Carbon Leakage and Competitiveness under the EU ETS

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Carbon Leakage and

Competitiveness under the EU ETS

Joshua Prentice*

Abstract

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.

i. Introduction

The introduction of a carbon price either through an emissions trading scheme or a carbon dioxide tax can create the risk of carbon leakage. Carbon leakage involves the potential re-location of industrial production from a nation with a carbon price to a country which does not place a carbon price or comparable greenhouse gas emissions restraints on their domestic industry. The re-location of industrial production may lead to an increase in global greenhouse gas emissions as production processes in the new host nation are likely to be more emissions intensive and less energy efficient. The European Union Emissions Trading Scheme (EU ETS) is a ``cap and trade'' system. The EU ETS is a cornerstone of the EU's policy to combat climate change and its key tool for reducing industrial greenhouse gas emissions in a cost-effective manner.

To address the risk of carbon leakage within industrial sectors covered by the EU ETS, a series of provisions relating to carbon leakage were included in the EU ETS Directive which established the trading scheme.

Under the definition of carbon leakage in the EU ETS Directive, affected sectors must show that they meet certain thresholds relating to direct and indirect costs caused by the introduction of a carbon price and are exposed to a high level of trade exposure with countries outside the EU.¹Installations within sectors

and subsectors deemed to be exposed to a significant risk of carbon leakage receive a share of their emissions allowances (EUAs) free of charge between 2010 and 2014.² In December 2009, the European Commission published the finalized list of sectors and subsectors which were deemed to be exposed to a significant risk of carbon leakage.³ A new carbon leakage list for 2015-2019 is to be compiled during the coming two years and presented by the Commission by the end of 2014.⁴

The preparation of a new carbon leakage list provides an ideal platform from which to assess the effectiveness of the current 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.⁵ In examining the effectiveness of the carbon leakage list, this paper examines several key criteria which formed the basis of the Commission's deliberations about the carbon leakage list in 2009. These criteria include; the scope of the carbon leakage definition under the EU ETS Directive, assumptions about the carbon price under the EU ETS, auctioning of permits to sectors on the carbon leakage list, and an analysis of comparable climate policy measures by other nations.

Although they were other criteria which the Com- mission used in compiling the carbon leakage list in 2009, these four criteria have been highlighted by the Commission as the cornerstones of their deliberations in compiling the carbon leakage list.⁶ By critically

* Joshua Prentice currently works as a Policy Officer at the Swedish Energy Agency. He holds a Bachelor of Laws (First Class Honours)/Bachelor of Arts (First Class Honours) from the Australian National University. This work represents the views of the author only and does not constitute an official position of the Swedish Energy Agency. All statements and errors remain those of the author. Contact email: joshua.

prentice@energimyndigheten.se.

1Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community [2003] OJ L 275/32, Art. 10a.

2Ibid at Art. 10a, para. 12.

3Commission Decision of 24 December 2009 determining, pursuant to Directive 2003/87/EC of the European Parlia- ment and of the Council, a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage L 1/10.

4Directive 2003/87/EC establishing a scheme for greenhouse gas emission allowance trading, supra, n. 1, at Art.

10a, para. 13.

5Commission Decision on a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage, supra, n. 3, at para. (2).

6Commission Decision on a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage, supra, n. 3, at para. (10); European Commission, Accompanying document to the Commission

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analyzing these four criteria, this paper argues that the current carbon leakage list provides too much support for ensuring the global competitiveness of EU industry sectors which is to the detriment of the efficacy of the EU ETS in reducing greenhouse gas emissions.

II. Carbon Leakage ± Theoretical Considerations

There is no settled definition of carbon leakage within contemporary academic scholarship or policymaking.

Despite the lack of a common definition, there are several key elements to carbon leakage which policy- makers and academics have identified. The introduction of climate policy measures, in particular a carbon price, can create the risk of carbon leakage.⁷A carbon price may result in higher production costs and electricity prices for domestic industry.⁸Price increases may cause domestic industry to lose market share to foreign competitors whom are not subject to a comparable carbon price and can increase their production levels because of the relative cost advan- tages.⁹A business may ultimately choose to relocate its production processes from a nation with a carbon price to a country which does not have a comparable climate policy regime.¹⁰

The re-location of production processes may lead to an increase in greenhouse gas emissions globally as production processes in a nation without an equally rigorous climate policy regime are likely to be more emissions intensive and less energy efficient.¹¹ It is important to highlight that carbon leakage does not encompass standard business risks such as decreasing demand or increased costs for labor and raw materials which may affect an industry's global competitiveness.

Geographical factors can also play an important role in the assessment of a particular industry sector's susceptibility to carbon leakage.¹² Certain homogenous products can be manufactured in different locations without effecting quality which makes it easier for the re-location of production facilities due to a carbon price.¹³ Alternatively, re-location of production facilities is less likely if proximity to locally- sourced raw materials is essential.¹⁴ Transport costs for both raw materials and end products may also be relevant in any potential re-location decisions.¹⁵

Emissions-intensive and energy-intensive industries are typically described as the sectors most at risk of carbon leakage.¹⁶ Emissions-intensive industries such as aluminum production and oil refining are often at risk as they have limited scope for reducing emissions in production processes.¹⁷ Energy-intensive industries such as pulp and paper, iron and steel-making may face the threat of carbon leakage as a result of rising electricity prices due to the introduction of a carbon price and their limited ability to reduce total energy use or switch to renewable alternatives.¹⁸ A fundamental question in the assessment of a specific sector's

exposure to the risk of carbon leakage becomes the extent to which increased costs can be passed onto (end) consumers. The transferability of costs to consumers is dependent upon a number of factors, in particular the extent of global competition.¹⁹Producers

cont.

Decision determining a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage pursuant to Article 10a (13) of Directive 2003/87/EC 4-9 (2009); European Commission, Green Paper ± A 2030 framework for climate and energy policies COM(2013) 169 final, 3, 11 (2013).

7International Energy Agency, Issues behind competitiveness and carbon leakage, 27ff. (IEA Information Paper, October 2008); European Commission, Accompanying document to the Commission Decision determining a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage pursuant to Article 10a (13) of Directive 2003/87/EC, 5-9 (2009); TNO Built Environ- ment and Geosciences, Greenhouse Gas Efficiency in EU and non-EU nations ± Consultancy Study for the European Commission, 7-9 (2009); Gilbert E. Metcalf, David Weis- bach, The Design of a Carbon Tax 33 Harvard Environ- mental Law Review 499, 502-503 (2009), SteÂphanie Monjonab, Philippe Quiriona, A border adjustment for the EU ETS: reconciling WTO rules and capacity to tackle carbon leakage 11(5) Climate Policy 1212, 1214 (2011); CE Delft, Carbon Leakage and the Future of the EU ETS Market, 14 (2013); Fores, Reform of the EU ETS system, 27ff. (2012); Copenhagen Economics, Carbon Leakage from a Nordic Perspective, 17-19 (2012).

8International Energy Agency, supra, n. 7, at 27; European Commission, supra, n. 7, at 7; Metcalf, Weisbach, supra, n.

7, at 502.

9International Energy Agency, supra, n. 7, at 27; Mon- jonab, Quiriona, supra, n. 7, at 1214; Copenhagen Econom- ics, supra, n. 7, at 17.

10International Energy Agency, supra, n. 7, at 27;

Monjonab, Quiriona, supra, n. 7, at 1214; Copenhagen Economics, supra, n. 7, at 17.

11Copenhagen Economics, supra, n. 7, at 19ff.: Interna- tional Energy Agency, supra, n. 7, at 27; TNO Built Environment and Geosciences, supra, n. 7, at 8.

12Monjonab, Quiriona, supra, n. 7, at 1215; Copenhagen Economics, supra, n. 7, at 19-21; TNO Built Environment and Geosciences, supra, n. 7, at 8-10.

13Monjonab, Quiriona, supra, n. 7, at 1215; Copenhagen Economics, supra, n. 7, at 19-21; TNO Built Environment and Geosciences, supra, n. 7, at 8-10.

14Copenhagen Economics, supra, n. 7, at 19-21.

15Copenhagen Economics, supra, n. 7, at 22.

16International Energy Agency, supra, n. 7, at 59-66;

Copenhagen Economics, supra, n. 7, at 19-21.

Copenhagen Economics, supra, n. 7, at 39-52.

Copenhagen Economics, supra, n. 7, at 39-52; Monjonab, Quiriona, supra, n. 7, at 1217.

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of homogenous products which can be easily sourced regionally or globally from alternative suppliers are less able to pass on cost increases due to strong market competition than producers of products which are unique in their composition or function.²⁰ The aforementioned policy concerns were central in discussions regarding carbon leakage provisions under the EU ETS.

III. EU ETS Directive ± Definition of Carbon Leakage

The EU ETS is a ``cap and trade'' system and forms a cornerstone of the EU's policy to combat climate change and its key tool for reducing greenhouse gas emissions. The EU ETS is the world's largest emissions trading scheme and covers more than 11,000 stationary installations and aircraft opera- tors.²¹ The first trading period of the EU ETS ran between 2005 and 2007. The second trading period entered into force in 2008 and ended on 31 December 2012. The third and current trading period com- menced on 1 January 2013 and runs until 2020. To address the risk of carbon leakage for industries covered by the EU ETS, a series of provisions relating to carbon leakage were included in the EU ETS Directive which established the trading scheme.²²

Installations within sectors and subsectors deemed to be exposed to a significant risk of carbon leakage receive a share of emissions allowances (EUAs) free of charge.²³ The European Commission argues that the free allocation of EUAs assists to ensure the global competitiveness of certain industry sectors covered by the EU ETS in the face of competition from industry sectors in nations which are not subject to a comparable carbon price.²⁴ Article 10a of the EU ETS Directive describes the conditions that must be met if a sector or subsector is considered to be at significant risk of carbon leakage for the purposes of the EU ETS. A sector or subsector shall be deemed to be exposed to a significant risk of carbon leakage if:²⁵ (a) the sum of direct and indirect additional costs induced by the implementation of this Directive would lead to a substantial increase of production costs, calculated as a proportion of the gross value added, of at least 5 percent; and (b) the intensity of trade with third countries,

defined as the ratio between the total value of exports to third countries plus the value of imports from third countries and the total market size for the EU (annual turnover plus total imports from third countries), is above 10 percent.

Notwithstanding these requirements, a sector or subsector is also deemed to be exposed to a significant risk of carbon leakage if:²⁶

(a) the sum of direct and indirect additional costs induced by the implementation of this Directive

would lead to a particularly high increase of production costs, calculated as a proportion of the gross value added, of at least 30 percent; or (b) the intensity of trade with third countries, defined as the ratio between the total value of exports to third countries plus the value of imports from third countries and the total market size for the EU (annual turnover plus total imports from third countries), is above 30 percent.

In analyzing whether a given sector or subsector fulfills the requirements under Article 10a of the EU ETS Directive, the European Commission shall assess to what extent it is possible for a sector to transfer the costs of a carbon price onto consumers without significant loss of market share to less carbon efficient installations outside the EU.²⁷ The Commission's assessment shall take into account both the direct cost of purchasing the required EUAs and indirect costs from higher electricity prices.²⁸For the purposes of the Commission's analysis, it is assumed that there will be 100 percent auctioning of EUAs ± and no free allocation ± when assessing the potential direct costs caused by a carbon price under the EU ETS.²⁹

21European Commission, European Union Emissions Trad- ing Scheme, http://ec.europa.eu/clima/policies/ets/index_

en.htm (accessed 4 July 2013).

22Directive 2003/87/EC establishing a scheme for greenhouse gas emission allowance trading, supra, n. 1, at Art.

10a.23Directive 2003/87/EC establishing a scheme for greenhouse gas emission allowance trading, supra, n. 1, at Art.

10a, para. 12.

24Commission Decision on a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage, supra, n. 3, at para. (2); European Commission, at supra, n. 6, at 7-9.

25Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community, supra, n. 1, at Art. 10a, para. 15.

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3.1 List of sectors or subsectors deemed to be exposed to a significant risk of carbon leakage

After assessing the requirements outlined in Article 10a, the Commission presented a finalized list of sectors and subsectors deemed to be exposed to a significant risk of carbon leakage on 24 December 2009. The first ``carbon leakage list'' is applicable for the free allocation of EUAs between 2010 and 2014.

The carbon leakage list contained a broad range of sectors including cement manufacturing plants, crude petroleum refineries and paper and pulp processing installations. In compiling the carbon leakage list, the Commission's assessment was based on the assumption of an average carbon price of EUR 30 per ton.³⁰ This EUR 30 per ton carbon price was taken from economic modeling for the Commission's impact assessment for the EU's climate and energy package which included emissions reductions, renewable energy and energy efficiency targets for 2020.³¹

Furthermore, the Commission analyzed the potential direct and indirect costs under a carbon price and EU-based industry's trade intensity with nations outside the EU. The Commission's assessment focused on two key criteria:³²

a) The extent to which third countries, represent- ing a decisive share of global production in sectors or subsectors deemed to be exposed to carbon leakage, firmly commit to reducing greenhouse gas emissions in the relevant sectors or subsectors to an extent comparable with the EU and in same time frame;

b) The extent to which plant carbon efficiency in these countries is comparable to that of the In its publication of the first carbon leakage list,EU.

the Commission informed that it reached the conclusion that only Norway, Iceland and Switzerland had agreed to reduce greenhouse gas emissions in the relevant sectors or subsectors to an extent comparable with the EU.³³ According to the Commission, these three countries did not represent a decisive share of global production in the affected sectors.³⁴In addition, the Commission announced that it was not possible to compare the carbon efficiency of EU- based installations with installations outside the EU as there was a lack of reliable global data with sufficient detail on carbon efficiency at a sectoral level.³⁵ Due to the lack of reliable data, the Commission stressed that the criteria on carbon efficiency had no effect on the compilation of the carbon leakage list in 2009.

3.2 Amendments to the carbon leakage list and presentation of a new carbon leakage list (2015- 2019)

Following the publication of the finalized list, the Commission may, on its own initiative or at the request of Member States, add sectors or subsectors to the carbon leakage list on an annual basis.³⁶The

addition of a sector shall only be made following a qualitative assessment of various criteria including energy efficiency opportunities, market conditions and the effect on profit margins of a carbon price within the particular sector or subsector.³⁷ Since 2011, the Commission has added a small number of sectors ± such as the manufacture of bricks and tiles

± to the carbon leakage list.³⁸ Moreover, a new carbon leakage list for 2015-2019 shall also be presented by the Commission by 31 December 2014.³⁹The new list will be compiled using the same criteria of direct and indirect costs and trade intensity as laid out in Article 10a of the EU ETS Directive. Sectors which are on the current carbon leakage list are not automatically included on the new list and must fulfill all the necessary criteria anew in order to be included on the second carbon leakage list. The Commission has begun preparatory work for the new carbon leakage list with on-going consultations with EU member states, industry and environmental groups and research institutes sched- uled during 2013 and 2014.⁴⁰

34Ibid.

35Ibid.

38Commission Decision of 11 November 2011 amending Decisions 2010/2/EU and 2011/278/EU as regards the sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage 2011/745/EU.

40European Commission, Carbon Leakage and the EU ETS, http://ec.europa.eu/clima/policies/ets/cap/leakage/index_

en.htm (accessed 4 July 2013).

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IV. Effectiveness of the Current Carbon Leakage List

Discussions regarding the presentation of a new carbon leakage list for 2015-2019 provide an ideal platform from which to assess the effectiveness of the current carbon leakage list. In compiling the current carbon leakage list through lengthy negotiations in 2009, the Commission sought to strike an important policy balance between ensuring the global competitiveness of certain industry sectors covered by the EU ETS whilst maintaining the effectiveness of the EU ETS in reducing greenhouse gas emissions.⁴¹ This paper argues that the current carbon leakage list has been effective in ensuring the global competitiveness of European industry but the fulfillment of this policy goal has been to the detriment of the efficacy of the EU ETS in reducing greenhouse gas emissions. In critically examining the effectiveness of the current carbon leakage list in achieving the stated policy goals, this paper analyses four criteria; the scope of the carbon leakage definition under the EU ETS Direc- tive, assumptions about the carbon price under the EU ETS, auctioning of permits to sectors on the carbon leakage list, and an analysis of comparable climate policy measures by other nations.

4.1 Broad scope of carbon leakage definition

The definition of carbon leakage in Article 10a of the EU ETS Directive was the basis of the Commission's compilation of the carbon leakage list in 2009. A breakdown of the carbon leakage list shows that many of the listed sectors and subsectors did not satisfy the two-step definition of carbon leakage contained under paragraph 15 of Article 10a.

Table 1: Breakdown of sectors on carbon leakage list⁴² Carbon leakage Number of Verified Percentage of definition sectors on emissions total industrial

carbon (ton) emissions under

leakage list EU ETS

Article 10a 13 219,302,751 36

Paragraph 15

Article 10a 2 177,572,917 29

Paragraph 16(a)

``Sum of direct and indirect additional costs greater than 30%''

Article 10a 133 157,232,891 26

Paragraph 16(b)

``Intensity of trade with third countries greater than 30%''

This two-step definition required both the sum of direct and indirect additional costs of the implementa-

tion of the EU ETS Directive to be at least 5 percent of gross value added and the intensity of trade with third countries to be above 10 percent.⁴³ The vast majority of sectors which were deemed to be at risk for carbon leakage fulfilled one of the two alternative requirements.⁴⁴ Many sectors which may not be energy- intensive qualify on the carbon leakage list due to high trade exposure with other countries. Some of the sectors which are included on the carbon leakage list due to their high trade exposure include musical instrument manufacturers.⁴⁵

There was no information provided in the preparatory materials to the EU ETS Directive why the European Commission chose the specific thresholds for changes in production costs and trade intensity.

The broad, alternative definitions provided under Article 10a of the EU ETS Directive created a situation where more than 60 percent of all sectors which are covered by the EU ETS were deemed to be at risk of carbon leakage.⁴⁶The alternative definitions of carbon leakage under the EU ETS Directive were designed to ensure targeted support was provided to the most trade exposed industries which were covered by the EU ETS.⁴⁷ However, the classification of over 60 percent of the sectors under the EU ETS as subject to serious risk for carbon leakage indicates that the definition of carbon leakage was likely too broad. The free allocation of EUAs to over 60 percent of all sectors covered by the EU ETS can have the potential to undermine the efficacy of EU ETS in reducing greenhouse gas emissions across a number of industrial sectors in a cost-effective manner.

42Commission Decision on a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage, supra, n. 3, at Annex 1; CE Delft, supra, n.

7, at 20, 35.

45Commission Decision on a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage, supra, n. 3, at Annex 1.

46European Commission, EU ETS and Carbon Leakage, http://ec.europa.eu/clima/policies/ets/cap/leakage/index_

en.htm (accessed 4 July 2013); CE Delft, supra, n. 7, at 19.

47European Commission, at supra, n. 6, at 7-9; Commission Decision on a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage, supra, n. 3, at para. (2).

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4.2 Carbon price assumptions

The Commission's assessment of direct and indirect costs was also based upon the assumption of a price of EUR 30 per ton for EUAs.⁴⁸ Prices for EUAs have fallen steadily from a high of approximately EUR 34 per ton in mid-2008 to current prices of approximately EUR 4 per ton as displayed in the graph below.

Table 2: Price development of EUAs between 2008 and 2013

The assumption of a EUR 30 per ton price for EUAs was far higher than the actual carbon price during the vast majority of the second trading period between 2008 and 2012. Furthermore, the EUR 30 per ton price assumption forecast steep cost increases for businesses under the EU ETS which did not eventuate.

In using such a high carbon price, the Commission concluded a number a sectors were at serious risk of carbon leakage which led to their inclusion on the carbon leakage list. These sectors were provided (financial) support in the form of free EUAs for cost increases which never eventuated. Many of these sectors were subsequently able to sell a number of their free EUAs on the market at a financial gain due to a downturn in production levels as a result of the economic and fiscal crisis following 2008.⁴⁹

4.3 Auctioning of permits to sectors on the carbon leakage list

The Commission assumed in its original analysis in 2009 that sectors which were deemed to be exposed to the risk of carbon leakage would still need to purchase a majority of their EUAs between 2010 and 2014.⁵⁰ EUAs were to be allocated free of charge to affected sectors and subsectors using a benchmarking method for each particular product.⁵¹ A product benchmark was based on a value reflecting the average greenhouse gas emission performance of the 10 percent best performing installations in the EU producing a given product.⁵²Under the Commission's analysis, approximately 60 percent of emissions from sectors deemed to be at risk of carbon leakage would be above the relevant product benchmarks.⁵³ Therefore, the sectors and subsectors deemed to be at risk for carbon leakage would be required to purchase EUAs for all emissions which exceeded the relevant product benchmark.

Although the final figures on auctioning levels for the second trading period have not yet been released, the Dutch research institute, CE Delft, estimates in its

report from April 2013 that the figure of 60 percent is very unlikely to be attained.⁵⁴ CE Delft's assessment concludes that a more reasonable figure would be approximately 20 percent ± a figure which is supported by the preliminary auctioning figures from the Commission.⁵⁵ A major contributing factor for the lack of emissions over the product benchmark was a steep drop in production levels in almost all sectors on the carbon leakage list due to the financial crisis of 2008 and onwards. Installations had been assigned EUAs free of charge based on pre-crisis levels of production under the benchmarking system. When the full effects of the financial crisis hit the sectors covered by the EU ETS, many suffered steep production declines which created a surplus of EUAs for production which never occurred.⁵⁶Installations could then sell the surplus of EUAs whilst knowing that they had received a sufficient number of free EUAs to cover their now lower than expected emissions.⁵⁷

4.4. Examination of comparable climate policy measures by other nations

The Commission's analysis in 2009 also assumed that the EU ETS would be limited only to then 27 member states of the EU.⁵⁸ Since 2009, the EU ETS has been

49Point Carbon, Policy Analysis of the Second Trading Period of the EU ETS, 2-4 (2013).

50European Commission, Free Allocation based on benchmarks, http://ec.europa.eu/clima/policies/ets/cap/allocation/

studies_en.htm (accessed 4 July 2013). See also CE Delft, supra, n. 7, at 27.

52Commission Decision 2011/278/EU of 27 April 2011 determining transitional Union-wide rules for harmonised free allocation of emission allowances pursuant to Article 10a of Directive 2003/87/EC of the European Parliament and of the Council.

53The figure of 60% is based upon the individual sector reports which the Commission produced during 2009, see Commission, supra, n. 50; CE Delft, supra, n. 7, at 27.

54CE Delft, supra, n. 7, at 27.

55CE Delft, supra, at n. 7, at 27. CE Delft's estimates are based upon the quarterly auction reports which the Commission produces with details of the turnover and revenues from auctions held. Although all data is anon- ymous, figures for each sector of the EU ETS are available which CE Delft has used to make its assessment of the levels of EUAs purchased by sectors deemed to be at risk of carbon leakage.

56Point Carbon, supra, n. 49, at 4; CE Delft, supra, at n. 7, at 27.

57Point Carbon, supra, n. 49, at 4.

58There are currently 28 member states of the European Union. Croatia joined the EU on 1 July 2013.

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steadily integrated with installations in other countries

± Croatia, Norway, Liechtenstein and Iceland ± and linkages with other national emissions trading schemes in Switzerland (2014) and Australia (2015) are planned. Moreover, a number of regional emissions trading schemes have entered into force around the world since 2009 including the Tokyo emissions trading scheme,⁵⁹ California's emissions trading scheme,⁶⁰and the Regional Greenhouse Gas Initiative (RGGI) which comprises nine states in the United States.⁶¹ The Commission concluded that only Nor- way, Iceland and Switzerland had agreed to comparable greenhouse gas emissions reductions in the relevant sectors. Moreover, these three nations did not represent a decisive share of global production in the affected sectors.

The Commission did not provide any information in its analysis of what may be deemed as comparable efforts by nations to reduce greenhouse gas emissions in relevant sectors. Furthermore, the Commission did not expand on the notion of what is required for a nation or region to ``represent a decisive share of global production in the affected sectors''. The economies of Tokyo, California and nine North- eastern states are larger than many of the individual EU member states. Due to the size of the respective economies involved, these regional schemes are arguably of comparable effect to measures undertaken by nation states such Switzerland and Australia which the Commission has indicated may be considered as comparable. Although the Californian and RGGI schemes are limited only to the electricity generation sector ± which is clearly narrower in scope than the EU ETS ± a central element of the carbon leakage definition under the EU ETS Directive is the indirect costs passed onto manufacturers as a result of the implementation of a carbon price.⁶²

Industry in both California and in the nine RGGI states will likely face a comparable cost burden from increased energy prices as the respective carbon prices under the EU ETS and the respective state-based schemes in the United States are similar at present at approximately EUR 4 per ton (approximately USD 5.2). Therefore, an argument could be made in the compilation of the new carbon leakage list for 2015- 2019 that national and regional schemes comprising significant economies should be included in an analysis of comparable measures to reduce greenhouse gas emissions in affected sectors.

V. Conclusion

The introduction of a carbon price through an emissions trading scheme such as the EU ETS can create the risk of carbon leakage. To address the risk of carbon leakage and to ensure competitiveness of certain industry sectors covered by the EU ETS, a series of provisions relating to carbon leakage were

included in the EU ETS Directive which established the trading scheme. Under the definition of carbon leakage in Article 10a of the EU ETS Directive, affected sectors must show that they meet certain thresholds relating to direct and indirect costs caused by the introduction of a carbon price and are exposed to level of high trade exposure to countries outside the EU.In December 2009, the European Commission published the finalized list of sectors and subsectors which were deemed to be exposed to a significant risk of carbon leakage. Installations within sectors and subsectors deemed to be exposed to a significant risk of carbon leakage receive a share of EUAs free of charge between 2010 and 2014. A new carbon leakage list for 2015-2019 is currently being compiled and this provides an ideal platform from which to assess the effectiveness of the current 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.

In examining the effectiveness of the carbon leakage list, this paper has examined four key criteria; the scope of the carbon leakage definition under the EU ETS Directive, assumptions about the carbon price under the EU ETS, auctioning of permits to sectors on the carbon leakage list, and an analysis of comparable climate policy measures by other nations.

By critically analyzing these four criteria, this paper has argued that the current carbon leakage list provides too much support for ensuring the global competitiveness of EU industry sectors which is to the detriment of the efficacy of the EU ETS in reducing greenhouse gas emissions. A breakdown of the current carbon leakage list shows that many of the listed sectors and subsectors did not satisfy the two-step definition of carbon leakage relating to both direct and indirect costs and trade exposure. The vast majority of sectors met one of the alternative definitions which related to either direct and indirect costs or trade exposure ± resulting in a situation where over 60

59Environment of Tokyo, Tokyo Cap and Trade, http://

www.kankyo.metro.tokyo.jp/en/climate/cap_and_trade.

html (accessed 4 July 2013).

60California Environmental Protection Agency, Cap and Trade Program, http://www.arb.ca.gov/cc/capandtrade/capandtrade.htm (accessed 4 July 2013).

61The nine states which comprise the RGGI scheme are Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont, see Regional Greenhouse Gas Initiative, Regional Green- house Gas Initiative CO2 budget trading programs, http://

www.rggi.org/ (accessed 4 July 2013).

62Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community, supra, n. 1, at Art. 10a, para.s 15-16.

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percent of sectors covered by the EU ETS were deemed to be at serious risk of carbon leakage. To change the thresholds or definition of carbon leakage in the EU ETS Directive would require a legislative process. Due to the time delays and political uncer- tainty involved with this legislative process, there are other, more preferable methods which the Commis- sion may pursue to ensure a greater targeting of support for sectors at risk of carbon leakage.

A potentially useful starting point would be to revise the assumptions and modeling of the carbon price under the EU ETS. In 2009, the Commission used a carbon price of EUR 30 per ton ± a price assumption which was well above the actual spot prices since mid-2008. There is currently no information on which carbon price the Commission will use in its analysis when compiling the new carbon leakage list. However, the Commission should select a carbon price which is more in line with spot prices of approximately EUR 4 per ton when compiling the new carbon leakage list for 2015-2019. Similarly, the Commission can ensure that sectors deemed to be at risk of carbon leakage must purchase a greater volume of permits than they have done between 2010 and the present day. Although the Commission correctly implemented a benchmarking procedure for the free allocation of EUAs, a significant drop in production levels as a result of the financial crisis led to a surplus of EUAs being allocated to affected sectors. It is essential that any free allocation of permits via benchmarking more closely follows actual production levels to prevent a similar surplus from accumulating again.

Furthermore, it is unclear how the Commission will interpret the ``comparable measures'' element of the carbon leakage definition under the EU ETS Directive when compiling the new carbon leakage list for 2015- 2016. In 2009, the Commission placed a strong emphasis on measures and policies which were implemented by nation states. This narrow approach meant that broad and economically important regional initiatives such as the Tokyo, California and RGGI trading schemes were overlooked. Due to the size of the respective economies involved, these regional schemes are arguably of comparable, if not greater, effect than measures undertaken by nation states such Switzerland and Australia. Therefore, the Commission should take a broader perspective of comparable measures to include both nationally and regionally significant efforts to reduce greenhouse gas emissions. By implementing these changes when compiling the new carbon leakage list for 2015-2019, the Commission will likely go a long way in striking a better policy balance between 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.

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