Risk Of Carbon Leakage Research Articles

Sectors Under Scrutiny: Evaluation of Indicators to Assess the Risk of Carbon Leakage in the UK and Germany

One of the central debates surrounding the design of the European Union Emissions Trading Scheme is the approach to address carbon leakage concerns. Correctly identifying the economic activities exposed to the risk of carbon leakage represents the first step in mitigating the risk effectively. This paper assesses the robustness of the quantitative assessment criteria used by the European Commission for Phase 3. For example we apply the criteria to data for UK and Germany and compare the results with the Commissions’ assessment conducted at the aggregated EU level. This reveals that sectors’ exposure risk to carbon leakage can vary across different Member States due to differences in production processes, technologies and fuel mix; process emissions; recycling rate differences; product mix differences; sector classification, statistical boundaries, activity allocation differences; and finally difference in data quality. Overall, we find that relative carbon intensity of sectors, measured as cost increase relative to gross value added, provides a robust metric. The analysis also highlights the importance of using high quality and disaggregated data for this assessment.

A Global CO2 Tax for Sustainable Development?

The Rio+20 conference in 2012 called for goals of promoting green industries and improving the quality of institutions worldwide. Is a global CO2 tax the best global solution for achieving this twin goal? As most countries in the world are highly corrupt, an adequate regulatory instrument should be able to work in a simple way that does not rely on strong formal institutions for enforcement. We argue that this is the case for a global CO2 tax. A uniform CO2 tax can be introduced as a “painted” energy tax that provides the needed incentive to switch from brown to green industries and minimizes the risk of carbon leakage. The achievement of the specific 2-degree target level is discussed as an example implying huge tax revenues that may be invested in better institutions. In perspective, the idea of having one instrument solving one problem will probably ease forthcoming political discussions and sustainability conferences substantially since the focus is on one issue rather than many.

Climate policy and the ‘carbon haven’ effect

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

Carbon Leakage and Competitiveness under the EU ETS

The introduction of a carbon price through an emissions trading scheme such as the European Union's Emissions Trading Scheme (EU ETS) can create the risk of carbon leakage. The European Commission presented a list of sectors which were deemed to be exposed to a significant risk of carbon leakage in December 2009. The listed sectors receive a share of emissions allowances free of charge between 2010 and 2014 as a policy response to the risk of carbon leakage within industrial sectors covered by the EU ETS. This paper analyses the effectiveness of the Commission's carbon leakage list in achieving two important policy goals - ensuring the global competitiveness of certain industry sectors covered by the EU ETS whilst maintaining the efficacy of the EU ETS in reducing greenhouse gas emissions.

Industry Compensation under Relocation Risk: A Firm-Level Analysis of the EU Emissions Trading Scheme

When regulated firms are offered compensation to prevent them from relocating, efficiency requires that payments be distributed across firms so as to equalize marginal relocation probabilities, weighted by the damage caused by relocation. We formalize this fundamental economic logic and apply it to analyzing compensation rules proposed under the EU Emissions Trading Scheme, where emission permits are allocated free of charge to carbon-intensive and trade-exposed industries. We show that this practice results in substantial overcompensation for given carbon leakage risk. Efficient permit allocation reduces the aggregate risk of job loss by more than half without increasing aggregate compensation. (JEL H23, Q52, Q53, Q54, Q58)

On the Empirical Content of Carbon Leakage Criteria in the EU Emissions Trading Scheme

The EU Emissions Trading Scheme continues to exempt industries deemed at risk of carbon leakage from permit auctions. Carbon leakage risk is established based on the carbon intensity and trade exposure of each 4-digit industry. Using a novel measure of carbon leakage risk obtained in interviews with almost 400 managers at regulated firms in six countries, we show that carbon intensity is strongly correlated with leakage risk whereas overall trade exposure is not. In spite of this, most exemptions from auctioning are granted to industries with high trade exposure to developed and less developed countries. Our analysis suggests two ways of tightening the exemption criteria without increasing relocation risk among non-exempt industries. The first one is to exempt trade exposed industries only if they are also carbon intensive. The second one is to consider exposure to trade only with less developed countries. By modifying the carbon leakage criteria along these lines, European governments could raise additional revenue from permit auctions of up to €3 billion per year, based on a permit price of €30.

Industry Compensation Under Relocation Risk: A Firm-Level Analysis of the EU Emissions Trading Scheme

When regulated firms are offered compensation to prevent them from relocating, efficiency requires that payments be distributed across firms so as to equalize marginal relocation probabilities, weighted by the damage caused by relocation. We formalize this fundamental economic logic and apply it to analyzing compensation rules proposed under the EU Emissions Trading Scheme, where emission permits are allocated free of charge to carbon intensive and trade exposed industries. We show that this practice results in substantial overcompensation for given carbon leakage risk. Efficient permit allocation reduces the aggregate risk of job loss by more than half without increasing aggregate compensation.

How Vulnerable Is India’s Trade to Possible Border Carbon Adjustments in the EU?

This paper presents an empirical exercise with the aim of adressing the following research questions: (a) how vulnerable is India's trade to any future border carbon adjustments in the European Union (EU) and (b) which sectors/items are most likely to be affected? The exercise is based on the EU List released in December 2009, in which the bloc has identified 164 (sub)sectors as deemed to be exposed to a significant risk of carbon leakage. In light of the finding that the Harmonized System's (HS) six-digit items corresponding to the (full) EU List comprise the lion's share of India's exports to the EU, it is argued in this paper that there is a very high probability of any such border measure having a considerable impact on India's exports to the bloc. The study further reveals that even if the EU decides to leave the 117 highly trade-intensive but low carbon-intensive sectors (included in the EU List) outside the ambit of any future border carbon adjustments, the overall vulnerability of India could still be quite high. Among the four BASIC countries (namely, Brazil, China, India and South Africa), India appears to be the second-most vulnerable, after South Africa.

The EU ETS Rules on Carbon Leakage and Energy Intensive Industry in the Federal Republic of Germany

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.

The Interface Between the Trade and Climate Change Regimes: Scoping the Issues

As governments increasingly adopt policies to reduce greenhouse gas emissions, concern has grown on two fronts. First, carbon leakage can occur when mitigation policies are not the same across countries and producers seek to locate in jurisdictions where production costs are least affected by emission constraints. The risk of carbon leakage raises questions about the efficacy of climate change policies in a global sense. Secondly, it is precisely the cost-related consequences of differential mitigation policies that feed industry concerns about competitiveness. We thus have a link between environmental and competitiveness perspectives that fuses climate change and trade regimes in potentially problematic ways as governments contemplate trade actions to manage the environmental and/or competitiveness consequences of differential climate change policies. On the trade side of this relationship, we have the reality that the GATT/WTO rules were not originally drafted to accommodate climate change policies and concerns. The purpose of this paper is to analyze the relevance of certain WTO rules to the interface between climate change and trade, focusing in particular on border measures, technical regulations on trade, standards and labelling, and subsidies and countervailing duties. It concludes that in the absence of clear international understandings on how to manage the climate change and trade interface, we run the risk of a clash that compromises the effectiveness of climate change policies as well as the potential gains from specialization through trade.

Operating and Financial Investments by European Utilities Over 2004-2009: What Role for European Mitigation Policies?

One of the objectives of the European Union Emissions Trading Scheme (EUETS), the EU’s flagship cap-and-trade policy, is to give an incentive to carbon-constrained entities to invest in a production apparatus that emit less carbon. So far, analytical work and related evidence has been limited to rather short-term impacts (operations and carbon trading). This paper investigates longer-term impacts considering both operating investments and financial investments in power generation.The paper surveys corporate investor communications over 2004-2009 for the five most carbon-constrained European utilities (RWE, E.ON, EDF, Enel and Vattenfall). We ask ourselves to what extent has the EU ETS actually given the proper incentive to invest in low-carbon generation and what is the impact (both incidental and voluntary) of external growth investments on the ETS profile of the European utilities under scrutiny. Have the changes of ownership altered the EU ETS compliance perimeter?The paper concludes that in the early years of the EU ETS, European utilities investments were considerably more influenced by non-climatic considerations, notably (1) the strategic repositioning of the industry towards a regional energy utility business and (2) environmental and competition-related regulations. In the absence of a consensual counterfactual investment scenario over the period, we can only highlight that some investments performed and planned are clearly in favor of mitigating carbon emissions without attributing this solely to the EU ETS but also to the flurry of direct support mechanisms to renewables or energy markets developments. The beginning of a tighter constraint in phase II and expectation regarding phase III triggered clearer investment-related responses on the part of regulated entities: highly carbon-emitting plants cancelled in favor of plants emitting less CO2 or regulated entities fully using offset project mechanisms to foster investments in lower carbon power plants. However, some responses are rather creative, require further monitoring and need to be addressed by the policymakers (risk of carbon leakage and plant commissioning unduly postponed). This calls for more transparency requirement in the reporting exercise.

Grandfathering, auctioning and Carbon Leakage: Assessing the inconsistencies of the new ETS Directive

The new ETS Directive defines three different allocation rules, granting exemption from auctioning to those sectors exposed to the risk of Carbon Leakage. This article analyses the inconsistencies that characterize this new allocation rule and it concludes that the methodology designed to assess the risk of Carbon Leakage is more politically driven than economically grounded. The results of the Carbon Leakage risk assessment reveal that grandfathering is going to be the dominant allocation rule during the third phase also. However, not only the exemption from auctioning is unlikely to mitigate Carbon Leakage, instead of improving the allocation transparency and granting harmonization of higher rules but also the new ETS allocation rule is likely to increase the distortions of competition, worsening rather than improving the harmonization within the ETS.

Proposals on Carbon-related Border Adjustments: Prospects for WTO Compliance

Recently the practice of border adjustment in international trade has attracted much interest in the context of climate change. The risk of carbon leakage, the competitive disadvantage of industries in countries introducing a cap on emissions and the desire to induce large greenhouse gases emitting countries to join international climate change mitigation actions are the main reasons for considering import restrictions on products with high carbon footprint originating from uncapped nations. The aim of this paper is to examine current proposals on emissions-related border adjustments measures - tabled in the EU and the US - using the WTO legal framework on border adjustment and detect possible legal flaws which could lead to conflict with WTO law in the future. Special scrutiny is given to the proposals on the requirement for importers to submit emission allowances at the border and allowance rebates on exportation. The key questions are whether regulatory distinction between products based on their carbon content is permissible under the national treatment obligation of Article III of the GATT and whether an emission allowance requirement can qualify as an indirect tax acceptable for adjustment. The test on WTO compliance presented in this paper shows that proposals to include reports in national cap-and-trade systems and suggestions on emissions allowance rebates on exports are vulnerable to WTO challenge. The weaknesses of an emission allowance requirement for importers lie in the peculiarities of an emission allowance requirement as a quasi-tax linked to non-incorporated Processes and Procuction Methods (PPMs), in the criteria chosen for import coverage or exclusions and in the implementation details. Proposals on allowance rebates contradict environmental objectives and risk getting in conflict with WTO rules on subsidies.

Border Tax Adjustment to Combat Carbon Leakage: A Myth

Discussions about unilateral trade measures as a means to combat climate change have become quite fashionable notwithstanding warnings against unilateralism and protectionism from the leaders of G-8 and G-20 in times of an economic crisis. A system of ‘border tax adjustment’ on imports is suggested in order to countervail the cost of domestic emission trading systems. The proponents argue that without such measures, a country having adopted an emission trading system would not only lose economically but also environmentally. The standard reason given to justify this argument is the notion of carbon leakage, namely, the danger that energy-intensive production would move from countries with domestic policies to reduce greenhouse gas emissions based on a carbon price for emitters to regions that do not have a binding and costly regulatory CO2 regime. Recently, the discussions have been fuelled by the Waxman/Markey Bill, adopted on 26 June 2009 by the House of Representatives and by a French non-paper, presented at the informal EU Environment Council held in July 2009. These two initiatives aim to establish, in the context of a domestic emission trading system, a system of ‘border tax adjustment’ against some imports from some countries, namely, those that are seen as not contributing enough in the fight against climate change. The revised European ETS Directive does not provide for border measures. It instructs the European Commission to submit a report to the Council and the European Parliament no later than 30 June 2010 assessing whether energy-intensive sectors are exposed to a significant risk of carbon leakage and explicitly outlines the inclusion of imports in the European Union’s ETS system as one of several actions. The joint WTO-UNEP paper on trade and climate change has been widely regarded as a justification from a legal point of view of such measures. While there are many proponents for such measures, there remains a considerable amount of skepticism; politicians, business organizations, and scholars have warned against such an approach. The following short note will discuss the feasibility of ‘border tax adjustment’ in relation to domestic climate change legislation as well as some WTO legal aspects along the following questions: (1) Are there target countries for border measures? (2) Would border measures help to combat climate change and could they be administered without too much bureaucracy? (3) How should border measures be qualified under General Agreement on Tariffs and Trade (GATT)?

The ETS Reform and Carbon Leakage: Economic Analysis of the New ETS Directive

After recalling to which extent the inefficiencies emerged during the Emissions Trading Scheme past trading periods are related to its institutional framework, as defined by the Directive 87/2003/EC, this article focuses on the major provisions of the 2008 European Commission Proposal for a new ETS Directive. The aim of this article is to analyze if and how the Emissions Trading Scheme functioning will be improved during the post-Kyoto trading period (2013-2020). The article focuses on three variables. First, it analyzes the new procedure and criteria for setting the ETS cap. Then, it moves to analyze the new default allocation rule, which is auctioning, and the related risk of Carbon Leakage, discussing both the criteria to assess it and the measures to prevent it. Finally the article focuses on the procedure and criteria to divide the ETS cap among the trading sectors in an effective way. The paper concludes that, while the ETS cap setting reform has contributed to improve the ETS effectiveness by reducing market distortions, the same cannot be written in the case of the new allocation rule. Instead of improving the allocation transparency and granting higher rules harmonization, the EC has defined highly discretionary and inefficient criteria to assess the sectors' exposure to Carbon Leakage and the corresponding allocation rule, thus increasing distortions, uncertainty and non-homogeneity within the ETS. While in a theoretical closed economy auctioning is superior to grandfathering, the way auctioning is going to be implemented in the third ETS trading period is far from being the efficient and effective allocation rule described by the European Commission.

Soft or tough guys in Kyoto? Free-rider incentives and the Samaritan's Dilemma

One crucial precondition for the overall achievement of the Kyoto Protocol by 2010 is the participation of the USA. According to political economy theory, big countries have the strongest incentives to provide global collective good provisions. Reality, however, does not seem to follow this logic, as the USA dropped out in The Hague (2000). One main argument for the USA to drop out was the risk of carbon leakage, i.e. the fact that investments would shift to big developing countries such as China and India. We apply the approaches of collective action theory by Olson (1965) and the Samaritan's Dilemma game by Buchanan (1975) to this problem. The policy recommendation on how to make the USA rejoin the agreement is that other countries should support the USA in its tough policy towards big developing countries, i.e. to define preselected rules for participation and delegate the decision-making power to a neutral international institution such as the World Trade Organization. This initiative may both induce big developing countries to join the Kyoto Protocol and may also ensure that the USA will rejoin and that all Annex B countries will reach their stated target levels.