Why carbon leakage matters and what can be done against it

Close the carbon loophole

Climate policy: Bucket or drainer?

A series of studies has recently used emissions embodied in net imports (EENI) to argue for the consumption‐based accounting (CBA) approach. These publications have been generating much attention from the media and academia for ‘providing an opportunity to inform effective climate policy’. However, policymakers must be cautious when considering if CBA can be used to replace or just to supplement current practice of production‐based accounting (PBA). Terms such as ‘carbon leakage’, ‘emissions transfers’, and ‘CO2 outsourcing’ have been uncritically overused as there is little evidence that EENI is the result of climate policy. Furthermore, CBA overlooks ‘insourcing’ of polluting industries by producing regions when blaming consumers for emissions. To avoid misinformation, EENI should be called just that. CBA's practicality is limited as it involves more data‐intensive calculations and higher transaction costs than PBA. The success of CBA will rely on consumers to put pressure on producers. Eventually, it is still producers that need to reduce emissions. PBA is more practical by directly placing pressure on producers along with environmental laws and regulations. CBA will be counter‐productive to global emissions control if producers increase emissions due to reduced responsibility over the emissions incurred by the production of their exports. However, CBA could be used to persuade consumers to choose low‐emissions products, support producers' sustainability efforts, and reduce nonbasic consumption. WIREs Clim Change 2015, 6:1–8. doi: 10.1002/wcc.325This article is categorized under: Climate Economics > Economics of Mitigation The Carbon Economy and Climate Mitigation > Policies, Instruments, Lifestyles, Behavior

Steep and rapid reductions in greenhouse gas emissions are required from the industrialized countries. An important policy concern is that these emission reductions could lead to increases in emissions elsewhere. This leakage effect can be avoided by suitable choice of policies.I study the greenhouse gas abatement policy of a large coalition of countries that faces competition from countries with laxer emission policies, comparing the changes in emissions from the rest of the world and in competitiveness of dirty industries caused by different policy options. My analysis is based on a two-region, two-good model of endogenous growth with directed technical change.I compare two approaches to allocation of emissions associated with the supply of internationally traded goods and services: production-based and consumption-based accounting. When technical change and complementary policies are omitted, emission constraints based on either approach cause emissions in the rest of the world to increase, although through different mechanisms. However, an emission constraint creates incentives for energy-saving innovation and countries' emission policies can include various complementary measures in addition to the emission constraint. These factors can cause also the rest of the world to reduce emissions. Models that omit these factors yield too low recommendations on emission reduction targets.In order to maximize global emission reductions achieved with unilateral policy, production-based emission constraints should be applied on sectors where there are good possibilities to substitute other inputs for fossil energy, and there are decreasing returns to scale in carbon intensive activities. Consumption-based emission constraints achieve larger global emission reductions in sectors in which fossil energy and other inputs are strongly complementary and returns to scale on the regional level are not strongly decreasing.Complementary policies, such as subsidies to energy efficiency investments, subsidies to R&D of energy-saving technologies, transfer of technology to developing countries and relaxing the protection of intellectual property rights, can reduce or reverse carbon leakage. Each of these policies only reduces global emissions under specific conditions. Choosing suitable policies and differentiating between economic sectors is of great importance.If border measures are applied on imported carbon-intensive goods, it is important to account for the relative carbon intensity of individual producers. A regular border tax levied per tonne of product does not encourage producers in the rest of the world to clean up their production.

Carbon leakage occurs in any carbon pricing regime that is not global, which means all of them so far. That is inherently unfair to sectors that are subject to a carbon price but compete with those that are not. The European Green Deal aims to rectify the problem in the EU Emissions Trading System (ETS) by moving beyond the current second (or third) best option, which allocates emissions quotas for free for industrial sectors, and by putting a price on carbon at the EU border for selected but not yet named sectors. Our recent model-based analysis compares the impact of a future border carbon adjustment (BCA) mechanism for the power sector with the option of extending the EU ETS to countries exporting power to the EU. We demonstrate how differences in the two policy tools translate into markedly different impacts. We conclude that expanding the geographical scope of the EU ETS is a more effective climate policy tool than a BCA. First, it would reduce emissions, while a BCA would not. Second, emission trading brings real competition: Regions neighbouring the EU will be better integrated into the EU single market with a level playing field and lower greenhouse gas emissions. On the other hand, the BCA would fence off the EU power sector and increase greenhouse gas emissions. Third, compared to a border carbon tax, expanding the ETS also yields more revenue to exporting neighbouring countries facing higher-than-average challenges to change their fossil-heavy power systems. Key policy insights The introduction of a new policy tool, the border carbon adjustment mechanism, which aims to create fair competition and trigger more ambitious climate policy action in trading partners, is a legitimate action of the European Union. However, the extension of EU ETS is a more effective climate policy tool than a border carbon adjustment mechanism as the latter increases overall emissions. The border carbon adjustment mechanism is rather a competition policy tool that provides a level playing field for electricity producers inside and outside the EU. The price impact of the policy tool choice merits attention: the extension of the EU ETS drives up prices in neighbouring countries (except the West Balkan region), but the additional quota revenues can be used to alleviate the burden on vulnerable social groups.

In a world with uneven climate policies, the carbon price differentials across regions could shift the production of energy‐intensive goods from carbon‐constrained countries to ‘carbon havens’, or countries with laxer climate policy. This would reduce the environmental benefits of the policy (carbon leakage) while potentially damaging the economy (competitiveness concerns). A review on these questions is provided in this article. First we discuss the main terms involved, such as carbon leakage, competitiveness, sectors at risk, or climate spillovers. Then we analyze the studies evaluating the carbon leakage risk. Most ex ante modeling studies conclude to leakage rates in the range of 5–20% (if no option to mitigate leakage is implemented), whereas ex post econometric studies have not revealed statistically significant evidence of leakage. Different policy options to face these issues are then examined with an emphasis on Border Carbon Adjustments (BCA). BCA consist in reducing the carbon price differentials of the goods traded between countries. Properly implemented, they can reduce leakage (by around 10 percentage points in ex ante modeling studies) in a cost‐effective way but are controversial because they shift a part of the abatement costs from abating countries to nonabating countries. Their impact on international negotiations is unclear: they could encourage third countries to join the abating coalition or trigger a trade war. Besides, their consistency with World Trade Organization (WTO) rules is contentious among legal experts. WIREs Clim Change 2014, 5:53–71. doi: 10.1002/wcc.245This article is categorized under: Climate Economics > Economics of Mitigation

Purpose – This paper examines South Korea’s potential status as a carbon leakage country, and the level of risk posed by the Korean emissions trading scheme (ETS) for Korean industries. The economic effects of border carbon adjustments (BCAs) to protect energy-intensive Korean industries in the process of achieving the carbon reduction target by 2030 through the Korean ETS are also analyzed. Design/methodology – First, using the Korean Input–Output (IO) table, this paper calculates the balance of emissions embodied in trade (BEET) and the pollution terms of trade (PTT) to determine Korean industries’ carbon leakage status. Analyses of the risk level posed by carbon reduction policy implementation in international trade are conducted for some sectors by applying the EU criteria. Second, using a computable general equilibrium (CGE) model, three BCA scenarios, exemption regulations (EXE), reimbursement (REB), and tariff reduction (TAR) to protect the energy-intensive industries under the Korean ETS are addressed. Compared to the baseline scenario of achieving carbon reduction targets by 2030, the effects of BCAs on welfare, carbon leakage, outputs, and trading are analyzed. Findings – As Korea’s industrial structure has been transitioning from a carbon importing to a carbon leaking country. The results indicate that some industrial sectors could face the risk of losing international competitiveness due to the Korean ETS. South Korea’s industries are basically exposed to risk of carbon leakage because most industries have a trade intensity higher than 30%. This could be interpreted as disproving vulnerability to carbon leakage. Although the petroleum and coal sector is not in carbon leakage, according to BEET and PTT, the Korean ETS exposes this sector to a high risk of carbon leakage. Non-metallic minerals and iron and steel sectors are also exposed to a high risk of carbon leakage due to the increased burden of carbon reduction costs embodied in the Korean ETS, despite relatively low levels of trade intensity. BCAs are demonstrated to have an influential role in protecting energy-intensive industries while achieving the carbon reduction target by 2030. The EXE scenario has the greatest impact on mitigation of welfare losses and carbon leakage, and the TAF scenario causes a disturbance in the international trade market because of the pricing adjustment system. In reality, the EXE scenario, which implies completely exempting energy-intensive industries, could be difficult to implement due to various practical constraints, such as equity and reduction targets and other industries; therefore, the REB scenario presents the most realistic approach and appears to have an effect that could compensate for the burden of economic activities and emissions regulations in these industries. Originality/value – This paper confirms the vulnerability of the Korean industrial the risk of carbon leakage, demonstrating that some industrial sectors could be exposed to losing international competitiveness by implementing carbon reduction policies such as the Korean ETS. The contribution of this paper is the identification of proposed approaches to protect Korean industries in the process of achieving the 2030 reduction target by analyzing the effects of BCA scenarios using a CGE model.

The European Union’s unilateral action on climate change has the potential to expose its energy intensive industries to undue competition from economies where lower standards of climate policies are in operation. This “green paradox” may result in carbon constrained energy intensive industries relocating their operations away from the EU as a result of international competition and increased costs in domestic production, giving rise to “carbon leakage”. For the Federal Republic of Germany, with its export driven economy dominated by energy intensive manufacturing industries, the prospect of carbon leakage is of particular interest. This article investigates the policy considerations underpinning the carbon leakage debate and the measures designed to address leakage risks, in particular sectoral approaches and free allocation of emission allowances. The concept of positive carbon leakage will be developed with the article arguing that the energy intensive industry in Germany is capable of adapting to carbon leakage by use of innovation and increased energy efficiency. The article concludes that the risk of carbon leakage in Germany is of a minimal nature and therefore considerably overstated. In order to minimise the risk of leakage further, sectoral approaches should be considered for the EU’s most energy intensive industries.

A comprehensive national climate policy needs to provide both producers and consumers with incentives for reducing greenhouse gas emissions. Too often, policy discussions focus on emissions reduction among producers. This limited perspective fails to take into account the complex relationship between emissions production in one region and consumption demands in another. All economic production requires both a producer and a consumer. If no consumer for a good or service exists, then that good or service will not be produced. We understand the producer’s role in generating Canada’s greenhouse gas emissions, but often forget the consumer’s role. In this paper, we explore both the conventional production-based emissions accounting as well as consumption-based accounting, wherein all of the emissions generated in order to produce a final consumption good are allocated to consumers of those goods. Production and consumption are not a simple case of cause and effect. Rather, production emissions diverge strongly across Canadian provinces while consumption emissions tend to be similar. Significant interprovincial and international trade flows in emissions enable this pattern. Recognition of these trade flows provides important insights for the development of Canada’s national climate change strategy. Interprovincial trade flows provide a strong argument in support of Canada’s forthcoming national carbon price. By ensuring the large majority of emissions in Canada are similarly priced – regardless of where they are produced – it minimizes the risk of interprovincial carbon leakage (where companies avoid the carbon price by relocating to a jurisdiction with weaker climate measures) and increases the likelihood that Canadian consumers will face an incentive to adjust their demand of domestically produced carbon intensive goods. Implementation of a national carbon price must make allowances for production sectors with significant international trade flows in emissions, or risk damaging that trade. Higher costs for Canadian producers can have a detrimental effect on competition in these sectors, resulting in less demand for Canadian products domestically and internationally. It can also lead to international carbon leakage. The resultant increase in global greenhouse gas emissions defeats the purpose of enacting stringent regulations in Canada. Striking a balance requires that the federal government create complementary policies that reduce the burden of a national carbon price on trade-exposed Canadian producers while still providing incentives for them to invest in reducing their emissions. In Canadian sectors with minimal trade exposure – i.e., those with emissions that are largely produced and consumed within Canada – it is best to focus complementary policies to a national carbon price on achieving additional emissions reductions. The utilities, personal transportation and residential sectors are all good targets for these types of complementary policies. Another important policy question is how to equitably divide the burden of meeting Canada’s national emissions reduction target across the provinces. This does not lend itself to simple solutions. Some provinces have significant hydroelectric resources, providing them with a non-fossil fuel electricity source that leads to lower emissions. An approach that mandates similar emissions intensities per capita across Canada will be to those provinces’ advantage. However, there is also a historical approach to burden sharing that puts the provinces with lower emissions at a disadvantage. This allows a province like Alberta to have higher emissions levels because it has always had them. The best model for distributing Canada’s emissions reduction target is a hybrid one that all provinces can support without any of them feeling they are at a disadvantage. There is a strong case for granting all provinces an equal right to consumption emissions as a starting point. However, a final emissions allocation must come with the recognition that a province’s consumption is often supported by production emissions outside of that province. Drafting climate policy can be fraught with consequences that come from focusing on one side only of the production/consumption equation. Where consumption drives emissions is as important as where they are produced. A balanced policy that reflects the implications of domestic and international emissions trade flows is the best and fairest way for Canada to contribute to reducing the world’s greenhouse gas emissions.

A comprehensive national climate policy needs to provide both producers and consumers with incentives for reducing greenhouse gas emissions. Too often, policy discussions focus on emissions reduction among producers. This limited perspective fails to take into account the complex relationship between emissions production in one region and consumption demands in another. All economic production requires both a producer and a consumer. If no consumer for a good or service exists, then that good or service will not be produced. We understand the producer’s role in generating Canada’s greenhouse gas emissions, but often forget the consumer’s role. In this paper, we explore both the conventional production-based emissions accounting as well as consumption-based accounting, wherein all of the emissions generated in order to produce a final consumption good are allocated to consumers of those goods. Production and consumption are not a simple case of cause and effect. Rather, production emissions diverge strongly across Canadian provinces while consumption emissions tend to be similar. Significant interprovincial and international trade flows in emissions enable this pattern. Recognition of these trade flows provides important insights for the development of Canada’s national climate change strategy. Interprovincial trade flows provide a strong argument in support of Canada’s forthcoming national carbon price. By ensuring the large majority of emissions in Canada are similarly priced – regardless of where they are produced – it minimizes the risk of interprovincial carbon leakage (where companies avoid the carbon price by relocating to a jurisdiction with weaker climate measures) and increases the likelihood that Canadian consumers will face an incentive to adjust their demand of domestically produced carbon intensive goods. Implementation of a national carbon price must make allowances for production sectors with significant international trade flows in emissions, or risk damaging that trade. Higher costs for Canadian producers can have a detrimental effect on competition in these sectors, resulting in less demand for Canadian products domestically and internationally. It can also lead to international carbon leakage. The resultant increase in global greenhouse gas emissions defeats the purpose of enacting stringent regulations in Canada. Striking a balance requires that the federal government create complementary policies that reduce the burden of a national carbon price on trade-exposed Canadian producers while still providing incentives for them to invest in reducing their emissions. In Canadian sectors with minimal trade exposure – i.e., those with emissions that are largely produced and consumed within Canada – it is best to focus complementary policies to a national carbon price on achieving additional emissions reductions. The utilities, personal transportation and residential sectors are all good targets for these types of complementary policies. Another important policy question is how to equitably divide the burden of meeting Canada’s national emissions reduction target across the provinces. This does not lend itself to simple solutions. Some provinces have significant hydroelectric resources, providing them with a non-fossil fuel electricity source that leads to lower emissions. An approach that mandates similar emissions intensities per capita across Canada will be to those provinces’ advantage. However, there is also a historical approach to burden sharing that puts the provinces with lower emissions at a disadvantage. This allows a province like Alberta to have higher emissions levels because it has always had them. The best model for distributing Canada’s emissions reduction target is a hybrid one that all provinces can support without any of them feeling they are at a disadvantage. There is a strong case for granting all provinces an equal right to consumption emissions as a starting point. However, a final emissions allocation must come with the recognition that a province’s consumption is often supported by production emissions outside of that province. Drafting climate policy can be fraught with consequences that come from focusing on one side only of the production/consumption equation. Where consumption drives emissions is as important as where they are produced. A balanced policy that reflects the implications of domestic and international emissions trade flows is the best and fairest way for Canada to contribute to reducing the world’s greenhouse gas emissions.

Major US electric utility climate pledges have the potential to collectively reduce power sector emissions by one-third

What explains the choice of corporate political strategy in environmental politics? Drawing on recent models of actor strategy formation in political economy, this article argues that basic material interests of firms are translated into strategies in the context of institutional environments. I advance a typological model that posits how distributional effects—positive versus negative—and perceived regulatory pressure—low versus high—interact in leading firms to adopt one of four ideal-type strategies: opposition, hedging, support, and non-participation. This article examines the model through the case of corporate strategies in the making of the European Union’s Emission Trading Scheme. The article contributes to theory-building on business strategy in environmental politics by offering a probabilistic explanatory model, and it flags hedging strategies as an increasingly prevalent form of business behavior.

Low-carbon production of iron and steel: Technology options, economic assessment, and policy

With limited progress in the UN climate change negotiations, the EU has been looking at ways to further reduce global CO2 emissions by extending the scope of its cap and trade system, most recently by including flights entering and leaving EU airspace. With the EU Aviation Directive entering into force on 1 January 2012, all airlines will need to hold permits to cover their CO2 emissions for flights operating in EU airspace. For instance, Singapore Airlines will be required to hold permits for CO2 emissions for its flights from Singapore to Frankfurt, which will include all CO2 emissions over Singapore, third countries, the high seas and EU airspace. As climate change is a global challenge, national and regional efforts to reduce CO2 emissions have an international impact by nature, particularly on trade. With the World Trade Organization (WTO) responsible for regulating world trade, this article analyses the consistency of the EU Aviation Directive with WTO rules. The EU's decision to include both non-EU and EU airlines under its cap and trade system is a response to the so-called carbon leakage and competitiveness issues that would have arisen if the scheme had been limited to EU airlines only. Carbon leakage arises when a carbon price leads domestic businesses to relocate to countries not pricing carbon or to increased imports of goods from countries not pricing carbon, resulting in no net reduction in global CO2 emissions. Competitiveness issues occur when a carbon price increases the price of domestically produced goods, causing consumers to substitute with cheaper imports from countries not pricing carbon, ultimately harming domestic industry and undermining support for these policies. With airlines providing an important international services trade, including CO2 emissions from aviation under the EU cap and trade system has important implications for international trade, particularly since air transport functions as an enabler of other forms of trade such as just-in-time manufacturing strategies, tourism, and business links. Despite the number of ways in which the Aviation Directive is in conflict with WTO rules, the article demonstrates that the type of WTO rules that the EU Aviation might violate are useful disciplines on how countries develop and apply climate change action that impedes international trade. Developing climate change measures consistently with WTO rules strikes an appropriate balance between giving WTO Members the policy space to take action to reduce CO2 emissions while maintaining an open and non-discriminatory trading system that supports economic growth and global welfare.

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