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Carbon Regulation and Competition in the European Airline Industry

Ertian Chen, Lichao Chen, Lars Nesheim

Abstract

The European Union Emissions Trading System is set to substantially increase the effective carbon price faced by airlines. To quantify the impact of this carbon regulation on the European airline industry, we estimate a two-stage model of airline competition with endogenous route entry, flight frequencies, and pricing using European data on market shares and prices. Counterfactual simulations reveal that the impacts of carbon pricing are highly asymmetric across carrier types and market segments. Consumer surplus declines by up to 25% overall, with medium-haul markets bearing the brunt at up to 90%, while short-haul markets experience positive net welfare gains (including carbon revenue and the social value of avoided emissions) as airlines reallocate capacity toward shorter routes. We find that airline profits decline by 8-45% across scenarios, while carbon tax revenue of $0.9-3.1 billion and a social value of avoided CO2 emissions of $0.5-1.4 billion partially offset the welfare losses. We also show that a hypothetical Wizz Air-Ryanair merger primarily benefits firm profits through network expansion synergies.

Carbon Regulation and Competition in the European Airline Industry

Abstract

The European Union Emissions Trading System is set to substantially increase the effective carbon price faced by airlines. To quantify the impact of this carbon regulation on the European airline industry, we estimate a two-stage model of airline competition with endogenous route entry, flight frequencies, and pricing using European data on market shares and prices. Counterfactual simulations reveal that the impacts of carbon pricing are highly asymmetric across carrier types and market segments. Consumer surplus declines by up to 25% overall, with medium-haul markets bearing the brunt at up to 90%, while short-haul markets experience positive net welfare gains (including carbon revenue and the social value of avoided emissions) as airlines reallocate capacity toward shorter routes. We find that airline profits decline by 8-45% across scenarios, while carbon tax revenue of 0.5-1.4 billion partially offset the welfare losses. We also show that a hypothetical Wizz Air-Ryanair merger primarily benefits firm profits through network expansion synergies.

Paper Structure

This paper contains 47 sections, 17 equations, 14 figures, 13 tables.

Table of Contents

  1. Introduction
  2. Background and Data
  3. Background: EU Emissions Trading System
  4. Extension to Aviation.
  5. Interaction with Sustainable Aviation Fuel Mandates.
  6. Heterogeneous Impacts across Carrier Types.
  7. Background: European Airline Industry
  8. The Rise of European Low-Cost Carriers.
  9. Slot Constraints in European Airports.
  10. Hubs, Airline, and Slot Constraints.
  11. Aircraft Utilisation.
  12. Data
  13. Model
  14. Airlines' first stage choices and consideration sets.
  15. Second Stage: Pricing
  16. ...and 32 more sections

Figures (14)

  • Figure 1: Route Maps of Air France-KLM (left) and Ryanair (right) in Q2 2019
  • Figure 2: Passenger, revenue, and frequency shares by airline group, Q2 2019
  • Figure 3: Network size, density, and efficiency by airline group, Q2 2019
  • Figure 4: Price Elasticity by Distance
  • Figure 5: Distribution of Fixed Cost per Flight Hour
  • ...and 9 more figures