Environment special: Green money

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Any airline that does not have a strategy to address environmental issues such as reducing its carbon footprint might soon find itself unable to get finance

It is often said that from an ivory tower, you can see forever and that goes some way to explaining why risk managers have such clear vision and foresight.

Speaking at the latest World Airlines Forum in Cannes, Eddie MacLaughlin, managing director of strategic risk consulting at insurance broker Marsh pointed out that, in fact, you do not need a crystal ball at all. Far from it. All you really need do is to assess where the wind is coming from, and then attempt to fly your proverbial kite in that general direction.

Explaining to delegates why they really should be aware of the importance of sustainability, the reality is that an airline's relative impact on the environment could easily evolve into a critical factor in the ability to raise vital future finance.

Risk analysis is increasingly giving as much weight to the effect of public perception as to the still uncertain scientific understanding of aviation's precise impact on the environment. And, unlike the methodical and systematic approach to the process of drawing logical inferences, public opinion can - and often - prove itself capricious, haphazard and unreasonable. But however unfounded and unfair, it can still wreak havoc on the bottom line - and terminally so too.

first choice and thomsonfly b787s

A risk manager will therefore as a matter of course take account of a business's holistic impact on the environment and will subject that to the same level of audit scrutiny as he would traditionally give to a business's balance sheet. "We don't have to prove we're right about the risk. We just have to prove we may be right," says MacLaughlin.

That seems certainly true of the approach being adopted by credit ratings agencies, which take a risk management approach and have the power to effectively condemn an airline operating on the thinnest of margins simply with a cursory downgrade. Without access to fresh capital, the game for aviation is frankly up.

In fact, the only reason why socially responsible investment is not so significant within the airline sector is due to its high level of private and state ownership. But that sheltered status could soon find itself under siege by what is fast emerging as a self-appointed duty of the finance sector to direct investment and financial flows towards a low carbon economy.

Financial allocation

George Godlin, a senior analyst at rating agency Moody's, says the gaining of traction of green issues in aviation and the gradual establishment of workable emission trading schemes, will itself generate acute interest in future allocation of financial resources.

"If there is successful adherence by European airlines through a formalised structure, that could well improve access to capital. These airlines could well show the way, be the harbingers of a trend and could ultimately become the model. But they will first have to demonstrate that they are managing these programmes effectively."

A specialist in the US airline market, he says the possible change of US administration in early 2009 could see the idea of emissions trading and environmental initiatives gain far more common currency. Further, he believes the advent of the Open Skies transatlantic air travel liberalisation - kindly viewed by free market champions stateside together with US airlines which desperately want to take capacity out of the skies - will further internationalise the debate over market-based measures.

Godlin says Moody's is preparing to publish what he calls standardised and right-sized rating methodology that will be applicable to all airlines and will include both financial metrics and qualitative considerations such as fleet age, fuel hedging strategies and geographic spread of risk. "Fleet age is something we monitor on a regular basis although, to be fair, an airline has a lot of competing issues to deal with: building balance sheet strength to weather prevailing market conditions, shareholder value issues, pressures from labour to share in more of the profits of the business, etc.

"Another pressure featuring in an airline's refleeting decision is, why refleet with what is available today when in two or three years' time with the advent of next generation aircraft, an airline could find itself at an immediate competitive disadvantage."

While many a US airline has an extremely healthy balance sheet - even those emerging from Chapter 11 bankruptcy proceedings - principally through operating efficiency, debt management and fuel costs, dig a little deeper and another picture emerges.

"You'll see that aircraft fleets are ageing with American and United flying aircraft of an average 15-20 years old. That not only translates into higher maintenance costs but less fuel efficient aircraft too and that could affect the appetite of the market to invest in them," says Godlin.

US airlines are not helped by the fact that in recognition of the need to take out capacity many of them have either deferred orders or sold production slots. "Airlines that prove to be laggards here could find themselves credit negative if they fail to make timely re-fleeting decisions. That's not to say that it is easy to improve your credit rating just by buying brand spanking new models, it is a balancing act with fleet age just one of many factors such fuel hedging strategy, aircraft financing arrangements plus matching fleet needs to actual operations right-sizing," he says.

Godlin says right-sizing could become critical as several larger regional jet candidates are preparing to muscle into the traditional territory of the single aisle within the next five years, timed to coincide with not only a mature Open Skies regime but also workable, proven emissions and environmental initiatives.

Maximizing the benefits

Melinda Harris, a senior economist at consultancy ICF International, which helps industries get ready for carbon constraints, says the well-prepared airline can take heart: "The beauty of emissions trading is that it is possible for all participants to be better off than under other forms of regulation. However, who wins and who loses is not automatic. From a business perspective, firms have to take steps to position themselves to maximize the benefits and minimize the costs."

Although different carbon policies can have widely different effects, she says that what is clear is that carbon controls are coming, and the whole industrial chain cannot afford to ignore this reality. "Decisions on new aircraft fleeting, long-term maintenance for older aircraft, and marginal route economics will all be affected by emissions regulations and any trading scheme. Even though regulations might still be a few years away, the time to start actively planning for a carbon constrained future is now," says Harris.

Airlines are already being urged to collect the most accurate emissions data possible between city pairs so they do not risk missing out on free carbon credits when emissions trading comes into force. Even though the final shape of the EU trading regime is yet to be determined, the vote by the European Parliament supporting a 2011 launch date could mean that operators will be required to provide more precise monitoring and reporting data from as early as 1 January this year.

Speaking at a conference in London last year, lawyer Nicholas Rock of Dewey & LeBoeuf warned that if independent validators disagree with their annual tonne-kilometre data (distance x payload) calculations, airlines could be forced to surrender their claim to free allowances and be forced to buy them on the market. "Levels of aviation activity in 2008 should therefore be assumed to be of particular significance," says Rock.

While the European Commission is still in the process of developing detailed guidelines for monitoring and reporting of emissions they are not expected to be ready until summer. Rock therefore recommends that distance is calculated on the basis of great circle measurement between airports of departure and arrival and that payload data features total mass of freight, mail and passengers. Fuel consumption should be calculated on the basis of amount of fuel in tanks on uplift, and then once each subsequent flight is completed.

A survey of 20 European airlines by PricewaterhouseCoopers found, however, that two thirds of those surveyed had yet to factor in the extension of the European Union scheme into their strategic planning, despite the fact it could come into effect as early as 2010, while only 40% have systems in place to monitor their carbon emissions.

Major change

Moreover, none of the respondents had IT systems capable of coping  with the compliance burden of any extension to the scheme, suggesting major operational changes and investments will be required at all of Europe's airlines over the next three years.

Klaus-Dieter Ruske, global transport and logistics leader at PwC, believes those operators that adapt their business models early would most effectively minimise the impact of the legislation. "The scheme will bring operational implications and a need to demonstrate compliance," he said "Many industry players are waiting for the legislative process to produce binding rules, but experience shows that early preparation pays off."

Hans Schoolderman, global carbon assurance leader at PwC agrees: "Companies who are better prepared are less likely to encounter costly hurdles once the legislation is in place. Perhaps more importantly, the investment community and consumers are also looking to companies to take the lead in heading off climate change."