European Air Traffic Facing Raising Fuel Prices and Carbon Permits: An Empirical Analysis

Abstract

This paper focuses on the analysis of the extent to which air traffic is affected by the proposal of the European Commission on including the aviation sector into the European emission trading scheme and the increasing fuel prices by using a panel data of 18 European Airlines from 1990 through 2007. We specify a structural econometric model which comprises a demand model of air transport services explaining how consumers select among the products supplied by the airlines and a pricing equation that describes how each airline sets its best price strategy given the cost structure it faces. Our main results are the followings. First, the airline industry in Europe is highly competitive with relatively high own and cross price elasticities. Nonetheless, economic margins are relatively large. Second, an increase in energy costs implies higher air fares and lower traffic levels. As a consequence, both consumer surplus and profit dwindle. Moreover, the cost pass-through rates are very high, so airlines are able to pass most of cost changes to consumers. In terms of carbon-dioxide emissions, this study supports the conclusion that the European Emissions Trading Scheme could indeed significantly impact the level of emissions of aviation while it should not drastically change the competitiveness of European airlines. However, the analysis also confirms that a policy aimed at reducing carbon-dioxide emissions of aviation would have a negligible effect on overall emissions. The impact of the change in energy cost on airlines and air traffic is a significant issue, and this paper provides a first step empirical analysis. Keywords: carbon-dioxide emission, fuel price, European airlines

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