'Carbon leakage': A challenge for EU industry[fr] 

On 23 January 2008, the European Commission proposed to revise the EU Emissions Trading Scheme (EU ETS; see EurActiv LinksDossier) for the period 2013-2020, setting out the EU's main instrument to meet its objective of reducing greenhouse gas emissions by 20% by 2020 compared to 1990 levels.

The proposal, part of a wider climate and energy 'package' of legislation, suggested capping emissions to 21% below 2005 levels by 2020 and expanding the scheme to include more industrial sectors.

Under the revised scheme, electricity producers would need to buy 100% of their CO2 emission permits at auction by 2020, for example. The Commission believes this would cause electricity prices to rise by 10-15%.

But heavy industry, including the cement, steel, aluminium and chemical sectors, argue that a tightened ETS would inflate their costs to such an extent that they would be forced to move their factories and jobs beyond the EU's borders, leading to a 'leakage' of CO2 emissions without any environmental benefits.

European cement producers, for example, warned that production could be wiped out in the EU completely. "At current CO2 prices of €25 per tonne, approximately 80% of clinker production will be offshored if no free allowances are allocated."

Such concerns have been particularly aired in Germany, which has the largest industrial base in Europe. Morevover, countries such as Poland, which rely heavily on coal for their power production, have claimed that the revised ETS would force coal-fired power stations to shut down, leading to rises in electricity prices of more than 100%.

EU heads of state and government clinched an agreement on the package during an EU summit in Brussels in December 2008 (EurActiv 12/12/08). Parliament signed off on the deal on 17 December (EurActiv 18/12/08).

A central bone of contention during the negotiations on the EU ETS proposal was the treatment of manufacturing sectors subject to competition from countries with less stringent CO2 emission-reduction regimes. Without safeguards, some claimed, the EU would risk a high degree of 'carbon leakage', meaning industries would simply take operations outside the EU's borders to where CO2 emissions are cheaper.

Exemption from emissions trading

To address these concerns, EU leaders have defined crtieria to determine which industries will be eligible to receive free CO2 pollution permits after 2013, when the revised ETS starts to apply. The guidelines are defined in an annex  to the conclusions endorsed by EU leaders at their December 2008 summit. 

Under the agreement, sectors exposed to a significant risk of carbon leakage will be granted 100% of their CO2 emission credits free of charge. However, only the cleanest factories will be eligible, as the free permits will be distributed "at the level of the benchmark of the best technology available". As a consequence, industrial installations which do not meet the benchmark will still have to pay for their emission rights, penalising the most polluting factories.

While the Commission will not identify the precise sectors concerned until June 2010 (pending the outcome of UN climate talks in Copenhagen), it has already identified industries which could possibly receive free allocations (EurActiv 22/09/08). In a non-paper , it said "primary aluminium, hot-rolled steel and slabs [...] and clinker would be likely to be strongly affected, and would therefore be amongst the substances likely to benefit from partial to totally free allocations". But the EU executive also maintains that these sectors were chosen only for "indicative purposes on the basis of the data available at this point, and should not be taken to prejudge the final results".

German heavy industry is particularly expected to benefit from free permit allocations.

Exposure criteria

Accoring to the criteria agreed by EU leaders, a sector is deemed to be at "significant risk" of carbon leakage if:

• The sum of direct and indirect additional costs induced by the implementation of the EU ETS directive would lead to an increase in production costs exceeding 5% of its Gross Value Added, and;
• if the total value of its exports and imports divided by the total value of its turnover and imports exceeds 10%.

A sector is also deemed to be exposed to a "significant risk" of carbon leakage if:

• The sum of the direct and indirect additional costs induced by the implementation of the EU ETS directive would lead to an increase in production costs exceeding 30% of its Gross Value Added, or;
• if the total value of its exports and imports divided by the total value of its turnover and imports exceeds 30%.

Fatal blow to ETS?

Critics maintain that giving exemptions to too many industries essentially takes the substance out of the EU ETS, since heavy industry then has little incentive to clean up its carbon act.

Proponents, however, argue that the system will still lead to considerable emissions cuts, because the overall EU emissions cap remains. In addition, the obligation for companies to upgrade their installations to the best-technology benchmarks so as to receive free allocations will also reduce emissions, argue representatives of the EU's chemical sector (EurActiv 16/12/08).

Global climate deal could make exemptions unnecessary

In any case, the exemptions may not prove necessary if a sufficiently stringent global climate deal is reached at the UN talks, which are expected to wrap up in Copenhagen in December 2009. Indeed, EU industries would then have assurances that international competitors will also sign up to strict climate rules.

But rapidly industrialising states like China and India are waiting for cues from the EU about how energy-intensive industries should be treated in a future climate change regime. The fear is that, following the EU's example, manufacturers worldwide could apply to obtain similar derogations, leading to runaway carbon emissions.

There are also considerable doubts about the likelihood of striking a global deal at the UN talks, due in part to the tight timetable leading up to the meeting. In addition, details about how emissions reductions will be monitored and enforced on an international scale have not been sorted out. The UN currently lacks an international emissions reduction 'police' force capabable of guaranteeing industry compliance, particularly in countries with widespread corruption, like China and India.

Towards sectoral agreements?

In the absence of a global climate deal, another option would be to forge separate international emissions reductions agreements specific to each industrial sector.

Such agreements would allow energy-intensive industries to operate under a separate carbon regime based on emissions reduction targets agreed by the industries themselves, sheltering the sector from unfair outside competition.

The idea has already found support among EU business leaders and commissioners sitting on the EU's High Level Group (HLG) on Competitiveness, Energy and the Environment. In its final report (8 November 2007), the group argued in favour of a 'bottom up' approach, whereby sectoral targets would be "initiated by business together with public authorities".

The World Business Council for Sustainable Development (WBCSD) recently put forward a paper outlining possible links between a global CO2 regime and sectoral agreements, arguing that a global carbon market could be built "progressively from local, national, sector or regional programmes, each contributing to the long-term goal".

But the extent sectoral deals can be implemented remains unclear. They are complex and "governments, negotiators and other stakeholders struggle to understand them," according to a report by the Centre for European Policy Studies (CEPS).

Germany, which has the EU's largest industrial base, has long insisted that the EU must take action on the risks of 'carbon leakage', pushing for specific recognition of the issue at a European summit in March 2008 (EurActiv 13/03/08).

At European level, the Alliance for Power-intensive Industries warned of an "enormous risk of de-industrialisation" in Europe as a result of higher power prices pushed up by the EU's carbon market. The alliance groups large consumers of electricity such as alloys, cement, ceramics, chlor-alkali, glass, iron and steel, lime, non-ferrous metals and paper industries.

"It would be neither good environmental policy nor economically viable if energy-intensive industries were to leave Europe and emit emissions, perhaps even higher ones, outside Europe," European Commission President José Manuel Barroso told EurActiv in a December 2007 interview. "We are currently studying different options to address these issues, such as continued free allocation of allowances [under the EU ETS], preferably on the basis of technological energy-efficiency benchmarks, international sectoral agreements and including importers of energy-intensive products – and excluding exporters - in the EU emissions trading scheme," he added.

However, the Commission does not want to preclude the outcome of global climate talks and insists that safeguard measures should be decided only after the Copenhagen UN meeting in December 2009.

Avril Doyle, the Irish Fine Gael MEP who steered negotiations on the revision of the EU ETS through the European Parliament, agrees: "It would be detrimental to the chances of international negotiations reaching an international climate agreement if certain sectors were to be named outright in the proposal."

ETUC, the European Trade Union Confederation, supports urgent measures to mitigate climate change but is concerned that the employment aspect "has been grossly underestimated so far in international climate change negotiations". According to Joël Decaillon, ETUC's confederal secretary, a global climate change deal should include "policies aimed explicitly at [...] managing the restructuring operations that could be triggered by a rapid transition to a low-carbon economy".

BusinessEurope, the European employers' association, says the EU should focus on realising the full potential of energy efficiency improvements rather than tightening the bloc's carbon market. A change in public procurement rules, "positive incentives" and mandatory eco-efficiency requirements should be part of EU efforts to increase energy savings in buildings and industrial processes, according to Folker Franz, BusinessEurope's senior advisor for environmental affairs.

The European public employers association CEEP warned of the potentially painful costs of climate action. "Any European energy and climate policy must be seen in the context of a global economy. Our industries, services and products must remain globally competitive. Making cleaner industry an asset in a global economy is a challenge. But a lopsided European approach leading in the end to a shrinking economy and to less employment has to be rejected."

In a 2007 report , the think tank Bruegel argues that Europe would suffer more than China, the US and other exporters from the switch to a low-carbon economy. "Europe specialises more than its main global competitors in industries with relatively high carbon emissions, such as minerals and chemicals, rather than in high-tech industries and services," Bruegel notes. This, it adds "would have a real effect on Europe's competitiveness in a world regulated by carbon pricing schemes such as the EU's emissions trading scheme." 

"In the absence of fair and undistorting carbon pricing schemes worldwide, there is a real risk that business will resort to regulatory arbitrage which will entail a shift in where emissions take place – but no reduction in global emissions," the paper continues.

However, others have played down the threat of carbon leakage. In a recent report, the International Energy Agency (IEA) said there has so far been no evidence that the EU ETS has prompted industry to relocate outside Europe. The paper sought to dismiss what it called the "noises made by a handful of sectors" by "demystifying" fears about the effects of asymmetric emission obligations across the world. 

Analysing heavy industries such as steel, cement, aluminium and refining, it said the scheme had not significantly altered trade flows or production patterns. However, IEA analyst Julia Reinaud, the author of the study, cautioned that "the future form of the EU ETS may change these findings for some heavy industries, as Europe has planned more ambitious emission reduction targets post-2012".

The Organisation for Economic Cooperation and Development (OECD) believes that the threat of carbon leakage, although real, had been "often overstated". In a statement released after a meeting of environment ministers in April 2008, it said "competitiveness impacts and risk of carbon leakage can be managed, especially in a context of strong international co-operation and common approaches". 

So-called sectoral agreements between industries in different countries could also be one alternative to participation in a carbon market, the OECD said. But some ministers were "less certain about the efficacy of these approaches," it added. 

Ministers are considering "a wide range of components, such as a shared vision about a long-term goal; binding mid-term targets for developed countries; monitorable, reportable and verifiable (MRV) support for the financing of technology transfer; and verifiable reductions below baseline in developing countries," according to the statement.   

Karsten Neuhoff, an economist and researcher at the University of Cambridge, said industry claims about carbon leakage were "exaggerated". "We looked at the UK and there was about 1% of production outside of the power sector that have either higher direct emissions or indirect emissions from power," he told EurActiv in a recent interview. "If you look at Germany, it's about 2%. [In Europe], the average is lower than that again. So it's only a very small part of our GDP which is very carbon intensive."

Claude Turmes, a Green member of the European Parliament, went further in criticising the motives of energy-intensive industries, saying they are trying to get a "free lunch" by creating excessive "hype" about the threat of delocalisation. "According to the energy-intensive industry lobby, EU industry is heavily exposed to global competition. But exposure to non-EU competition is not even 2% for the EU's lime and cement industry, and around 5% for EU refineries. For the steel sector, competition does not reach 20%," says Turmes in a paper  on carbon leakage circulated ahead of an EU summit in March 2008 (EurActiv 13/03/08).

According to Turmes, "the real agenda of companies like Mittal/Arcelor and Lafarge is to get completely off the hook from EU climate change efforts". He says the way forward is to follow the example of Denmark and Sweden, which both faced similar problems in the nineties when they introduced CO2 taxes for their industries. "Denmark and Sweden established the principle of earmarking of the revenues from these energy taxes. This was the right way to go: the industry actors had to integrate fully into their investment decisions the price of pollution, but received state aid for investments under certain strict environmental criteria."

In an interview with EurActiv, Eurogypsum President Jean-Pierre Clavel drew attention to the specific problems faced by his industry, saying factories had to be located near a gypsum source to be able to operate. Giving an example, Clavel said it could become more profitable to locate in Ukraine rather than in Poland once the new EU rules have entered into force. "So it will not be a sudden quick movement. It will be a change in the strategy," Clavel said.

-- Reactions to summit outcome --

The European chemicals industry reacted positively to the December 2008 meeting of EU heads of state and governments, saying it was "encouraged" by the language of the summit conclusions. 

"Carbon leakage has been recognised as a true risk by the European Council," said Alain Perroy, director-general of Cefic, the European chemical industry council. However, that commitment would now need to be confirmed both "legally and politically", he stressed. "We now need some precise conditions for exposed sectors to encourage efficient manufacturers," said Perroy. 

In particular, Perroy said the "trade intensity" of individual sectors needed to be defined more precisely, describing it as "essential" to consider downstream users of chemicals like the textile, car, housing and computer sectors. "It is crucial to include the value chain in the legal text to carry out the trade analysis including all users," Cefic stressed.

The European Greens were furious about the outcome of the summit, accusing each government of having acted "as a lobbyist for its own polluting industries" and "seriously damaging this crucial legislation". "Considerable exemptions for industries (and even the power sector) from the auctioning of emissions permits under the emissions trading scheme risk turning the scheme into a windfall profit-generating machine for those industries - rather than acting as a real incentive to modernise the economy," said the Greens/EFA Group in the European Parliament.

WWF, the global conservation group, deplored the fact that the European manufacturing sector was "largely granted full exemption from requirements to buy carbon permits" in discussions over the future of the EU Emissions Trading Scheme (EU ETS). It further regretted that "this was done in the absence of any strong evidence that such a requirement would impact on the international competitiveness of these industries".

In a joint statement , environmental groups and development organisations, including Greenpeace, Oxfam, the WWF, Friends of the Earth and Climate Action Network, regretted that as a result of concessions made to the manufacturing sector, consumers would now have to "pay for emissions permits that polluting companies get for free". They said auctioning of carbon permits "must become the norm for all industries covered by the EU ETS when the system comes up for review".