake in the EU-U.S. carbon spat?

BRUSSELS/LONDON Tue Nov 1, 2011 1:04pm EDT

BRUSSELS/LONDON Nov 1 (Reuters) - Twenty-six nations, including the United States, are expected to lodge a formal protest on Wednesday against a European Union law to make all airlines travelling to and from Europe pay for their carbon emissions.

The protest at the International Civil Aviation Organization (ICAO) meeting in Montreal, Canada, is likely to escalate transatlantic tension, which has triggered an anti-EU bill in the U.S. Congress.

It declared illegal the EU plan to make all flights buy carbon permits under the EU Emissions Trading Scheme (EU-ETS) from Jan. 1 to offset their emissions.

The proposed U.S. legislation could mark the beginning of a trade war, analysts and lawyers said. The following looks at some of the issues.

HOW LONG HAS THE DEBATE RAGED?

In 1997, the Kyoto Protocol on tackling climate change asked developed countries to work with the ICAO to reduce aviation greenhouse gas emissions.

Aviation accounts for about 3 percent of total EU greenhouse gas emissions but this is forecast to keep rising.

ICAO considered regulating carbon emissions on the basis of international airspace and decided this was impractical.

Problems included regulation of emissions while planes were flying over the high seas, which would be "orphan pollution" -- i.e the responsibility of no one.

Frustrated by the lack of progress, the EU -- which has taken a leading role in tackling climate change -- in 2005 concluded that bringing aviation into the EU ETS would be the most cost-efficient and environmentally effective option for controlling aviation emissions.

In protest at the EU law, the Air Transport Association of America, American Airlines and United Continental took their case to the High Court in London, which referred it to the European Court of Justice (ECJ) last year.

In October, the advocate general in a preliminary opinion said the EU was acting within the law. Her opinion is not binding, but is a good gauge of the ECJ's final ruling expected early next year.

WHAT DIFFERENCE WOULD A FORMAL PROTEST AT ICAO MAKE?

EU lawyers have said any decision by the ICAO council would not be legally binding, but could be a step towards a formal dispute procedure, in which the president of ICAO would mediate.

Lawyers specialised in the airline industry said ICAO was an appropriate forum, although they questioned whether that would change the EU's position.

"It's doubtful an ICAO challenge will dissuade the EU from its current plans," said Gabriel Sanchez, adjunct professor of law at the International Aviation Law Institute, Chicago.

ICAO, he said, "does not have a good track record with respect to issuing final rulings in aviation disputes."

HAVE THE AIRLINES CHANGED THEIR STANCE?

Lobby groups said the airlines have radically shifted position.

In a paper in 2007, seen by Reuters, trade group, the International Air Transport Association (IATA) assessed the "financial impact of extending the EU ETS to airlines."

In sum, it said the impact on revenues would be minimal.

Even if prices for EU Allowances (EUAs) rose to 100 euros per tonne of CO2 emitted (compared to around 10 euros now) and passenger numbers shrank by 37 million, "the impact on airline profits would be minimal."

This week, IATA said it had always been consistent.

"Our views have not changed. The 2007 paper analysed a different scheme design to what the EU delivered," IATA Chief Economist Brian Pearce told Reuters.

"IATA supports emissions trading in principle, but only if it does not distort competition or be imposed extra-territorially. The design of the current EU ETS does both of these.

"Airlines in practice will not be able to raise fares to reflect ETS costs, because of unequal competitive impacts between EU and other airlines. So the ETS will adversely impact airline profits."

A report last week said the scheme could cost airlines around 2 billion euros ($2.8 billion) by 2020.

WHAT IS HAPPENING IN CONGRESS?

Last week, the U.S. House of Representatives approved legislation to make it illegal for U.S. passenger and cargo airlines to comply with the EU law.

There has not yet been companion legislation in the U.S. Senate, but Washington and EU sources said a proposal was expected in the coming weeks.

WHAT HAPPENS IF PROPOSED U.S. LEGISLATION IS SIGNED INTO LAW?

Lawyers said that if the U.S. draft legislation became law, airlines could find themselves unable to fly into Europe for fear of breaking either U.S. law or the EU law.

A way out of the impasse could lie with a 1996 blocking regulation passed by the EU, which made it illegal for EU entities to comply with the Helms-Burton Act that strengthened the U.S. embargo against Cuba.

Effectively, it would mean staving off one piece of blocking law with its own blocking legislation.

"If the U.S. adopts a law prohibiting compliance with the ETS (and any taxes or fines due under it) for U.S. companies, that law will likely apply also to EU subsidiaries," said Lucas Bergkamp, a partner at Hunton & Williams in Brussels.

"In response, the EU could add the U.S. law to the annex of the blocking regulation agreed in response to the Helms-Burton Act on Cuba.

"EU member states could then enforce the ETS against the EU subsidiaries of U.S. airlines," he said.

COULD THERE BE EXEMPTIONS?

The EU Commission has repeatedly said it will not back down.

However, it told the China Air Transport Association in June there were provisions in ETS rules to exempt airlines of countries taking equivalent steps to cut emissions from aviation.

"I would not be too surprised to see some exemptions," said Matteo Mazzoni, carbon analyst at Nomisma Energia.

"Eventually, they are always the most accepted compromise in this kind of deal."

WHAT WILL BE THE IMPACT ON THE MARKET?

Opinion is divided on the impact of the row on the carbon market.

Exempting U.S., Chinese and Indian airlines from the ETS would reduce the aviation sector's total demand for carbon permits by nearly 12 percent next year, according to researchers RepuTex.

Under current rules airlines will need to buy an estimated 47 million carbon units next year but this could shrink to 41.5 million if the EU Commission exempts airlines from the three main countries opposed to the targets.

Low demand could heap pressure on EU Allowances (EUAs), which hit a two-and-a-half year low this summer.

"We are increasingly concerned by the continuing level of opposition to inclusion in the EU ETS (..) and by the risk this opposition poses to our forecasts for net EUA demand from the aviation sector over 2012-20," said Deutsche Bank last month.

Others say airline demand was not forecast to be high at first anyway as airlines are only required to pay for 15 percent of the carbon they emit in 2012 and will be given permits for free to cover the other 85 percent.

"According to our model, if everything proceeds as it should, aviation will start to become a factor no earlier than 2015. Till then, EUA demand from air carriers is likely to remain pretty much limited," Mazzoni added.

A couple walks along the rough surf during sunset at Oahu's North Shore, December 26, 2013. REUTERS/Kevin Lamarque

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