Earlier this month, Reuters reported that the European Commission could extend its carbon markets scheme to flights leaving the region, targeting the aviation sector’s significant greenhouse gas (GHG) emissions.This would expand the European Union Emissions Trading System (EU ETS), which currently mandates carbon pricing for flights operating within its borders. The EU had initiated a compliance-based system in the absence of a global regulatory mechanism, but it may now be transitioning towards wider enforcement. It could have implications for the aviation sector at a time when fuel costs have risen due to the war in West Asia.The Financial Times reported that the move could raise prices for long-haul flights and invite opposition from airlines. It has parallels to some of the EU’s earlier green policies, at times criticised for adversely affecting developing countries like India, alongside productivity.Carbon markets assign a financial value to carbon emissions. Originating from the 1997 Kyoto protocol on reducing GHGs, they have helped create financial incentives for industrial decarbonisation. Largely of two categories, carbon markets are compliance focussed or voluntary markets.Carbon compliance markets usually operate on a cap-and-trade principle, meaning that a central regulatory authority establishes a ceiling limit on total allowable emissions. Entities that achieve emission sustainability goals can trade their surplus permits, while those exceeding their allocations must purchase more permits to comply. Essentially, it imposes a direct cost for carbon emissions.The ceiling limit also reduces year by year, aimed at reducing total emissions.In 2023, the International Energy Agency reported that aviation accounted for 2.5% of global energy-related CO2 emissions, having grown faster between 2000 and 2019 than rail, road or shipping. Carbon markets can play a critical role in the sector, with few decarbonisation alternatives and cleaner Sustainable Aviation Fuels still being costly.Story continues below this adThe EU’s novel approachIn 2005, the EU ETS was conceived as a novel regulatory mechanism. It aimed to reduce GHG emissions through a binding directive applicable across industries. It is built on a “polluter pays” principle, according to the European Commission website, “ensuring that those who emit pollutants pay for the right to do so.”In 2012, the aviation sector was formally integrated into the EU ETS. Here, entities are subject to stringent monitoring, reporting, and verification protocols. Each emission allowance acquired by airlines represents legal authorisation to emit one tonne of CO2.Also Read | Top 10 most polluted airports in the world: Indian airports release 27.6 million tonnes of CO2Under the European Union Aviation Allowance method, airlines procure allowances through three channels — freely allocated permits through the EU-ETS, purchasing more allowances through government auctions, or trading in secondary markets with other entities. Between 2023 and 2024, free aviation allowances witnessed a 28% reduction.Last year, emission allowances were traded at €73.43 per tonne on the auction market while it averaged €74.35 per tonne in the secondary markets. Capgemini has projected that a minimum threshold of €120 per tonne must be reached by 2030 if true sectoral decarbonisation is to be achieved. Generating €38.8 billion in 2024 in auction revenue, ETS emissions as a whole are now around 50% below 2005 levels.Story continues below this adThe aviation sector faces two milestones this year: the phase-out of free permits, further raising costs for airlines, and a European Commission assessment for the inclusion of international airspace into the ETS framework. The latter would result in a “carbon price” on emissions from flights departing the region, Reuters reported.CORSIA: An international alternativeAround a decade after the EU-ETS, a global mechanism for regulating aviation emissions was launched. “Amidst a lot of discussion about the efficacy and reliability of carbon markets, the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) came into play,” Trishant Dev, Deputy Program Manager at the Centre for Science and Environment (CSE), New Delhi, told The Indian Express.Administered by the International Civil Aviation Organisation, it diverges from the EU’s model. CORSIA consists of purchasing and cancellation of emission units through investments in offset projects focussed on methodologies like reforestation, industrial carbon capture or habitat restoration. Credit verified NGO’s such as Eden Reforestation Projects generate carbon credits through long-term landscape restoration. They are then purchased by airlines as part of the voluntary carbon market.It aims to achieve carbon-neutral growth, that is, balancing carbon emissions with absorption of carbon, and maintaining emissions at 85% of pre-Covid levels. “Offset projects work by setting an agreeable baseline. Once that baseline is set, any emissions that go above and beyond are the focus of offsetting. It is not like the EU, where the baseline is constantly reducing year-by-year,” Dev said.Story continues below this adIt is slated to apply from 2027, contingent on a successful European Commission assessment that will audit its alignment with the 2015 Paris Agreement. However, the Paris Agreement mandated absolute emission reduction rather than carbon neutrality, which CORSIA enables. It also raises an enforceability issue, especially for developing nations. The transition to compliance carbon markets will require precisely monitoring emissions and allowing independent verification, and not all states have such capacities.Further, voluntary market regulators involved in assessing carbon offset projects have previously faced criticism due to a lack of formal oversight.Carbon leakage and green protectionismFor the EU, the justification for expanding the EU-ETS is also rooted in “carbon leakage” — when strict green regulations result in industries relocating to jurisdictions with weaker environmental laws.While the EU-ETS utilises a high-cost cap that is annually lowered, CORSIA relies on abundant, low-cost voluntary offset credits, which have been criticised for not exerting sufficient pressure to alter airlines’ behaviour.Story continues below this adSome precedent can also be found in the Carbon Border Adjustment Mechanism or CBAM. It is an import duty that the EU imposes on goods produced through processes that generate greater carbon emissions than domestic European manufacturers are allowed to emit. Dev said, “The CBAM is born out of the concerns that European industrial competitiveness might be seriously affected”, calling it “essentially a green protectionist wall”.A major criticism is that it leads to the EU disproportionately shifting the costs of decarbonisation onto developing nations. “For them, carbon pricing is a unilateral trade instrument that works. Yet, it is against the Common But Differentiated Responsibilities (CBDR) principle under the United Nations Framework Convention on Climate Change (UNFCCC), as it ignores the country’s development status,” Dev said.Also Read | Making money from methane emission reductions in paddy fieldsCBDR acknowledges that while combating climate change is a global effort, the major onus of responsibility lies on developed countries, owing to their historically large-scale emissions.On January 1 this year, the CBAM entered its definitive phase and imposed financial liabilities on carbon-intensive imports. Indian exports like steel and aluminium were affected, with compliance costs in shifting from coal-dependent blast furnaces to renewable electric furnaces. In particular, smaller and medium enterprises bear the “major additional costs”, Dev said.Story continues below this adIndia has expedited its own domestic Carbon Credits Trading Scheme (CCTS) of late. However, there are asymmetries compared to Europe. “If India’s CCTS system were to become operational tomorrow, it would be much lower. Even if you look at the Chinese ETS model which traded nationally at an average €10.88, the cost is lower than the roughly €74 that the primary EU-ETS market traded allowances for across 2025,” Dev said.Any such market faces the risk of oversupply of credits — a problem that has crashed some previous schemes. The EU-ETS system automatically adjusts the supply of allowances to be auctioned, withdrawing them during times of surplus and releasing them when they are low. “India however, faces the concern of preventing an oversupply of devalued credits in the market”, Dev was quick to point out.Navigating cross-border pricing while shielding smaller players in India’s supply chain from ballooning compliance costs might emerge as a macroeconomic challenge over time. In the case of aviation, that might happen sooner rather than later.