Lack of viable fossil fuel alternatives a key ESG risk for investors, according to Morningstar.
The difficulties of replacing fossil fuels will make it hard for the commercial air sector to reduce its greenhouse gas (GHG) emissions in line with the Paris Agreement as global consumer demand for continues to accelerate.
This is the biggest among a number of “major ESG risks” facing investors in the commercial air sector, according to a new report by US data and analysis firm Morningstar.
Morningstar says carbon emissions from air travel pose a serious risk to investors’ ESG credentials over the coming decades. Currently many around the world can’t afford regular air travel, limiting the sector’s overall global environmental contribution to 2.5% of carbon emissions and 3.5% of all emissions that contribute to climate change. However, with rising incomes the report warns that aviation’s share of emission could leap to 22% by 2050.
Aircraft jet fuel predominately comes from fossil fuels, with air travel being “notably one of the highest GHG-emitting ways to get from one place to another”, and there are severely limited near-term economic opportunities for sustainable alternatives. Due to this, an increasing focus on climate change is a risk for investors in commercial flights.
The sector has recently taken steps to move towards net zero, with the International Civil Aviation Organisation (ICAO) pledging to support an “aspirational” net zero aviation goal by 2050, with the goal being accepted by the 193 countries who are members of ICAO. However, the deal has been criticised by green groups, who have branded it “weak and not legally binding”.
Electrification and fossil fuel alternatives have been widely discussed as ESG-friendly replacements for fossil fuels but are limited by technology and economics. It’s “highly unlikely that electrification will come for most commercial air travel in the foreseeable future” according to the report. It says that batteries are “far too heavy for how much energy they can carry” and sustainable aviation fuels (SAF) and hydrogen are far too expensive to be implemented.
A number of issues surrounding SAFs would need to be addressed for it to be a viable alternative fuel source. There are solutions to improving the viability of SAFs, including increasing feedstock options, further investment in production and development of new infrastructure.
Morningstar’s report suggests that carbon offsets could mitigate the carbon impact of air travel, but are seeing very little uptake in customers, while potential carbon taxes might not do much to change customer behaviour.
A long-haul first-class flyer generates roughly four times the GHG emissions a fellow passenger sitting in economy does. These more expensive seats not only taking up more space and weight on the aircraft, but tend to end up empty more often than affordable ones.
Air travel also accounted for five of the six modes of transport with the highest GHG emissions per distance travelled.
For investors, a key concern raised by the report is that despite fuel burn falling nearly 40% between 2005 and 2020, developing further future efficiency gains will “require significant investment”. Additionally, any major fleet renewals will require significant investment from airlines, which will impact investors.
According to the report, the sector’s most meaningful ESG risks “stem from the largest costs of flying-labour, fuel, and safety”. These combine for over 80% of a commercial flight’s direct operating costs, and the report warns investors exposed to commercial air travel directly through airlines or indirectly through commercial aircraft and parts manufacturers that they “must pay attention” to ESG risks that can directly affect these costs.
Human capital risk should be a “major focus” for investors, according to Morningstar. “A flight can’t operate itself”, and with regulators across the globe implementing strict requirements for pilot training and qualifications and minimum number of crew, it is a significant factor for investors in the sector.
Airlines are particularly exposed to human capital risk, with their relationships with pilots is particularly important due their critical role in operations. Additionally, their roles in safety, and the potential labour shortage leaving airlines “struggling to maintain schedules with enough required staff”. While manufacturers face a much lesser threat, the threat still exists.