Airlines can make either of two difficult choices—bear these costs and take a hit to their bottom line or pass these costs on to end-consumers, which will depend on prevalent pricing, the competitive position of the airline and consumer willingness to pay such fees on the routes flown. In case the costs of these allowances are passed on to consumers, the average ticket price on the London-Paris route, for instance, is likely to rise 18% (considering per passenger emissions of 0.250 ton of Co24).
The impact on airline companies will depend on their average fleet age as well, considering older fleets tend to generate higher emissions because of fuel inefficiencies. Therefore, companies having a newer fleet would have a higher operating margin on account of lower maintenance costs and higher fuel efficiencies, and going forward, lower allowance purchases as well.
This is evident from the table above, with Ryan Air and Pegasus having the highest operating margins in line with their lower fleet age.
In the near to medium term, this scenario is difficult to reverse for companies operating older fleet. This is considering the high capex requirements and operational challenges associated with aircraft deliveries due to a substantial order backlog at the world’s largest aircraft manufacturers, Airbus and Boeing.
Modernise fleet, increased SAF use, tackle emissions
Airlines need to mitigate the quantum of emissions through replacement of their older fleet with newer ones or with the use of SAF.
Higher price and production capacity constraints of SAF: Though increased use of SAF is likely to be the way forward, it is fraught with challenges in terms of pricing and scaling up production. According to the International Air Transport Association, SAF could contribute ~65% of the reduction in emissions needed by the aviation sector to reach net zero in 20505.
That said, according to the European Aviation Environmental Report, the current SAF supply remains at ~0.05% of the total aviation fuel used in the EU, which signifies a significant challenge with respect to scaling up production. Moreover, the average price of SAF is ~2.5x higher than that of conventional fuel. While it can be lowered through economies of scale, it is currently a farfetched proposition.
Fleet modernization will call for heightened capital expenditure requirement: The prospect of replacing the fleet in the near-to-medium term is marred with challenges since it entails high capex, which may strain an airline company’s cash flow.
Sustainability-linked loans can help bridge funding gap
What is the proposed flight path? Aviation being a hard-to abate sector, it is relatively difficult to transition to net-zero with currently available technology given cost constraints. Hence, sustainable financing will play a critical role in incentivizing aviation players to pursue fleet improvements.
Banks with sustainability initiatives and processes in place will be able to accommodate the rising demand for sustainability-linked loans (SLLs). The EC is also considering proposals around granting lighter capital treatment to sustainable debt. However, financial institutions need to convince regulators regarding the genuineness of their sustainability-linked financing to safeguard themselves from the accusation of greenwashing.
SLLs, bond issuances rising, but still at nascence
According to the World Economic Forum, the aviation sector needs to invest ~$185 billion annually to achieve net-zero emissions by 20506, which is 2.4 times the current investment of passenger airlines. The issuance of SLLs has trended upward in recent years and is expected to grow.7 For example, CDB Aviation, the Irish subsidiary of CDB Leasing, as part of its goal to develop sustainability-linked leases and other innovative sustainable finance products for the aviation industry, issued a combined $1.23 billion sustainability-linked term loans in December 2023 and April 2024, aiming at reducing CO2 intensity, latest-generation aircraft fleet share and other social causes.
