American Airlines positioned to take lead post ICAO CORSIA
Shift in airline emissions regulations post Paris and ICAO advantageous to AA.
Under the Obama administration American Airlines (AA) has felt increased pressure to reduce their greenhouse gas (GHG) emissions. Building on the Clean Energy Act from 1963, Obama tasked the Environmental Protection Agency (EPA) to look into airlines. As of July 25th 2016, the EPA concluded “that greenhouse gas (GHG) emissions from certain types of aircraft engines contribute to the pollution that causes climate change and endangers Americans’ health and the environment.”[1] This announcement, while obvious to many, is instrumental to the US imposing restrictions on domestic and international airlines. It builds on the success this past April, where 193 countries signed the Paris Agreement to curtail air pollution by 2020.2 In hopes of putting real action behind the Paris Agreement, just this past month the International Civil Aviation Organization (ICAO) ratified the “Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) to address any annual increase in total CO2 emissions from international civil aviation.” 3 CORSIA is described as a “market-based measure” to freeze pollution from international commercial aviation at 2020 levels, beginning as a voluntary measure in 2020 and going into full effect in 2027.4 Under CORSIA countries who cannot maintain their 2020 emissions levels into the future would need to purchase additional GHG credits, thereby impacting their bottom line.4
AA, being the world’s largest airline by revenue and fleet size, is directly impacted by the restrictions enacted under CORSIA, and the dubious upcoming domestic restrictions to be enacted by the EPA. Just days from the election, the future of domestic aviation policy is the air as the EPA, AA, and consumers await the outcome of the election. Under Clinton, it is clear that Obama climate change policy will continue. It’s likely the EPA would implement a domestic policy like the ICAO CORSIA, curtailing pollution at 2020 or even 2015 levels. To mitigate a lot of the upcoming changes, American enacted a new plane a week initiative leading to the youngest fleet of amongst the major US carriers.5 This helps because modern A-321neo aircraft are 20% more fuel and carbon emission efficient than the last generation of A320s.6
Given the likely shift in domestic policy, the upcoming international standards post 2020, and fuel price volatility I think the US airline industry to ripe for a shake-up. AA is positioned to be the most impacted by the shifts and while it’s young fleet of fuel efficient planes will help; it won’t be enough to meet the changes. To prepare for the emissions changes AA has four levers: it can optimize its fleet, create a more dynamic network of routes and schedules, develop strategic partnerships to boost utilization, and or adjust it pricing model to be sensitive to weight.
All of these four options create value for American through increasing efficiency in the form of return on assets. Meaning, how can AA use its planes to create more customer value in the form of flight miles, without emitting more.
First, on fleet. American can phase out older planes, consider swapping engines to new next-gen efficient engines, and or consider swapping interiors for lighter carbon fiber like materials. Most of these options are capital intensive however. Alternatively, AA can consider optimizing routes and scheduling in real-time, meaning remove waste, cost, and ultimately emissions through a demand driven network. In terms of routes, it could remove or add routes in real-time as sales demand fluctuates. Similarly, it could dynamically adjust which planes are scheduled on which routes and try to optimize the number of seats on that route. While historically difficult given range requirements, advancements in ETOPS ratings, proliferation of mid-size aircraft like B-787, and digital scheduling and routing, it’s now become an algorithm problem.
Externally, it can rethink its partner strategy. AA currently sub-contracts its regional flights to local carriers and can extend this practice to more of its domestic routes. Regional carriers operate smaller aircraft, which do not have the scale benefits in terms of emission per customer flight mile, that AAs flagship B-777s and competitor’s A-380s have. This is because of two factors, first scale (e.g., seats) weight benefits in designing a plane, and because the take-off of the plane is the time in which it’s least efficient.7 Partially divesting from its domestic market would be radical but could yield higher profitability.
Lastly, a revenue lever could change customer packing behavior and lead to lower weight being carried onboard and subsequently less fuel consumed. This could take the form of either a scaling cost with carry-on weight, or in the form of an incentive system for individuals with no carry-on. While currently “bare-bone” rates are implemented in lost cost carriers they could become a way to mitigate cost of economy international airfare post the ICAO 2020 agreement. (800 words)
[1] https://www.epa.gov/newsreleases/epa-determines-aircraft-emissions-contribute-climate-change-endangering-public-health
2 http://unfccc.int/paris_agreement/items/9444.php
3 http://www.icao.int/environmental-protection/Pages/A39_CORSIA_FAQ2.aspx
5 http://phx.corporate-ir.net/phoenix.zhtml?c=117098&p=irol-newsArticle&ID=2213314
6 http://www.airbus.com/aircraftfamilies/passengeraircraft/a320family/a321/
Thanks for the thoughtful analysis on the airline industries response to climate change. You mentioned AA can optimize its fleet to include more planes with the latest engine technology and carbon-fiber materials. Of course, while this is an expensive option, do you think it’s worth it for airline companies to try to become the “Tesla of airplanes” rather than pursue incremental energy efficiency gains for its older planes? How beneficial is this first-mover advantage, in terms of learning? And, do you think consumers will care if the plane they fly is “greener” than the competitor’s, or will they only care about the price of their plane ticket?
Regarding the cost of carry-on luggage, I’m worried that this sort of “airline ticket tax” can harm less wealthy customers more disproportionately. This is why we tend to be way of sin taxes like alcohol and tobacco – the taxes use up a greater proportion of poorer people’s income compared to those who have more money. If people are coming onto planes with no carry-on, perhaps there is a business opportunity in providing, at all airports, or even at final destinations (e.g. hotels), essential amenities and apparel for arriving customers. Of course, it will be important to implement such ideas in a carbon-neutral way.
Interesting post! My biggest question is related to competition and first mover disadvantage in the airline industry–which seems somewhat reflective of the broader debate around who should bear the cost of achieving carbon neutrality. Is American Airlines unique in facing this issue due to the age of its fleet or its routes? Do some airlines (in particular, the gulf-state sponsored airlines like Emirates and Qatar Airways) have a natural advantage in being able to internalize costs instead of passing them on to end consumers?
One point I had about the analysis above – the fleet and route optimizations you mention seem like it they would result in a positive ROI, regardless of climate change regulations (it strikes me that “dynamically adjusting which planes are scheduled on which routes and trying to optimize the number of seats on that route” is something AA should be doing anyways). I wonder if climate change is then just a catalyst that allows AA’s management to sell new capital and operational projects to its investors and other stakeholders.
After reading the above post on how (and why) airlines will need to reduce their carbon emissions, I am left with more questions than answers. I acknowledge that encouraging all industries to reduce their carbon emissions is important to achieving meaningful reductions in emissions, but I wonder if arbitrarily sticking to 2020 emissions levels makes sense. For example, are airlines less fuel efficient from an emissions/person cost? I have to imagine that a trip from Boston to LA results in higher emissions should that person drive than if they were to take a plane. Governments should take a holistic approach to reducing carbon emissions and not punish industries that are already more efficient. Instead, emissions that contribute to global warming should be priced appropriately via a carbon tax or similar methodology. This will allow the free market to determine which companies and technologies are best at reducing emissions and will result in a better overall outcome for everyone.
Thanks for the insightful post! I agree that the airline industry needs to adopt newer and more efficient planes to minimize its contribution to global warming, but also needs to scale back on their first-class and business-class seats too, since they take up more space per person. Although replacing a fleet with new planes don’t happen overnight, and the required capital can be immense, they can utilize “leasing” as an alternative way to procure these aircrafts with minimal upfront costs.
In regards to changing their pricing structure, this again becomes a trade-off for the airline as AA could lose its customers to competitors for charging on weight. That is why I think this requires not only an AA shift, but an industry-wide collaboration to address these issues – including cargo carriers and private jets – the latter probably being the worst in per person efficiency.
Thanks for the thoughtful post – I think you posed a lot of interesting options that AA could pursue. However I am a bit skeptical of some of the options related to its fleet. I don’t know that optimizing routes would really result in a noticeable change in overall emissions, and I would assume that AA would already have performed this optimization to the best of their abilities, just to try to improve their own profitability. Similarly, I wonder about dynamically adding routes – this seems like it would be very challenging logistically, and also like something that AA would have already implemented if it was feasible. I also think a commenter above made a really great point about not disproportionately punishing the airline industry when in fact it is more efficient than other transportation alternatives. I completely agree that whenever the government imposes regulations, it needs to take an extremely thoughtful and holistic approach to avoid severe unintended consequences.
Interesting post and a good read. Definitely agree that changing packing behavior could be an interesting way to incentivize customers to limit baggage, thereby limiting the weight of the airplane and saving GHG emissions. I actually wrote my blog post on the aviation industry as well, and it was amazing to see how even small changes to the weight of an aircraft can drive substantial savings in fuel consumption. For Southwest, their One Report suggested that a technological change as simple as using tablets instead of heavy paper manuals and charts drove a 500K reduction in gallon consumption in 2015 alone.
If the airline could provide incentives to get people to bring less baggage, that would be a more efficient system overall. This would be especially true for airlines with no baggage fees (including Southwest Airlines). Since people do not currently pay for baggage on these airlines, they would behaviorally have a natural inclination to bring more than what is optimal. There is no cost to the individual (it’s a value add of the airline), but there is a negative externality in driving the weight of the aircraft.
However, if a carrot or small stick (e.g., free drink on airplane or nominal fee) were introduced to regulate and create a ‘price’ for the bags, less people would bring bags when optimal to do so (e.g., a short-haul when they can just use a carry-on). Everyone is better off, and the airline can save substantially on fuel costs, reducing GHG overall and helping drive sustainability.
It has been well known that for years airplanes have been the worst polluters on the planet. It’s great that hopefully this CORSIA treaty will force Airbus and Boeing to develop better, more fuel efficient planes. I hope that the money they airlines save on using less fuel per flight they re-invest in customer experience by taking out some seats in the cabin and allowing for more leg room!! On, “scheduling in real-time, meaning remove waste, cost, and ultimately emissions through a demand driven network. In terms of routes, it could remove or add routes in real-time as sales demand fluctuates. Similarly, it could dynamically adjust which planes are scheduled on which routes and try to optimize the number of seats on that route.” – this poses a great business opportunity for an HBS grad. The ability to schedule flights real time would mean that whenever there is an HBS trip, be it Ski Trip or Spring Break or Thanksgiving we could increase the size of the scheduled plane earning more money and meaning that students wouldn’t have to pay so much on flights!