Established in 2005, the EU’s Emissions Trading System (EU ETS) was originally designed as a mechanism to help the EU meet its climate goals. Effectively the world’s largest carbon market, it operates on a “cap-and-trade” principle whereby a limit was placed on how much carbon individual industries such as aviation were allowed to produce, and companies operating within these industries could cover their emissions through surrendering permits, or allowances, for every tonne of carbon they released. Initially these permits were given for free, and thereafter a company could buy any additional permits needed, making them a tradeable allowance. The fewer emissions they produced, the fewer permits they needed to surrender, bringing a financial incentive to carbon reduction. The main goal was to incentivise industries to reduce emissions efficiently by imposing fines for exceeding emission limits.
A delayed reaction after the pandemic
Aviation was added to EU ETS in 2012, initially including flights within the EEA. However, when COVID-19 struck, air travel plunged, meaning a significant decline in carbon emissions that left airlines with surpluses of EU ETS allowances. Lack of flight meant many airlines chose to sell their surpluses to generate much-needed revenue when ticket income was low. However commercial flight activity returned to pre-pandemic levels around 2023, and with the EU ETS also expanding its scope that year to include all flights departing from the EEA, the temporary financial cushion has disappeared.
Furthermore, the EU ETS began the complete phase out of free allowances in 2024, initially reducing by 25 per cent, then rising to 50 per cent in 2025, and completely phased out by 2026. As an example, a large European airline with a fleet of 100 aircraft operating from bases within the EEA that had 700,000 permits to begin with and which by 2026 will need to buy 700,000 tonnes of carbon allowances at €80 per tonne will see an increase in annual operating costs of €56m. Translating this to a per passenger cost, this would equate to approximately €10 cost on every seat on every flight. Market prices for EU ETS are forecast upwards, so the implications are significant, particularly for short-haul operations where margins are slim and fare sensitivity is high. Early estimates from PACE [Platform for Analysing Carbon Emissions] suggest that by 2027 the additional cost per seat may reach €13 for standard economy fares.
Are all airlines equally exposed?
Not all carriers will feel the pressure equally. Flights outside European airspace are out of scope. This uneven exposure means the regulatory change is not just environmental in ambition, but deeply economic in reach. Operators with primarily EU traffic or EEA departing traffic are seeing substantial increases and facing difficult choices such as absorbing the cost, restructuring routes, accelerating efficiency investments - or ultimately - passing these costs on to passengers.
RM Block
While the EU ETS is advancing, similar schemes are emerging elsewhere. The UK has aligned its own aviation emissions trading structures closely with European norms. At the same time, countries such as China, are setting up carbon markets for aviation. Some are even thinking about including other effects of flying, like contrails and nitrogen oxide emissions, which also contribute to climate impact
This suggests that what might once have been a regional compliance issue within the EU is becoming a global competitive necessity. Carbon pricing regimes may vary in detail, but the trend is towards more jurisdictions expecting aviation to account for its climate impact in cost-terms.
Mitigation levers: Fleet renewal, SAF and data
The primary lever an airline can pull is to replace current generation aircraft with “new gen”, effectively younger more efficient replacements. Aircraft age, design, and fuel efficiency are no longer secondary concerns, they are central to competitiveness, as older less efficient aircraft burn more fuel per passenger kilometre and therefore generate more carbon emissions. Under EU ETS, that translates directly into higher operating costs. An example would be replacing an Airbus A320 with a new Airbus A320 Neo which, depending on routes flown, can deliver between 15 per cent and 20 per cent fuel (and carbon) savings. In efficiency per passenger terms, these newer lighter aircraft have higher seating capacity, spreading the lower amount of carbon over a greater number of passenger seats, a key metric in the business. However, the process of modernization is slow, with just over 30 per cent of aircraft having been replaced by new gen, and a six-year lead time on new orders from Boeing and Airbus.
Sustainable aviation fuel (SAF) is a type of fuel that is produced from renewable resources and has the potential to significantly reduce lifecycle carbon emissions compared to traditional jet fuel. Treated under current EU ETS rules as zero-emission, it will, over time, offer a second path to improved operational efficiency. However, scaling production and infrastructure will take time, and SAF today is two to three times more costly than conventional fuel with supply restricted to a limited number of airports. To assist, the EU has made up to 20 million EU ETS allowances available between 2024 and 2030 to help offset the price premium.
Improved data for decision making is a key third pillar. The requirement for financiers of aviation to report the Scope 3 emissions of the assets that they are financing, whether voluntarily or under mandatory obligation, has been shining a light on all aspects of aviation, from bank lending and aircraft leasing through to export credit underwriting and structured financing of airports themselves. Today’s modern and sophisticated data platforms provide improved monitoring, emissions tracking, and modelling tools for carbon reduction pathways that are helping support all stakeholders committed to driving the industry’s Net Zero goal by 2050. Powerful platforms such as PACE provide an independent third party partner, integral to cost control and long-term resilience of the business.
