Climate change is world news and Environment, Social and Governance issues are taking centre stage in the aviation world. Investor ESG concerns and the industry’s response to carbon emissions and future technology are evaluated by the industry.
Advances in computer technology are cited very often as a major disruptor in almost every major industry. Banking and finance, especially, is being challenged by the onslaught of digital firms offering user-friendly mobile and virtual Sustainability is the revitalised mission for the next decade. In the final year of the 2010s, the environmental agenda was thrust front and centre onto the world stage. The figurehead for this renewal in the green agenda is Greta Thunberg, a teenage activist from Sweden, who began a one-woman crusade by striking from school every week outside the Swedish parliament in the summer of 2018 her movement later grew into a climate strike of 4 million people across 161 countries in 2019. Thunberg has addressed the United Nations, US Congress, and UK Parliament on climate issues and has since been named as Time Magazine’s 2019 person of the year. Thunberg’s determination to remain carbonneutral has meant that she has refused to fly since 2015, preferring to sail across oceans and travel by train so as to not contribute to carbon emissions. Her refusal to fly has contributed to the phenomenon of flygskam, or ‘flight shaming’, which is prevalent in Europe, especially Scandinavia. A UBS survey of more than 6,000 people in the US, Germany, France and the UK, found that 21% had reduced the number of flights they took over the last year. This is a trend that is predicted to deepen and continue in developed markets.
As a carbon emitter, aviation is an obvious target for environmentalists. Airports and aircraft have therefore been targeted by protesters. Despite statistics proving that net carbon emissions from the aviation industry are around 2% of the global total, the industry to date has been unsuccessful in relaying that message to the travelling public. This situation is changing, albeit slowly, in a charge led primarily by the manufacturers. They are emphasising the move to cleaner, more efficient new-technology aircraft, which can be recycled more easily, as well as investing into research exploring the use of biofuels.
In his video interview, Paul Meijers, executive vice president, leasing and financing – customers, Airbus, points to the new technology now being delivered is slowly replacing the older equipment with more fuel efficient engines that are structuring double digit fuel burn improvements compared to the previous generation of aircraft. But adds that the manufacturer is looking much beyond the next few years, out towards 2030 and 2050, investing in new technologies that will address the challenge of reducing the industry’s carbon footprint.
Airbus is pioneering more advanced future technology, such as hybridelectric propulasion and new concepts known as ‘wake energy retrieval’. The Airbus fello’fly demonstrator project seeks to assess the technical, operational and commercial viability of two aircraft flying together for long-haul flights, saving 5-10% on fuel consumption per trip.
Industry bodies are also working towards addressing aviation emissions with targets set by the International Civil Aviation Organisation (ICAO) and the Committee on Aviation Environmental Protection (CAEP). However, there are indications that these targets do not go far enough or fast enough. Although airlines are responsible for only a small portion of the total transportation sector emissions, other sectors, such as power generation and road transport, have made significant strides towards reducing emissions, while progress in the airline and aerospace market has been slower.
Figures from the 2019 European Aviation Environment (EVE) Report, published by the European Union (EU), show that air passenger numbers in the 28-member bloc had increased by 20% since just 2017, and by 60% compared to 2017, with a further 42% expansion being predicted by 2040.
These figures are echoed by the International Air Transport Association (IATA), as well as most major industry players, who are predicting a 4% annualised increase in passenger traffic over the same period. However, the improvements in airline fuel efficiency, and the resulting reduction of carbon emissions, are expected to move more slowly.
The climate crisis has put aviation in the spotlight with the introduction of a new phrase to the global vocabulary ”flygskam” or “flight shaming”. People should be concerned about the environmental impact of all industries. That includes aviation, which accounts for 2% of global human generated carbon emissions. However, they need to be reassured of our commitment to sustainability. We have been driving climate action for over a decade.
Consider the recent ESG Focus report by ratings agency Moody’s. This report predicted that the US utility and power sector, the second largest CO2 emitter in the world’s biggest economy, is on course to achieve a 27% reduction in CO2 output by 2030. By contrast, even the most optimistic predictions expect improved fuel efficiency to reduce airline emissions per passenger mile by 15%, all while the total number of flights will increase.
The combination of increased passenger numbers and greater public attention on aviation means the sector is acutely exposed to Environmental, Social and Governance (ESG)-related risks, compared with certain other CO2 emitters. The risk of this turning into a change in investor sentiment towards the aviation sector is very real. Recently, the activist hedge fund TCI announced plans to target firms that fail to disclose their carbon dioxide emissions, a movie that makes environmental concerns an explicit threat to aviation industry players’ balance sheets.
And it’s not just hedge funds – the Principle for Responsible Investing, a UN-backed initiative to make ESG a mainstream investment factor that is supported by a number of the world’s largest institutional investors, told Airline Economics, that airlines and aerospace were becoming more of a priority for the organisation, and that it was one of the sectors covered by the UN-based initiative Climate Action 100+.
IATA chief executive Alexandre de Juniac, speaking at the Sustainable Innovation Forum in Geneva on 10 December 2019, said that the climate crisis has put aviation in the spotlight and he restated the sector’s commitment to reducing its emissions. The problem is that, relative to other industries, aviation faces major technological limitations due to the amount of power required to generate propulsion; electric batteries are not yet as efficient as a litre of kerosene.
One of the major positives for the aviation industry is that the entire market is united in the goal of reducing emissions by reducing fuel consumption, since it is the leading cost for airlines. More efficient aircraft result in both higher profits and lower emissions. The emphasis to date has been on what the industry will do to reduce emissions, with the work it has already done to reduce emissions and the many economic benefits of aviation are being given less prominence. For example, flying across oceans is often the most efficient form of transport for leisure, business and emergency medical needs alike. The connectivity that aviation brings enables globalisation and GDP growth, which some see as critical in the fight for climate change.
When you’re flying longer distances, or you’re crossing an ocean, it’s a whole lot more efficient to fly. In the 1980s, we were hush kitting aircraft due to the focus on noise restrictions. We’ve switched from threecrew, three-engine aircraft to two-crew, two-engine aircraft. Engines have become more efficient, aircraft are lighter and burn less fuel on a relative basis, and airlines are also more efficient, with more seats per plane so that we move more people.
Better and further communication of the advances that have been made by the aviation industry is supported by almost every participant in this study.
Becker repeats again that aviation accounts for 2% of world emissions; this is far less than the maritime industry, which is less of a target, while auto emissions are also far greater. “People forget that aviation’s only 2%; it’s just a big, easy target. Every airline publicises what they are doing from a sustainability or an environmental perspective – from recycling to selling carbon offsets and working with manufacturers to reduce their carbon footprint. The industry is working on it and all manufacturers are working on building sustainability and being responsible for sure. If we as an industry don’t do something – and this is why IATA, CORSIA, and ICAO are taking the lead – it’s going to be done for us, and we’re not going to like it.”
It is clear that the aviation industry will be impacted in the short and longer term by the environmental concerns.
“Millennials and younger generations are much more aware of climate matters. Interestingly, they also tend to be attracted by cheap short trips,” notes Fiscel. “These generations, increasingly concerned about climate matters, might cut on their aspiration to fly regularly to discover new cities. I wouldn’t be surprised if the expansion of the low-cost model slows down accordingly, although very significant offsetting initiatives have recently been undertaken by airlines, particularly in Europe.”
Short-haul travel is expected to take a hit in the coming years. Longer-haul travel will likely become restricted, and certainly more expensive, if environmental changes are forced upon the industry by regulations or additional taxes. The industry needs to work to improve its emissions on its own and the catalyst for ESG change may come from investors.
Cowen’s Helane Becker spends her working life meeting with investors; in 2019, she noted a significant change in investor interest in ESG. “I go to Europe probably six times a year and in 2019 the number two question from investors after ‘What’s your favourite stock?’ is ‘What’s going on from an environmental perspective with the group?”
Other bankers concur that investors are asking these questions, but as yet, they are not pricing in ESG-weighting to deals or keeping out of aviation deals due to ESG concerns.
“It starts with the investors,” notes SKY Leasing’s Wiley. “We talked to a number of the ESG funds during our fundraising process. They’re effectively willing to accept a lower return if you can offer some sort of ESG angle. The question is whether new-technology aircraft, like a brand-new NEO, are considered an ESG-qualified product. Those are real-time discussions that are happening in the space. So, you may see a green fund one day but right now they’re still kind of preliminary discussions – but this really needs to be driven by the investors demanding that they want to see a different type of product from the lessors.”
Although green aviation bonds are certainly not on the horizon now,but green financing has arrived for aviation assets. Deutsche Bank acted as lender on the first ever green financed aircraft to Swedish regional airline Braathens Regional Airlines (BRA). The 72-600 aircraft is leased from Avation and is part of a new order for five 72-600s. Vigeo Eiris, an independent agency providing ESG ratings, expressed the opinion that the project of replacing aging regional jets with new ATR 72- 600 aircraft is aligned with the Green Loan Principles (GLP) established by the Loan Market Association in 2018.
These generations, increasingly concerned about climate matters, might cut on their aspiration to fly regularly to discover new cities. I wouldn’t be surprised if the expansion of the low-cost model slows down accordingly, although very significant offsetting initiatives have recently been undertaken by airlines, particularly in Europe.
Some market observers believe that aviation could become subject to a framework similar to the Poseidon Principles, which assess and disclose the climate alignment of ship finance portfolios that are in line with the International Maritime Organisation’s ambitions to reduce shipping’s total annual emissions by at least 50% by 2050.
Although formal principles are not being earmarked for aviation at the moment, there are signs that certain banks and rating agencies are applying “green” weighting to certain investments. “Investors have been and are becoming much more concerned about ESG issues and they will clearly play a growing role when making investment decisions,” says NordLB’s Wulf. “Aviation finance will not be spared by this trend. At NordLB, for example, we have had a policy for years that allows us only to finance aircraft that meet the latest CO2 and noise emission regulations. Going forward, I believe this will become even stricter, and it could well be that some banks and investors will only be able to look at the latest-technology aircraft, or can only invest in airlines and/or lessors that also have a compensation scheme in place to offset their carbon footprint.”
Florian Maier, managing partner of EMP Structured Assets, suggests that ESG could also have a price one day too: “ESG is a big issue amongst investors. I was doing a roadshow in the Nordics this summer. You hear it everywhere. It’s a big issue in Germany as well – not so much for investors who are already invested into our industry, but the new ones are concerned about an ESG conflict with aviation. Eventually, prices will go up. Investors will reflect that in the yields that they’d require. Maybe ESG will get a price someday, but this is an ongoing movement.”
However, this concern could become a factor that curtails aviation investment in the future. The stark message to the aviation industry is that there is a need to work together as an industry in order to present a better and more united picture of how the industry has become much more efficient over the past three decades, as well as setting out how the industry plans to improve emissions going forward.