climate policy and industrial competitiveness: ten insights from europe on the eu emissions trading...

8/8/2019 Climate Policy and Industrial Competitiveness: Ten Insights from Europe on the EU Emissions Trading System

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CLIMATE & ENERGY PAPER SERIES 09

CLIMATE POLICY AND INDUSTRIAL COMPETITIVENESS:TEN INSIGHTS FROM EUROPE ON THE EU EMISSIONS TRADING SYSTEM

MIChAEL GRUbb

Chief Economist, Carbon Trust; Chair, Climate Strategies

ThOMAS L. bREwER

Research Director, Climate Strategies

MISATO SATO, Doctoral Student, London School of Economics

RObERT hEILMAYR, Research Analyst, World Resources Institute

DORA FAzEkAS, Research Manager, Climate Strategies


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Tis paper would not have been possible without unding rom the ransatlantic Climate Bridge, an initiative jointly

launched by German Foreign Minister Dr. Frank-Walter Steinmeier and German Environment Minister Sigmar Gabriel to

connect and support those working to address the challenges o climate change, energy security, and economic growth at

the local, the state, and the ederal level in the United States and Germany.

Te writing o this report was supported in part by a grant rom the Norwegian Royal Ministry o Foreign Aairs.

Climate Strategies aims to assist governments in solving the collective actionproblem o climate change. It connects leading applied research on international

climate change issues to the policy process and to the public debate, raising the

quality and coherence o advice provided on policy ormation. It convenes inter-

national groups o experts to provide rigorous, act-based, and independent assessments o international climate change

policy. o eectively communicate insights into climate change policy, Climate Strategies works with decision-makers in

government and business, particularly, but not restricted to, the countries o the European Union and the EU institutions.

www.climatestrategies.org

Te Carbon rust was set up by the U.K. government in 2001 as an independent company to ac-

celerate the move to a low-carbon economy. Its mission is to accelerate the move to a low-carbon

economy by working with organizations to reduce carbon emissions now and develop commer-

cial low-carbon technologies or the uture. www.carbontrust.co.uk

2009 Te German Marshall Fund o the United States. All rights reserved.

No part o this publication may be reproduced or transmitted in any orm or by any means without permission in writing

rom the German Marshall Fund o the United States (GMF). Please direct inquiries to:

Te German Marshall Fund o the United States

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copies are also available. o request a copy, send an e-mail to [email protected].

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About GMF

Te German Marshall Fund o the United States (GMF) is a non-partisan American public policy and grant-making

institution dedicated to promoting greater cooperation and understanding between North America and Europe.

GMF does this by supporting individuals and institutions working on transatlantic issues, by convening leaders to discuss

the most pressing transatlantic themes, and by examining ways in which transatlantic cooperation can address a variety o

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Europe: Berlin, Bratislava, Paris, Brussels, Belgrade, Ankara, and Bucharest.


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Climate Policy and Industrial Competitiveness:en Insights rom Europe on the

EU Emissions rading System

Climate & Energy Paper Series

July 2009

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Climate Policy and Industrial Competitiveness:

en Insights rom Europe on the EU Emissions rading System3

U.S. C b .

Wx-Mk b w b H

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x w -

- , U.S. k

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x x

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ES) k

U.S. b, w ,

w:

1. Emissions trading works

MI EU ES

E b 13

b x (MCO)

, 5 ,

x w. I

k

,

w

() E

b x.

Recommendation: D

EU x.

2. Everyone will learn

C b x b bj

bb; ,

, w b b.

N b

w w b b . EU

ES b

, w w

,

.

Recommendation: B

x

.

3. Prices can be volatile and affected by

numerous unforeseen factors, which to date

have reduced prices below expectations

EU ES b q

k b w x.

w

b j.

O ,

wb , CO .

W j,

b w--x

w-b

. Db

b w bk w b b

k b .

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EU x

b

j, b

,

b

.

4. GDP impacts are small

, EU ES b b

bj

bw j,

1 EU

(GDP). M,

Executive Summary


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he German Marshall Fund o the United States4

x w-b ,

b

.

Recommendation: D

b

. E

b j.

5. Industry can profit

E b

. I, EU ES,

E

x. W ,

,

, (

R 7).

Recommendation: R b

xz ,

b

.

6. International competitiveness impacts are

limited to a small number of industry sectors

F ,

b

w b

b.

b

, x, x

. A ,

b w

, ,

. Hw, b-

, .

Recommendation: C b

w x . F ,

b .

7. Free allocation introduces risks of windfall

profits

A , b

b ,

q , . S

b b b

bk, b

w

k.

Recommendation: D z

b

b , w b

b

. C b bw

.

8. Free allocation can also degrade program

efficiency

I b

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k -:

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, .

Recommendation: A b bw b

-b

z w


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w . b bw w

b , x

k,

b

, b,

.

9. There is a compelling economic rationale to

maximize auctioning

A

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w-b . I

b b

w-b ,

b

b , /

.

Recommendation: Mxz .

10. Unilateral border adjustments may be a

politically appealing way to respond todomestic pressures from special economic

interests, but they risk serious problems in

the international trading system

b b j

b w E, b

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k

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b qb w

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Recommendation: N

b j, z k, w

b b .

k

EU ES. A ,

w EU

ES x U.S.

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w-

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b

w ( b

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b ).

EU U.S.

- w

b , j -

b EU x

q .

P (-), EU ES

w b b U.S. x

.


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.

Section5discussesthepolicytoolsthatare

b

k .

C z

b .

Introduction1

Questions about

the effects on

the international

competitiveness

of U.S. industry

... acquire aparticularly sharp

edge if there

is a prospect

of companies

relocating to

other countries

without similar

regulations.


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The EU experience

to date is that

cost projections

are frequently

overstated and

caps have proven

easier to achieve

than anticipated.

Key issues or U.S. legislation

S , b

w,

-- . I

. I

, b w

x

x ,

w. EU

x j

q

.

A U.S. k b

w b ,

b b,

j ,

b b .

Wx-Mk b b U.S. H R J

6 GHG

b C

.

I b Wx-

Mk -- EU ES .

R 1, EU b

5 w U S

( C 1 ). EU ES

,

, b w . Wx

Mk b, b ,

, ,

, w

x 87

U.S. .

Caps and Costs2

Box 1. Emission caps in Waxman-Markey and the EU ETS

Chart 1. Proposed emission reductions under the Waxman-Markey bill

Chart 1 shows U.S. emissions in 1990 and 2005, and the reductions proposed in the Waxman-Markey bill. These targets

would cover most of the U.S. economy. By contrast, the EU ETS caps industrial emissions (including electricity production),

representing about half of the EUs CO2 emissions and over 40 percent of total greenhouse gas emissions (see Chart

2), and other sectors are addressed through different policies.* Emissions from the EU ETS sectors have been declining,

and are generally projected to be cheaper to control, while those covered by other policies have been rising. Chart 2

shows this division and the proposed total caps for 2020, which are set within EU goals to achieve 20 percent reductions

(relative to 1990 levels) by 2020 unilaterally, or 30 percent if there is an effective international treaty.

* F x, bj x x qb , wk . E C E Pk b Mb S . S: CS

2050204020302020201220051990Baseline

0

2

4

6

8

10

12

Waxman-Markey,HR 2998,Upper range

Waxman-Markey,HR 2998,Lower range

Businessas usual

emissions

GtCO2

e


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The emission

targets outlined

in the Waxman-

Markey bill as

passed by the

U.S. House of

Representatives

are some of the

most aggressive

GHG goals of any

proposal serious

considered by

Congress in

recent years. EU ES

, b b

. EU

ES b , b w w 5.

Wx-Mk b 5.

I ,

bw EU ES Wx-

Mk :

TheEUETSisaninternationaltrading

, 7 b

E U. Lk

U S,

z w k

b b

, E w

w wk b .

B , EU ES

z ,

b w b

w , N A

P, bj b E

C.

TheEUETSwasfromtheoutsetdesigned

. P I, 57,

w -

bq

j b w

bq . P II,

81, w

EU K P

. P III w b

13.

, b N A P

z , EU

D Db 8.

Chart 2. EU greenhouse gas emissions, 19902020, and the EU ETS component

Source: Carbon Trust, Cutting carbon in Europe: The 2020 plans, June 2008

EU-27

GtCO2

e

0

1

2

3

4

5

6

2025Review of cap

2020E2020E

Post-Kyoto agreement?

Baseline

-8%

58%

42%

20051990

No -20%

61%

39%

Yes -30%

Emissions

outside of

the EU ETS

Emissionsinside of

the EU ETS

Non EU ETS

-10% to -17%

or more on

2005

EU ETS

-21% to -30%

or more on

2005


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Withineachphase,allowancesarefixedexcept

w . F x,

b b j

.

D w ,

b w

EU x.

Caps have been easier to achieve than

originally projected

B , EU ES . b w

b .

C 3

k E Aw U

.1

I P I (57), b

bk , b

1 I , b x . Ow, x, -

x U.S. , $1.484 (k J 6, ) .

b w.

P I b bq

(w bk w w)

- . A b

P I w ,

w z.

Hw, w k

w P II (81) w

k . P II b

8, , b

w .

x. U.K.

, w w

bk; b

b

w b , .

U.S. R G G I (RGGI)

,

,

w , w

.

35

30

25

20

Euro

s

perton

15

10

5

0

30

25

20

15

10

5

0

MtCO

2

Dec 2007 Dec 2010

OTC volume

Exchange volume

Dec 2009

Dec 2008

Q1 Q2

2005 2006 2007 2008 2009

Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Chart 3. European Allowance Units prices and volumes 200509

Source: Point Carbon


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There has been both over-allocation and

signiicant emissions abatement

U.K. ES EU ES P I

b b x

b w x

b . S

q .

MI- b E

B (8), w w .

b EU ES

(C 4), w w

EU ES x 1 b .

A ,

w

b

.

B EU ES .

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w b

b $3 CO (CO)

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D, 7) EU ES

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w 5 6, ,

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w b 51 MCO/

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b E B

EU ES EU b 13 MCO

,

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EU ES P II 8.

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x 8

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I b b / -w b /. I // w , b

. O //k w , .

3 D ww b j , j K (81) 18+/ MCO j j . S Cb (), The GlobalCarbon Mechanisms: Evidence and Implications.

Studies suggest

that the EU ETS

its first two years

cut emissions by

50100 MtCO2/

yr, or by around

2.55 percent.

Chart 4. Potential emissions and

the impact o the EU ETS

Source: Ellerman and Buchner (2008)

MtCO

2e

BAU

Emissions

Growth?

BAU

Emissions

Growth?

20062005Historic(2002)

0

500

1,000

1,500

2,000

2,500

+2.0% p.a.

+1.0% p.a.

+2.0% p.a.

+1.0% p.a.

Veried

Emissions

2005

EU ETS

Baseline

Emissions

Veried

Emissions

2006


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In stark contrast

to the strong

industrial

opposition to

the EU ETS

before it was

launched, the

evidence is that

companies in

all participating

sectors have

actually profited

to date.

Robust institutions with a legal basis have

been required to strengthen the system

P II EU ES

(81) w z

w k, w P I

w

w, b ($8

b) P II. N

, w bj

bb . M N A

P (NAP) w b

w b

P I b S 6.

U EU ES D,

E C w j NAP

- w

w K . P

II NAP w b w K ,

w

bw b-- j. I

Nb 6, C j

NAP q. B j

b , E C k

b .

5

5 5 . I , k

b bk w

EU ES.

I , C

E b 1

NAP.

w b CO

P II w b .

P II

w w, k P I, b ,

w w b

bk w w

P III .

x w w .

All participating industrial sectors have

proited rom the EU ETS

I k

EU ES b w ,

EU ES

b ,

.

w . O

w. A x w

b b w, w x

b ( Bx ).

P b x

w, w.

b b

w, (b x)

w k ( Bx ).

Wx-Mk b w

w b w w

b , w b

. w , b

b w b

.

Hw, Wx-Mk

w w EU ES

x w w ( -

b ). EU ES w

w; Wx-Mk

w w

. b

EU x w

b .


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BOX 2. Windall profts and opportunity cost

Emissions trading can either increase or reduce firm profits, depending on the extent to which a sector (i) has free

allocation, (ii) passes through costs to product prices, and (iii) undertakes abatement. The power sector in the EU ETS

Phase 1, for example, profited considerably by passing through CO2 prices to consumers while receiving allowances

for free. This increased revenues far more than any allowance shortfall raised costs. The EU ETS experience has thus

confirmed a general economic principle illustrated in Chart 5 below: companies may profit from emissions trading, to

a degree that depends on the extent of free allocation (vertical axis) and how much carbon costs are passed through

(horizontal axis).

Chart 5. Proft and loss as a unction o ree allocation and cost pass-through

(proft margin and price increase correspond to steel in Europe at 30/tCO2)

In competitive markets, profit-maximizing companies will tend to set price in relation to short-run marginal operating costs.

In such markets, the cost of producing an extra unit is balanced against the value of the additional sales. Emissions trading

increases this marginal cost, since companies either have to buy allowances or forego the opportunity to sell allowances, to

cover the extra emissions. Providing all directly competing companies face the same incentive, they will tend to raise prices

to reflect this opportunity cost. In the absence of any output-based compensation, this will tend to the full carbon price.

It is much as if energy prices rose and fed through the economy, but governments then compensated companies with

cash transfers. However, irrespective of free allocation, companies will still then strive to reduce their emissions as long

as the costs of doing so are lower than the market price of an emissions allowance.

A foundational report on this topic (Carbon Trust 2004), which included modelling of five industrial sectors, first predictedthat most sectors would profit from the EU ETS; this has been borne out by experience. Capping carbon means

that emitting it is no longer free: emitters and consumers can and should pay for it. The impact on firm profits and

competitiveness will depend upon who gets the resulting economic rents, and free allocation enables business to benefit

from this (Grubb and Neuhoff, 2006, explain the mechanisms further). It is estimated that power generators in Europe

have profited by many billions of euros from the EU ETS, and this reality has underpinned a wholesale move to auctioning

allowances to generators in Phase III of the scheme. The underlying principles however apply to any competitive market,

subject to constraints of competition from countries without carbon pricing.

ProtMargin

0%

0%

5%

10%

15%

20%

15%

100%

End-use price increase

%ofop

portunit

ycostp

assedon

toprice

10%5%

90%

39%

0%

Current prot margin

%o

fallowances

receivedforfree


16/40


The sequential

design of the

EU ETS, as the

worlds first major

greenhouse

gas trading

scheme, enabled

policymakers

to revise the

design in light of

experience.

Centralizedallocationrules

EU b . G

,

k.

k, b

j

w

. B b

b bk

, EU-w .

Amovetoauctioningasthedefault,withno

morefreeallowancesforthepowersector

W x E

E b , w w

b w

13.

w b

b P III ,

w b b, 5 .

I , EU ES

b z ,

z

-- .

k

b .

Learning by both policymakers and

businesses has been extensive and valuable

and has led to major improvements in design

or Phase III

q EU ES w wk

-

b, b b ,

w j ,

b k

x. P I b k

b

b w ,

b b -,, w . P II

,

q w

k x, j

b .

W - P II, EU

k k w .

P III w:

Steeperemissioncutbacks

b , wb EU

b 3 bw 1 .

M,

, w w

5. E kw

bz:

C , w

kw w b

b w .


17/40



While a specific

allocation

method may

be appropriate

for one sector,

it may have

more adverse

consequences

for distribution,

efficiency or

incentives for

innovation in

another.

w , bw w

k b k (

S 5). F

k

x ,

bk .

Wx-Mk b

w w

x EU.

S:

Forthepowersector,allowanceswouldbe

b

w

w ,

,

k b b. I, w

w x E

w k.

Output-basedformulasforallocationto

w b w

w .

k w , w

-.

Hw, w U.S. k

w x EU,

-b w

b. I - (

w b , w

) -

x . I , xb b bw. EU

b -

b , -

w w

, w

O , k w w .

A w EU,

w

x, , bj bb

. A

x w

,

b q. M

EU b , w

. W

b w,

b EU U S.

Allocation methods need to be adapted to

sector-speciic characteristics

A k

, w w z b

, w ,

. EU ES

w

w, b w

. W

b ,

q b,

.

A w

EU ES .

I P I, w b

bw . Pw

w , b

CO. I P II, b

b w b

, w w

w . P III k

Allocation and Incentives3


18/40


Losing such

opportunities

for low cost

abatement and

incentives for

innovation will

increase the

overall cost of

the program.

b bj .

Wx-Mk b b

w

.

Hw,

w-

. k

w b x-

b,

kW, b z

b. S, -

k , w

b w b

b

b . L

w- b

w .

Pk b w

b k w

.

Eiciency matters and perverse incentivesare possible

k , b-

- . W

b

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b k, w

q .

I

q

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b

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I ,

w w b

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b k ,

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b .

A w

,

z b

GHG. F, w

,

w

k,

b x

b . S, GHG b , b b

b b , b k

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b , ,

bk b

b , b

x.

M, EU b ,

, w

k, k x . G

w, xb b

,

b ,

b k b.

O , w


19/40



w k

. b

w

b wbk ww w

( )

. G w b-

w

w-b . E

x , w

, x

w .

, k

, z

b 1. A, w

b,

. G w b ( w

)

, b . Hw,

w

, k b

.

Benchmarking can retain incentives or irms

to invest in energy eiciency measures, but

is complex

I k

, b bk (

w b b ),

b

.

k ,

Table 1. Pyramid o inefciencies rom ree allowance allocation

Impacts on Increase plant operation

More expenditure on

extending plant life relative

to new build

Less Energy efficiency

investments and demand

substitution

Allocation Method Distortions

Bias toward

dirtier plants

Encourages

operation

Discourage

plant closure

Bias toward

dirtier plants

Reducesincentives for

consumers

Reducesincentives for

producers

Auction

Grandfathering with

Benchmarking

Capacity only X

Capacity by fuel/

plant typeX X

Grandfathering

with updating from

previous periods

Output only X Y X

Output by fuel/plant

type*X X X X X

Emissions X X X X X X

Output-based *

(undifferentiated)allocation or rebates

Final product X X XX

Intermediate product(e.g. clinker)

X X XX XX

S: A N (8)

* O-b , w b , k w .

N: X .

XX .

Y /.


20/40


Efforts to avert

windfall profits

risk solving

one problem

at the expense

of creating

another

reduced

economic

efficiency.

. I w , w

() k k

,

bk . S EU

b bk w

P II EU ES.

Hw, bk

b x, w

. Cx

w k

b, w b

x

.4 xb

b k-b

.

D , w b

bk P II,

EU k x b

w bk P III.

Free allocation based on outputs poses

dierent issues.D b

(.. ), q

b , Wx-

Mk b.

b b

k x

. P b bk

,

w w

b- ,

b b w

. S

w w w, -b

4 EUMb S w EU ES bk b w b b .

j

b. B

b , -b

,

b .

I, b

-b .

S b b

. I ,

b

, b b .

,

-b ,

x S 4 5.

The unavoidable tradeo points to a bigger

role or auctioning

O EU ES, k

w b w z

U S.

w , w, k b x

. I , k

- .

bj b,

b w b

b

b

.

EU

b b

w (w b b ). R

,


21/40



Consequently,

there is an

underlying

economic

rationale to

maximize

the role of

auctioning

as a default

to create a

robust, fair, and

transparent

market

framework.

b ( b).

Cq,

xz

b, ,

k wk. A

, ,

w-b . I

b b . S

b ,

w-b , b b

,

x

. B ,

b

x b w ,

, z

b .

A

k k 1

w b b , k

b w k

w b .

Wx-Mk b

w

( b ).

I , - ,

w b

b b w

w.

, b bk .

O b z b

z, w

q

b . O

b b

w , w

b

. A ,

b ,

b b .


22/40


Cost differentials

due to labor and

other input costs

for most sectors

far outweigh any

international

differences in the

cost of carbon.

Competitiveness: Whos at Risk?4Macro-level GDP impacts are modest

S b

b b

. S w

x E U

S.

j

b x

b ,

w .

S, E C (8)

EU ES .3.7 GDP, q w

w . M,

x w-b

( x),

b

.

N b

b . E ,

b

w b. b

, x,

x- . N

k b

b,

.

There are wide variations in impacts across

speciic sectors

b

w b

. , w

x. C 6

b k U.S.

b , b

,

, b GDP. ( Ax q

U.K. G.)

bw

k, b -

.

x

b . B b

, Cb (8) x

b b

, - U.K. :

Ironandsteel

Aluminum

Nitrogenfertilizers

Cementandlime

Basicinorganicchemicals(principallychlorine

k)

Pulpandpaper

I b U.S. U.K. ,

.5 GDP .

G, b

w bw GDP. F

, $/CO b

b

1 -.

B , GDP b

, U

S. Hw,

w , b

x. A $/CO

x . O

. Cb

(8) ,


23/40



Chart 6. Relative cost-sensitivity o U.S. manuacturing activities to CO2 pricing(6 digit NACE sectors)

Source: Data from Houser, Trevor, Heilmayr, Robert and Werksman, Jacob, Peterson Institute for International Economics

and World Resources Institute, forthcoming.

Notes: The vertical axis shows the implied cost increase if sectors pay the full cost of CO2 at $20/tCO2 as a percentage

of the sector value added. The horizontal axis indicates the scale of the activitys contribution to U.S. GDP. The area of

each column is proportional to total CO2 emissions. The blue bars show the cost of carbon that would be paid through

higher electricity prices (the majority of CO2 costs are passed through by the electricity companies, which would be largely

avoided under the Waxman-Markey proposals). The gray bars show the direct cost due to the carbon emitted through

direct fossil fuel consumption and manufacturing processes.

0.0 0.5 1.0 1.5 2.0

% U.S. GDP

0

5

10

15

20

25

30

45

40

Value

atstake

(CO

2

costincreas

e

relative

to

value

added)

Cement

Lime (51%)

Other basicorganicchemicals Secondary aluminum smelting

Industrial

gas

Flat glass

Other basic inorganic chemicals

Carbon black

Bricks & tiles

Alkalies & chlorine

Wet corn millingPlastics material& resin

Glass containers

Petroleum reneries

Blown glass

Alumina rening &primary aluminum

Nitrogenous fertilizers (57%)

PaperboardIron & steel& ferroalloy

Pulp mill

Direct CO2

impact

Indirect CO2 impact

b x

b , w k , , .

, b

x x $1/CO. (S b k

U.K. .)


24/40


Even small

shifts overseas

are politically

sensitive, and all

the more so if they

are associated

with carbon

leakage and thus

undermine the

environmental

benefits of the

cap and trade

program.

International trade eects are immaterial or

most sectors

Ex w , , b

w

. Cb w b

b, , . -- x , x, b

5 bw 1 6, w

b

w b b j b

.

F k ,

x, w

. A b S ,

b

x w () , ()

, ()k b. S w b

b b , b

,

k k

. P

. b ,

b .

I ,

b b

. F x,

b , b

b. F

. A

z b

wk

. b

w

(..

b ).

Evidence o impacts to date is nebulous

I

EU ES, b b b

EU b

x . W Bk (8)

x

w

Table 2. Impact o a 20/tCO2 carbon price on major U.K. energy-intensive productsMaximum

value at stake

at 20/tCO2

Minimum value

at stake at

20/tCO2

Trade intensity

(non-EU) Employment

Implied average product price

rise to offset 20/tCO2

Manufacturing Activity

0% free

allocation

100% free

allocation % % UK

0% free

allocation

100% free

allocation

Cement 33.9% 2.0% 1.8% 0.02% 14.54% 0.86%

Basic iron & steel and

ferro-alloys26.4% 2.4% 17.4% 0.08% 4.28% 0.39%

Refined petroleum products 12.3% 1.4% 19.3% 0.04% 1.07% 0.12%

Fertilizers & nitrogen compounds

inc. ammonia11.6% 5.7% 13.2% 0.01% 1.96% 0.96%

Aluminum 10.4% 9.3% 23.2% 0.04% 2.07% 1.85%

Other inorganic basic chemicals 9.0% 5.8% 20.6% 0.02% 2.36% 1.52%

Pulp, paper & paperboard 8.8% 3.4% 15.1% 0.06% 1.98% 0.76%

Source: Carbon Trust (2008), EU ETS Impacts on Profitability and Trade, Table 2.


25/40



EU b . I, W Bk

b , bb

-

. w

-

EU ES .

Hw, x k

b ,

w q b k,

. M EU w b , ,

k EU

k b b , b b

(Cb

8). A q U S

b b (A Pz,

) :

... CO $15/CO w 1.3

U.S. , b

.6 .

.7

. b

w w

x 1

w x b

,

.

Hw,

,

w b k

b --

. b b

k ,

x .


26/40


There are only

three fundamental

options to address

competitiveness

concerns.

M b . W

,

b . Hw, ,

, . I

b w b

, ,

. P (1) k

b ;

() b

q b; (3) w

b.

Leveling up is the best option in principle

A

b w , ,

w w j

b ,

x.

w b w b

w b

. Hw,

. P, z w

q

b b b

bz . M,

b . A w

w ,

w w b.

, z w

k,

w ( w,

w b)

b , .

Free allocation has been the deault option in

the EU, but it is being drastically reduced in

Phase III o the ETS

EU b

b . I P I

, P II , w

. M

j

(w q b

x, ) w

b w k .

Hw, k

b ,

wbk ,

S 3. (.. Gbb N

6)

P II, j

P III.

A P III w

. I w

kw ,

b

w , w

: , w

k ; () b k.

P III, 13,

, C 7. W

,

:

Powergeneration

, w b

E E

- ( k x

w b ).

Options and Prospects for Tackling

Carbon Leakage5


27/40



( )

w , w

b b

w . Hw,

w -

k ,

b

b , bj EU

.

Manufacturing, ,

,

b 57

.

w 13 8

, 3

b . w

.

Sectors b k

b k 1

. C 7

.

b

w, k

: EU ES w

Chart 7. Allocation and emission in the EU ETS

EUA

(1000s)

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

202020192018201720162015201420132012201120102009200820072006

Phase I

(20052007)

Phase II

(20082012)

Phase III

(20132020)

2005

Auctioning

Manufacturing at 100% of share

Manufacturing at declining level of share

NMS Power Sector free allocation

Free allocation to Industrial sectors

Free allocation to combustion installations

Cap

Veried Emissions

Veried emissions combustion installations


28/40


Leveling down

costs is either

ineffective at

tackling carbon

leakage, if it

is not aligned

with production

and investment

decisions, or it

starts to negate

more of the

incentives to

decarbonize along

the economic

system.

6 w 13, 785 b . A k

q k

k, b w

.5

Hw, w Wx-

Mk b b

b w -.

But ree allocation may not solve the leakage

problem, or may do so at a high cost

EU b (w -b )

k b k.

Ww w

. b w

w , w , k

b . B

w w

x

, w

,

w. -b b Wx-Mk b.

5 D b b b b, . M b - b k b , b b w b- , , . b w b E -, w w b k w w w 8 13. O w b b k b k - w k b . wk b , b b (N ).

. k b k b w,

b b k

k . B

w, b

, w

. w :

w k

b k, w

,

bz

. C x b ( Bx 3).

, w

w b

.

Unilateral border adjustment measures are

problematic and potentially counterproductive

D b j E

b b x b

, b w

. w w

EU ES P III

x (

EU D b

b j ).

Hw, z

, F

,

w

. B

b EU EU ES P III

b C .

b bj

b j, w k

b ,

w -


29/40



, w W

Oz (WO)

,

k z b

. M, x

b

- b ,

w q b

b, ,

bb .

BOX 3. Cement: A chunky problem

Cement production in the EU emits about as much CO2 as steel, and much more than international aviation.

It has received relatively little attention, but it poses a thorny problem for CO2 control that illustrates key

dilemmas in policy design.

Cement is a relatively simple product involving a few key steps. The basic process bakes limestone in a

kiln to produce nodules called clinker; the combination of raw fuel and CO2 driven off from the limestone

accounts for most of the CO2. The clinker is then crushed and blended to produce cement.

Studies with U.K. and German data find that carbon costs have a higher impact on U.K. cement costs,

relative to value added, than for almost any other activity (Climate Strategies 2008; see Appendix). Cement

is not cheap to transport overland, but it can be shipped in bulk, and carbon costs of $20/tCO2 would

create differentials sufficient to start overcoming international transport costs.

The impact of CO2 controls on cement may be corresponding diverse. Current European proposals to

classify cement as a sector at risk of carbon leakage, correspondingly granted 100 percent of its potential

share of the EU cap, would probably result in large windfall profits to inland producers protected by overland

transport costs. Yet at the same time, coastal producers could choose to reduce output from cement plants,

import cement instead, and cash in their allowances. The result would be windfall profits combined with

carbon leakage.

The Waxman-Markey bill proposals for output-based compensation are intended in principle to address

problems of both windfall profits and carbon leakage. Unfortunately the fact that most of the CO 2 comes

from production of clinker, as an intermediate input, risks making this ineffective. Cement producers could

produce cement so as to claim their compensation, but if they are near ports, they could still displace

domestic clinker production by imports and sell the resulting surplus allowances, again combining windfall

profits with carbon leakage.

Changing the provisions to compensate on the basis of clinker production would solve this, but exacerbate

the efficiency losses further. After power production, the cement sector has been the biggest source of

emission reductions in Europe, largely because operators have found ways to produce cement with less

clinker input. Radical innovations that would cut out the need for clinker entirely, including using some of the

waste products from steel mills, and wholly new chemical processes, are at the pilot stage. Compensating

clinker production would undermine all these potential sources of emission reductions. This is an extreme

form of the underlying principle that output-based compensation negates incentives to use the product

efficiently.

Practical options for the cement sector will be discussed in a forthcoming Carbon Trust report (Tackling

Carbon Leakage, September 2009).


30/40


There is a crucial

difference

between

pursuing border

adjustments

unilaterally, by

regions seeking

to protect their

industries, or

though multilateral

engagement.

q , b j

w w GA

b WO. I ,

-. w x

b j x

x. Lk w,

bk ,

WO A P, k

. b j w

b w

w ( xz b wWO ), q,

j b .

Border adjustments may take dierent orms

Different types of border adjustment by carbon-

capped regions

j

b .

k WO-b.

b w b j b

b WO-b. C

w b b -,

b bj,

q w

(C S: D , ). Hw,

,

k q

- .

A crucial and often overlooked point about

border measures is their interaction with freeallocation decisions

B j b b

.

, b

j, w b

WO . ,

, w b -b , b j

b k .

Use of export adjustments by exporting regions

I w b b

b

x x b . I

C

VA j, x x

- ,

. S b

w WO. Hw, b

k b k

b. M, w

b x

z .

Unilateral versus multilateral

bw

b j , b k

,

. A k C

S k Cb Lk b j b

x w

b b b j.

b,

k WO.

F

. Ob, w,

x k b .

Comparative approaches

F, b j

w b k k b EU

U S, , :

Becausefreeallocation(aspertheEUETS)

b k ,

( )

w ,


31/40



The scale

of adverse

competitiveness

or leakage

impacts are

clearly limited,

by sector and

time, in ways

that should make

the challenge

manageable.

. Hw x b b q -

, , ,

k

. EU

w -

b j, k

--k P

III .

Output-basedrebates,aspertheWaxman-

Mk b, w

w b

. Hw,

w b

. b

qk w

,

b b b . b

w b

-b , w

b x

- bj. Cq,

Wx-Mk

w w b-b b

j.

w

b k

b U.S.-EU w b b. F,

k

, b ,

w k b.


32/40


A Ex S:

1. Emissions trading works

Recommendation: D

EU x.

2. Everyone will learn

Recommendation:B

x .

3. Prices can be volatile and impacted by

numerous unforeseen factors, which to date

have reduced prices below expectations

Recommendation:C

EU x ,

b

j, b ,

b .

4. GDP impacts are small

Recommendation:D b

, E

b j.

5. Industry can profit

Recommendation: R b

xz ,

b

.

6. International competitiveness impacts arelimited to a small number of industry sectors

Recommendation: C b

w x . F ,

b .

7. Free allocation degrades efficiency andintroduces risks either of windfall profits

Recommendation: D z

b

b , w b

b

. C b bw

.

8. or additional inefficiencies

Recommendation: A b bw b -b

z

w w . b bw

w

b , x

k,

b

.

9. There is a compelling economic rationale to

maximize auctioning

Recommendation: Mxz .

10. Unilateral border adjustments may be a

politically appealing way to respond to

domestic pressures from special economic

interests, but they risk serious problems in

the international trade system

Recommendation: N

b j, z

k, w

b b .

Insights and Recommendations6


33/40



x b E

b ,

b

. C 8

w U.K.

. w b w x

(-) U.K. ;

. Ex wk w

w U.K. -

b EU ES.

I , w

15 b- ( S

I C 4- ). B

CO (b )

w . K ,

Appendix: Comparative Data on

European Industries Exposure7

Chart 8. U.K. Manuacturing activities most cost-sensitive to CO2 pricing

Source: Climate Strategies: Hourcade, Neuhoff et al. (2007)

Notes: The vertical axis shows the implied cost increase if sectors pay the full cost of CO2 at 20/tCO2 as a percentage

of the sector value added. The horizontal axis indicates the scale of the activitys contribution to the U.K.s GDP. The area

of each column is proportional to total CO2 emissions. The blue bars show the cost of carbon that will be paid through

higher electricity prices (equivalent to 10/MWh at 20/tCO2). The gray bars show the cost due to the carbon emitted

through direct fossil fuel consumption and manufacturing processes.

Valueatstake(CO

2

costincreaserelativetovalueadded)

Cement

Basiciron&

steel

Lime (MVAS 63%)

Fertilisers & Nitrogen

Aluminium

Other inorganicbasic chemicals

Pulp &

Paper

Malt

Coke oven

Industrialgases

Non-wovens

Rened petroleum

Household paper

Hollowglass

Finishingof textiles

Rubber tires& tubes

manufact.

Copper

Casting of iron

UK GDP

Flat glass

Veneer sheets

0%

10%

20%

30%

40%

0.0% 0.2% 0.4% 0.6% 0.8% 1.0%

4%

2%

50%

60%

Starches & starchproducts

Preparation of yarn

Other textile weaving

Retreading/rebuilding tires

Impact from direct emissions

Impact from indirect emissions (electricity)


34/40


, b

w .

A /CO, w

4

- ( bw

) b w

(1 ),

b U.K. GDP .5

, b 5 U.K.

.

x x

C . Sx w b

bj b

x

. A U.K. -

, b x

.

F k x x

b ;

x.

A -

x, w 51

(GVA) $1/CO,

b .

- w

b z, b

, - , ;

b (b )

.

A G

(C 1) w b

, k

G w

GDP .6

A, G -

b b w

b (

, ).

I b G U.K.

- x, b

w

b 36 GVA z,

b , .

b ,

w b b

$14/CO , w

b b

b

( x -CO ) .

, b 1

q /CO

, b -

.

q x x -

, w w

. G ,

b, j b

b, x

w.

Cb b ,

, w

6 N b, . F x, Ck, (SIC 3) - G. S, , b (SIC 1.1) 3- U.K.


35/40



Chart 9. Trade intensity and value at stake (relative to GVA) or top 25 U.K. sectors in 2004

Notes: Trade intensity here is defined as (value of exports to non-EU + value of imports from non-EU)/(annual turnover +

value of imports from non-EU).

This data reflects U.K. data in the context of the EU ETS. The vertical axis shows potential impact of carbon costs on

sector input costs as a proportion of sector value-added, prior to any mitigation or other response. The upper end of each

bar shows impacts with no free allocation of allowances (maximum value at stake). Under the Waxman-Markey bill output-

based compensation would tend to drop the top of the bar towards the lower end to a degree that depends on the degree

of overall free allocation to the sector. Here, the lower end corresponds to free allocations covering all direct emissions,

leaving residual impact of increased electricity costs (net or minimum value at stake). Under Waxman-Markey the electricity

price impact (bottom of bar or NVAS) would be largely removed. Here, data are shown for an allowance price of 20/tCO 2, a

corresponding 10/MWh electricity price increase, and negligible impact on other input costs.

The horizontal axis shows U.K. non-EU trade intensity, defined as (value of exports to non-EU + value of imports from non-

EU)/(annual turnover + value of imports from EU + value of imports from non-EU).

For consistency given incomplete availability of more recent data, trade data are mostly for 2004.

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0%

0%

10%

20%

30%

40%

50%

60%

70%

Malt

Household & toilet paper

Industrial gases

Hollow glass

Flat glass

Lime

Coke oven products

Potential Net and Maximum Value at Stake

Textile nishing services

Casting of iron

Rubber tires and tubes

Aluminum & productsPulp, paper and board

Preparation of yarn

Copper

Nonwovens and articles except apparelBasic iron & steel

Other basic organic chemicalsStaples

Fertilizers & nitrogen compoundsCement

Retreading & rebuilding of rubber tires Veneer sheet, plywood, laminboard etcRened petroleum products

Non-EU trade intensity

Value

atstake

(CO

2

co

stincrease

relative

to

value

added)


36/40


k .7 F EU , 5

- b q

x $4/CO,

b b w b EU

b .5

; w

b 5 (Carbon Trust,

2008).

k E Climate

Strategies: D ().

7 I -, / x k w EU EU. Y b w , .. - b - b- Nw I. F k k - , .

Q k x b

b (

), b

w w b

( w ) .

C 1

( GVA) b

b. I ,

b , w b

b, ( ),

w (

).

Chart 10. Germany industry cost impacts and GVA

Source: Graichen et al (2009)

0.0% 0.5% 1.0% 1.5%

% of German GDP

0%

10%

20%

30%

40%

50%

60%

70%

80%

Value

atstake

(CO

2

costincrease

relative

to

value

added)

Cement

Lime

Other basic inorganicchemicals

Starches & starch productsFlat glass

Pulp

Other basic organic chemicals

Ceramic tiles & ags

Bricks, tiles & construction products

Hollow glass

Sugar

Veneer sheets;plywood, laminboard;particle & bre board

Plastics

Processedpotatoes

Glass bres

Household &toilet paper

Other glass,processed

Aluminum

Fertilizers &nitrogen compounds

Paper & board

Othermineralproducts

Basic iron & steel

Copperproducts

Direct CO2 costs (0100% free allocation)

Indirect CO2

costs (pass-through electricity)


37/40



A, J. E. Pz, W. A. (). TheCompetitiveness Impacts of Climate Change

Mitigation Policies. A, V: Pw

C Gb C C, .

Cb (4). EU ETS Impacts on Industrial

Competitiveness. L: Cb .

Cb (6).Allocation and

Competitiveness in the EU Emissions Trading

Scheme. L: Cb .

Cb (8). Cutting Carbon in Europe:

The 2020 Plans. L: Cb .

Cb (8b). EU ETS Impacts on

Profitability and Trade: A sector-by-sector

analysis. L: Cb .

Cb (). The Global Carbon

Mechanisms: Evidence and Implications. L:

Cb .

D, E., V, K., D, W.

(7). F w

EU ES: Rw .

Sb Journal of Energy Engineering

ASCE, M 7.

D, D., H, J. C., N, K., S,

M. (). D D

EU ES C I, S

R. Cb, U.K.: C S.

D, S. (). k Lk W

Uq Cb P, S R.

Cb, U.K.: C S.

E, D. B, B. (8). O-A O Ab? A P

A EU ES B 56

E D. Environmental and Resource

Economics, 41, .

E C (8). Q Aw C

, P R, MEMO/8/34, J

3, 8. Ab : ://.//

RA.?=MEMO/8/3

4=H

G, V., S, K., M, F. C., M,

L.,D, V., S, J., Dk, J.

(8). I EU

G, Ok I R. Ab :

://www.w./bk/-/365.

Gbb, M. N, K. (6). A

C EU E

S: P Ow. Climate Policy, (6) .

73.

L, J. H, R. (8). Comparison of

Legislative Climate Change Targets. W,

DC: W R I, 8.

L, J. H, R. (). Emission

Reductions Under The American Clean Energyand Security Act. W, DC: W

R I, .

M, W. D. (17). Mk

.

Journal of Economic Theory 5(3): 35418.

N, K. (8). Tackling Carbon. Ab :

://www.....k/w-/

//3/k-b__38.

N, K. (). I EU ES P III, I O B.

Cb, U.K.: C S.

References8


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N, K. M, F. (8). R A E , S

R. Cb, U.K.: C S.

O, M. (165). The Logic of Collective Action.

Cb, MA: H U P.

W Bk (8). International Trade and

Climate Change. W, DC: W

Bk.


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