From 1 January next year, around 4,000 aircraft operators will be included in the EU's emissions trading scheme (EU ETS). Most flights landing and taking off from EU airports will be covered, regardless of the operator's nationality.
The airlines will join around 11,000 factories and power plants whose emissions are currently capped under the EU ETS, forcing them to buy permits to cover emissions above the caps.
Aviation is responsible for around 3% of the EU's greenhouse gas emissions, and its levels are growing at a faster rate than those of any other sector.
The cost of joining the scheme will be between €1 billion and €1.4 billion in 2012, analysts estimate, rising to as much as €7 billion in 2020.
Lufthansa, Europe's second-biggest airline, expects the EU ETS to cost it an extra 350 million euros a year from 2012, rising each year after that.
"Airlines do have a big challenge," said Peter Sharratt, global director for energy and sustainability at consultancy WSP Environment & Energy.
"It is extremely likely that the cost of airlines' carbon allowances will be passed on to customers."
The cost of a return economy flight from Europe to New York could rise by between €5 and €40, depending on carbon price levels and the extent to which an airline passes on EU ETS costs to consumers.
Lufthansa, Air France-KLM, British Airways and Iberia, Ryanair, Delta, Easyjet, Virgin Atlantic and Alitalia will receive the bulk of carbon permits.
In the short term, the EU ETS should not have too much impact on airlines such as these because they offer more premium, or first-class, tickets, and those customers are unlikely to notice extra charges from the cost of carbon.
Non-stop, long-haul routes are also more fuel efficient than the same aircraft's journeys on two or more short-haul routes, thereby reducing demand for permits.
Compared with rising jet fuel prices and aircraft lease payments, EU ETS costs may be marginal, but it could add to the financial sufferings of financially weak airlines, according to Standard & Poor's credit analyst Stuart Clements.
Costs will also likely increase over time in line with emissions growth and the price of carbon.
US airlines whose routes cross EU airspace have opposed inclusion in the EU ETS and filed a lawsuit, which is currently with the European Court of Justice in Luxembourg.
If they gain exemption from the scheme, it could put EU carriers at a significant disadvantage when competing with US carriers on the same international routes.
"For us, the EU ETS means a huge distortion of competition, especially as non-EU airlines will benefit from it," said Lufthansa spokesman Peter Schneckenleitner.
Some airlines could also drop less profitable routes.
"From next year, [route] planners will have to ask themselves whether such routes merit the allocation of scarce permits, or whether those permits would be best applied more lucratively elsewhere," said David Henderson, information manager at the Association of European Airlines.
Aircraft operators will need to develop hedging and trading strategies to manage the carbon price risk.
"The flag carriers, large low-cost airlines, the household names, tend to be very well-prepared - including non-EU airlines," said Point Carbon's Andreas Arvanitakis.
"But they tend to be well-prepared on data and compliance and are only now considering trading and hedging strategies."
Lufthansa said it had already defined a carbon-hedging strategy and that its fuel management department would be handling carbon transactions.
However, other operators covered by the scheme such as cargo airlines, corporate jet operators or distribution firms may find it easier and cheaper to pay a €100 fine for every tonne of excess carbon dioxide emitted.
The industry as a whole will receive 213 million carbon permits called EU Allowances (EUAs) in 2012, then 209 million a year from 2013 to 2020. As much as 82% each year will be given to airlines for free.
Analysts estimate the sector as a whole could have to buy up to 90 million EUAs on the open market to cover their emissions output.
The sector can cover another 15% of a year's cap in 2012 by buying cheaper UN-backed carbon credits or sovereign emissions credits, which may initially limit demand for EUAs.
Over time, aviation demand for carbon permits is likely to rise and push up prices as demand for flights increases, while new fuels and aircraft design offer the potential to reduce emissions only by an estimated 15 to 20%.
"I see demand for allowances from this sector growing with time to 2020. We see demand for [EU or UN] credits growing to 190 million tonnes annually by 2020," said Arvanitakis.
(EurActiv with Reuters.)