"An airline's exposure to carbon transition risks will be affected by a variety of factors, but route mix will be the most important consideration owing to differences in the regulatory regimes governing emissions from domestic and international flights," said Moody's Senior Vice President Swami Venkataraman. "The higher the proportion of an airline's flights that are international, the greater its exposure will be to carbon costs."
While the Paris Agreement regulates emissions from domestic flights within each country, emissions from international flights will be governed by the terms of the International Civil Aviation Organization's (ICAO) Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). CORSIA requires airlines to cap emissions from international flights at 2020 levels and to buy carbon offsets for emissions above that level.
According to the ICAO, countries accounting for about 85% of international flights have elected to voluntarily comply with CORSIA starting in 2021 rather than 2027, when implementation becomes mandatory. Few countries have implemented carbon emission caps for domestic flights in connection with their commitments under the Paris Agreement. Airlines that have a greater exposure to carbon costs due to a high share of international routes include unrated airlines such as Cathay Pacific, Emirates Airlines, Etihad Airlines, Qatar Airways and Singapore Airlines, as well as rated airlines such as Turkish Airlines (Ba3 stable), Qantas Airways Ltd. (Baa2 stable) and Air Canada (Ba3 stable).
ICAO projects fleet fuel efficiency to improve by between 1.39% and 2% annually over the long term. However, passenger traffic is expected to grow at a substantially higher annual pace of 4% to 5%, which will lead to growth in aggregate annual industry emissions and the requirement to purchase carbon offsets. Growing carbon offset costs have the potential to become significant relative to operating profit, but Moody's believes the industry will raise fares to help mitigate pressure on profitability.
"The industry has traditionally been a low margin business with aggregate operating margins of between 2% and 5% in most years, but at about 8% in recent years. We estimate that carbon costs have the potential to lower operating income by between 4% and 15% by 2025, and by between 7% and 35% by 2030, all else equal," said Moody's Senior Vice President Jonathan Root. "The ability of individual airlines to pass carbon offset costs to customers will determine the extent of pressure on their respective operating margins."
Moody's believes that looming carbon emission caps are unlikely to cause airlines to add to their existing order books solely to manage or minimize emissions. For most airlines, especially Asian carriers, investment in new aircraft is already a part of their fleet and capital investment plans. The respective order backlogs of Boeing and Airbus stand at about seven and nine years at current production rates. About 40% of the current order books will replace existing equipment.
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