Minimising volatility for the airline industry - Part 3 - Emissions Trading Scheme in practice
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Minimising volatility for the airline industry – Part 3 Emissions Trading Scheme in practice By: Jacqui Drew, Reval July 2012 Contents Summary Introduction on ETS directive for airline industry ETS – accounting treatment in practice Conclusion
About Jacqui Drew
Summary
Jacqui Drew joined Reval at the end
of 2011 as a Solution Consultant and
This publication is the third and final in our three part series dealing with “Minimising
is part of our elite team of Subject
volatility for the airline industry”. In the first publication we dealt with the Issue at Matter Experts. Jacqui specializes
hand now that airlines are being included in the European Union Emissions Trading in the valuation, hedge accounting
Scheme and the consequences this was leading to for airlines. The aim of the EU- and risk management modules of
ETS is to reduce emissions in a cost effective manner allowing companies to trade Reval. Prior to this, Jacqui was a
Senior Manager at Deloitte where
emission allowances and thereby determine how and where they reduce emissions.
she managed the audit support
From 1st January 2012 all airlines flying to and from the European Union are function in relation to the valuation
required to match their carbon emissions with carbon credits. Although each airline of derivative financial instruments
receives an allowance on an annual basis this is unlikely to match actual emissions and the application of hedge
and hence the airline will be exposed to this very volatile commodity. In the first accounting. There, Jacqui managed
a team of over 80 financial instrument
publication we highlighted the facts of this scheme, some initial views on what we
specialists across the UK. Jacqui is
are seeing in the market as well as touching on the opposition to this scheme in actively involved in advising clients
various countries. on valuation and hedge accounting
issues, presenting at seminars and
The second publication dealt with the accounting considerations and implications conferences and delivering training
internally and externally on financial
as expressed by Kush Patel, a Director at Deloitte in London specialising in the
instruments in all asset classes.
accounting for financial instruments under IFRS1 and UK Gaap2. The accounting Jacqui can be reached at Jacqui.
considerations are important as there is not a single accounting standard that deals Drew@Reval.com.
with emissions rights and liabilities and therefore there may be different application
in practice. As you will have noted from this paper depending on the accounting About Reval
Reval is a leading, global Software-
treatment adopted hedge accounting may or may not be beneficial and applicable
as-a-Service (SaaS) provider of
for every airline. comprehensive and integrated
Treasury and Risk Management
The third and final part in the series deals with a leading Airline sharing their (TRM) solutions. Our cloud-based
strategy, thoughts and comments on the EU-ETS. Again this paper highlights the software and related offerings enable
enterprises to better manage cash,
inconsistency that may be achieved between different airlines applying different
liquidity and financial risk, and includes
accounting treatment. This article was written by a Senior Finance Controller at one specialized capabilities to account
of Reval’s clients in the industry. for and report on complex financial
instruments and hedging activities.
The scope and timeliness of the
data and analytics we provide allow
chief financial officers, treasurers
and finance managers to operate
more confidently in an increasingly
complex and volatile global
business environment. Using Reval,
companies can optimize treasury and
risk management activities across
the enterprise for greater operational
efficiency, security, control and
compliance. Founded in 1999,
Reval is headquartered in New York
with regional centers across North
America, EMEA and Asia Pacific. For
more information, please visit www.
reval.com or contact info@reval.com.
1 International Financial Reporting Standards
2 Generally Accepted Accounting Principles
© 2012 Reval.com, Inc. All Rights Reserved | 2EMISSIONS TRADING SCHEME IN PRACTICE Introduction on ETS directive for airline industry In December 2008 the EU decided to extend the ETS directive with international aviation. The scope of EU ETS covers all flights to, from and within the EU, starting in 2012. It is expected that this will lead to a situation that European airlines will have to buy additional emission rights (on top of the free allocated rights) to mitigate their shortage in rights. This article describes the certificates that are available in the market to mitigate the shortage and describes how emission accounting has been applied in our business. The Quantity exposure (and by this the potential shortage that an airline faces) is calculated by using the fuel consumption in tons multiplied by a factor 3.15 (average factor for CO2 emission via jet fuel) to get CO2 tons. The shortage can be covered by the following certificates: AEUAs, EUAs, CERs, ERUs or Bio Fuel. In terms of our business coverage we use CER’s to the maximum (15%) and EUA’s to fill the remaining shortage. EUA’s are widely available since these are also linked to the utilities market whereas CER’s are slightly less expensive than EUA’s. © 2012 Reval.com, Inc. All Rights Reserved | 3
AEUAs – Aviation European Union Allowance A total of 214.8 mln CO2 ton will be created in 2012 (annually between 2013 and 2020: 210.3mln CO2 ton), 82% will be allocated for free, 15% will be auctioned and 3% will be for special reserve. Each country will have an AEUA auction, and can decide on the frequency, the volume and the auction platform to be used. There are no limitations on the amount of AEUAs, which can be used, however only airlines may submit AEUAs to cover their exposure. EUAs - European Union Allowance Created for the ground station emitters, such as utilities and power plants. The current market has a size of 2.4bln CO2 tons per year (factor 10 of the aviation market). Unlimited use is possible. CERs – Certified Emission Reductions These certificates come from CO2 reduction projects in developing countries. There are Green and Grey CERs. Green are from sustainable projects, such as hydropower, waste to energy projects. Grey come from the reduction of chemical gas projects, such as HFC-23 gas reductions. The latter is roughly 60-70% of the total CER market. In phase III (2013-2020), these certificates are no longer EU compliant as per the regulatory rules. Furthermore there is a limitation of 15% of the yearly consumption in 2012 and 1.5% per year in phase III. However this is cumulative and bankable, meaning that if the 15% has not been delivered in 2012, in 2013, it is possible to surrender 16.5%, etc. ERUs – Emission reductions The same as CERs, however these certificates originate from non-developing countries. Bio Fuel Each traceable drop of 100% bio fuel will reduce the emission exposure. 1 ton of Jet fuel is equal to 3.15 ton of CO2. Currently it is possible to fly on a maximum of 50% bio fuel. For example the 350 ton Bio Jet (50% blend), which we purchased for a specific European flight, will generate an exemption for 551 CO2 tons (350x50%x3.15). © 2012 Reval.com, Inc. All Rights Reserved | 4
ETS – accounting treatment in practice
The accounting treatment for emission rights has been a topic which is extensively discussed within the IASB3. The initially
issued IFRIC4 3 Emission rights (released per December 2004) was withdrawn already per June 2005. Up to today no
specific IFRS guidelines are additionally given on emission rights accounting. Below it is described how within our current
business practice we deal with the accounting of the CO2 emission rights. Our practice breaks the accounting part into two
elements:
• accounting for the CO2 rights accounting itself;
• accounting for the hedging of CO2 exposure.
CO2 rights accounting
Carbon quotas meet the definition of an intangible asset, as defined in IAS 385 paragraph 8: “An intangible asset is an
identifiable non-monetary asset without physical substance”. In fact:
• The quota is identifiable (it’s a right to pollute)
• Without physical substance
• Non-monetary because monetary assets are defined as: “money held and assets to be received in fixed or determinable
amounts of money”.
Carbon quotas are therefore recognized as intangible assets, as soon as the state gives quotas to the airline or when
the airline purchases them on the market before the emission period. Free quotas given by the state will be valued at net
value after allowances (IAS 206, paragraph 27), so at a nil value, bought quotas will be taken in consideration to calculate a
weighted average price. The intangible asset will be not amortized.
While the airline emits carbon, a provision for charge (operating) will be constituted linearly based on the budget or updated
budget. This provision represents the debt of the airline with the state. The valuation of the provision is made as follows:
• At the level of attributed and purchased quotas (spot or forward), an intangible asset is recognized. As the price is
determined, the provision should be valued at Weight Average Unit Cost of quotas.
• For the part not covered by purchase of quotas, there is no intangible asset in the Balance Sheet. The provision is
revalued, at each closing date, according to the price of quotas. The counterpart of this revaluation will be accounted
in operating result.
At the date of the restitution of the quotas, the intangible asset will be derecognized and the provision will be reversed.
3 International Accounting Standards Board
4 International Financial Reporting Interpretations Committee
5 International Accounting Standard 38: Intangible assets
6 International Accounting Standard 20: Accounting for Government Grants and Disclosure
© 2012 Reval.com, Inc. All Rights Reserved | 5Accounting for CO2 hedging To avoid the fluctuation of value of carbon quotas, the airline uses hedging instruments, mainly forward contracts. Forward contracts of quotas meet the definition of a derivative instrument (IAS 397:9): • No initial investment or a small initial net investment • Variation according to an underlying • Settlement at a future date The forwards are accounted at their fair value. These forward contracts are designated as the hedging instrument in a cash flow hedge of the variability of the consideration to be paid in the future transaction: purchase of quotas which are also the hedging instrument. As the underlying asset is also the hedging instrument, these contracts can be seen as a specific cash flow hedge, namely “All in one” hedge (IAS 39 – IG F2.5). Conclusion As can be noted from the above and read in conjunction with the other three papers in this series the accounting applied by organisations can be quite varied in application due to the lack of accounting guidance. In addition as more companies look to apply hedge accounting in practice practical issues may arise such as challenges faced with basis risk, issues around liquidity of instruments and availability of market data and tools used for assessment and measurement of hedge effectiveness. 7 International Accounting Standard 39: Financial Instruments: Recognition and Measurement © 2012 Reval.com, Inc. All Rights Reserved | 6
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