Point Carbon: border levelling should be among options to address carbon leakage
Michael Grubb and Simone Cooper, Climate Strategies
In this continuing world of unequal carbon prices, the issue of carbon leakage continues to be high on the international climate policy agenda.
Carbon leakage occurs when production moves to regions outside of a carbon pricing zone, compromising the environmental integrity of the carbon pricing initiative and impacting on a region’s GDP and employment.
The debate on determining sectors at risk; in terms of assessment criteria and thresholds, is well developed but inconclusive. Modelling studies have determined that only a handful of sectors are likely to be at a significant risk of carbon leakage. However, the European commission’s 2009 assessment identified 164 sectors “at risk”. The EU must now decide how to treat these sectors and to identify appropriate sector-specific responses to reduce the risk of carbon leakage.
Climate policy develops quickly. The lack of consensus on assessment criteria for carbon leakage has not precluded the evolution of the debate to assess which policy options will counteract competitive distortions from carbon pricing in specific sectors of the economy.
Free allocation has been widely viewed as the de-facto policy option in every sector. This protects energy intensive sectors by reducing their carbon costs. As a result, the rest of the economy has to deliver more to reach a given emissions target. Free allocation also dilutes the underlying incentives to undertake mitigation actions and decarbonise a sector and reduces auction revenue which could be used to finance mitigation, adaptation and low-carbon technology.
Free allocation is not free: overall, modelling by CIRED for Climate Strategies suggests that protecting the steel, cement and aluminium industries alone with free allocation could increase the costs to the rest of EU industry by 10-30 per cent, under the current EU target to reduce greenhouse gas emissions 20 per cent under 1990 levels by 2020.
Moreover, in the third phase of the EU ETS, from 2013-2020, free allocation could not offset all the carbon costs: legislation limits the amount of free allowances, particularly if the EU moves to a 30 per cent emission reductions target.
Instead of levelling down the costs for producers in the carbon pricing zone, there is also the opportunity to level carbon costs at the border, equalising the carbon costs with international competitors. By introducing sector-wide policies, suitably aligned with industry cost structures and likely channels of leakage, border levelling can be used as a non-discriminatory tool to ensure all installations in a sector face the same carbon costs.
Border levelling should be clearly distinguished from the wider debate on the use of border adjustments as a way of creating incentives for other countries to do more. Levelling is what it says: ensuring that energy-intensive products consumed in the EU pay a carbon price, irrespective of where they have come from, to avoid discriminating against domestic production. As such, it can in principle be entirely compatible with world trade law – unlike proposals to discriminate between other countries on the basis of their climate policies.
Both the effectiveness of free allocation and the ease of border levelling vary by sector. A recent study by the Carbon Trust applied the Climate Strategies research to cement, steel and aluminium, concluding that border levelling is unambiguously the preferred approach for cement. Given eight years of free allowances, cement firms covered by the EU ETS may find it more profitable to sell EUAs and import clinker, the most carbon-intensive part of the production process. Overall, free allocation could increase cement sector profits by €10-20 billion over phase three, without even stopping carbon leakage. But as a moderately simple product and process – without a high international trade value - it would be relatively easy to implement border levelling by requiring importers to purchase allowances per tonne of product, based on a sector-wide benchmark on emissions levels from best available technology.
Free allocation is not the most appropriate policy option in all sectors. Policymakers should consider expanding their tool box of policy options for addressing carbon leakage to include border levelling measures.
For further information on Climate Strategies see http://www.climatestrategies.org.uk
