Carbon Regulation and Competition in the European Airline Industry

TL;DR

This paper models how the EU Emissions Trading System impacts airline competition, revealing asymmetric effects on consumer surplus, profits, and welfare across different market segments and airline types.

Contribution

It provides a quantitative analysis of carbon regulation effects on airline competition, including welfare impacts and the potential effects of airline mergers.

Findings

Consumer surplus declines up to 25%, mainly in medium-haul markets.

Airline profits decrease by 8-45% under carbon pricing scenarios.

Carbon revenue and emission savings partially offset welfare losses.

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.