Lufthansa Group's green charges are a signal to regulators; other airlines may follow
IAG Chief Executive Luis Gallego has warned that funding the green transition means "flying is going to be more expensive". Meanwhile, Lufthansa Group has announced an Environmental Cost Surcharge to help with the additional costs of meeting environmental regulations.
Air France-KLM has had a sustainable aviation fuel (SAF) levy of between EUR2 and EUR24 since 2022. However, Lufthansa Group's environmental surcharge, of between EUR1 and EUR72, is also aimed at defraying other green transition costs.
European airlines face a greater range of such costs than most other regions.
As with fuel surcharges, the effectiveness of environmental surcharges in genuinely raising additional revenue is debatable. Price elasticity of demand for aviation probably means that surcharges lead to erosion of the underlying fares.
However, they send a signal to governments and regulators. They may help to stem the tide of taxes imposed on aviation in the name of the environment, but which effectively divert funds away from financing the green transition.
- Lufthansa Group can't bear additional environmental costs "on its own" – IAG's CEO notes that passing on costs will impact demand.
- Lufthansa Group's surcharge varies between EUR1 and EUR72, to cover part of the rising costs of SAF, emissions trading, and CORSIA.
- ICAO estimates additional environmental costs of USD13 to USD38 for an average trip, or between 9% and 5% of an average fare, in 2050.
Lufthansa Group can't bear additional costs 'on its own'
Lufthansa says that the group "will not be able to bear the successively increasing additional costs resulting from regulatory requirements in the coming years on its own".
As a result, it has introduced its Environmental Cost Surcharge, so that passengers contribute to covering part of these costs.
IAG's Gallego: passing on costs will impact demand
However, as IAG's Mr Gallego told the Financial Times (4-Jul-2024), passing on some of the incremental costs of flying "will have an impact on demand".
He argued that decarbonisation should be done "in a consistent way worldwide, not to jeopardise European aviation".
Lufthansa Group's surcharge varies between EUR1 and EUR72…
Lufthansa Group's new Environmental Cost Surcharge applies to its departures from the 27 EU member states, the UK, Norway and Switzerland, for tickets issued from 26-Jun-2024 for travel from 1-Jan-2025.
On short/medium haul, the surcharge is EUR1-EUR5 in economy and up to EUR7 in business class.
The long haul surcharge is EUR18-EUR36 in business, and up to EUR72 in first class.
…to cover part of the costs of SAF, emissions trading, and CORSIA
It is aimed at covering part of the incremental costs faced by airlines as a result of sustainability regulations that are specific to Europe.
Included in such costs are the requirement for minimum levels of sustainable aviation fuel (SAF), costs associated with the EU Emissions Trading System (EU ETS), and with the 'Carbon Offsetting and Reduction Scheme for International Aviation' (CORSIA).
The EU and the UK have SAF blend targets rising over time
The EU has introduced a SAF-blending mandate, stipulating the percentage of SAF in the aviation fuel mix over time. The UK plans to introduce a SAF mandate from 1-Jan-2025, subject to parliamentary approval.
The EU mandate requires SAF at 2% of aviation fuel from 2025, 6% from 2030, 20% from 2035, and 70% from 2050.
The UK aims for SAF at 2% in 2025, 10% in 2030, and 22% in 2040, but has no targets beyond that date.
Lufthansa Group says this will lead to additional costs in the billions of euro in the future.
SAF reduces CO2 emissions, but is much more expensive than jet fuel
The use of SAF can reduce CO2 emissions by up to 70%-80% on a life cycle basis, but it is currently very scarce, and amounts to well under 1% of aviation fuel consumption.
As a result, SAF is much more expensive than jet fuel: in 2022 SAF derived from wastes and residues was priced at around USD2,400 per tonne, which was 2.5 times the cost of fossil-based jet fuel.
However, SAF produced through carbon capture - known as synthetic fuel - can cost six to eight times fossil-based jet fuel.
Synthetic fuels are still in the development stage, but are regarded as more scalable, deriving from renewable electricity as their source of energy. They are less dependent on feedstocks than SAF derived from biomass, and lead to greater emissions reductions.
In order to encourage the use of SAF, the EU is to distribute 20 million free carbon emissions allowances under the EU ETS (see below) until 2030. These allowances will cover the price differential between SAF and conventional jet fuel for operators using SAF.
EU emissions trading: free allowances for airlines are being phased out
The EU ETS, which has been in place since 2012, controls the overall amount of carbon dioxide emissions in the bloc through the mechanism of tradeable certificates.
Based on the 'cap and trade' principle, with a cap that reduces annually, it makes polluters pay for their emissions by buying emissions allowances on the market.
Aviation was brought into the system in 2012.
It also covers emissions from the generation of heat and electricity, energy-intensive industries, shipping (from 2024), and road transport (from 2027).
For aviation, the EU ETS covers all flights within the European Economic Area (EEA). The UK and Switzerland also have emissions-trading systems covering flights between the EEA and those countries.
The free allowances given to airlines in the EU ETS are gradually being phased out, reducing to 75% in 2024, 50% in 2025, and zero from 2026 onwards.
In addition, the scope may be extended to cover flights from the EU to destinations elsewhere from 2027 if the European Commission finds that CORSIA (see below) has not made enough progress internationally.
CORSIA is ICAO's offset scheme
CORSIA is a scheme introduced by the International Civil Aviation Organization (ICAO) in 2016, under which growth-related carbon dioxide emissions in international aviation have been offset by the purchase of certificates since 2021.
For the period 2024 to 2035, emissions above 85% of the volume emitted in 2019 must be offset.
ICAO estimates additional costs of USD13 to USD38 for an average trip in 2050…
ICAO publishes an Environmental Report every three years. The most recent one, in 2022, included analysis of the additional costs of achieving net zero in 2050 under three scenarios.
Scenario 1 is the most easily attainable scenario, relying on measures with a high level of readiness, but the lowest climate ambition, while Scenario 3 is the least attainable, relying on measures with a low level of readiness, but the highest climate ambition.
For a short haul flight of 630km, the estimated incremental cost per passenger in 2050 under these scenarios ranges from USD4.40 to USD13 (in 2020 prices).
For a long haul flight of 5,800km, the range is USD25 to USD73.
For an average trip, with a length of 2,900km, the incremental cost per passenger in 2050 ranges from USD13 to USD38 per passenger (in 2020 prices).
…or between 9% and 25% of an average fare
For context, the average single fare in 2050 is estimated at USD140-USD160 per passenger (in 2020 prices).
At the midpoint of this average fare, i.e. USD150, the incremental costs range from 9% to 25% of the fare - which is a material impact.
Potential impact of environmental costs on ticket price
More European airlines may also consider environmental surcharges
So far, only Air France-KLM and Lufthansa Group have been applying mandatory environmental surcharges for all flights. Lufthansa Group's is the only one to be aimed at costs beyond SAF.
Most airlines offer passengers the option to pay a supplement to offset the environmental impact of their trip, but the take-up is low.
A mandatory surcharge may not be any more effective than raising underlying fares in generating additional revenue, since price elasticity of demand is likely to lead to reduced demand.
An advantage of adding a mandatory surcharge is that it is transparent, and highlights the need to cover additional costs.
Moreover, mandatory surcharges could - if applied widely across the sector - help to reduce political appetite to levy new and higher taxes on aviation for environmental reasons.
Taxes imposed to reduce emissions simply by reducing demand do nothing to help the green transition if (as is common) they are not earmarked for environmental investment in aviation.
A surcharge is like a self-imposed tax that stays in the airline and can be used to invest in the transition.
Lufthansa Group may not be the last European airline company to add an environmental surcharge.