EU industry and the ‘carbon leakage’ threat


Fears that tighter controls on CO2 emissions in Europe will drive factories to relocate abroad has led the EU to grant sweeping exemptions for industries deemed to be at risk. Aluminium, steel, iron and cement producers are likely to benefit from the preferential regime.

In 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, argues that a tightened ETS would inflate 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 aired particularly vociferously 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%.

Since the price of carbon fell to a record low of €5.99 in 2012, the EU has been investigating ways of staggering the auction of carbon allowances to raise prices to a level at which low carbon investments could be incentivised. 

While some industrial giants have welcomed such a move as a prop to their investments, large segments of energy-intensive industry have uneasily warned that the higher the EU's carbon price, the greater the chances that polluting companies might relocate outside its borders and beyond any form of regulatory oversight. This argument has a long genesis.

EU heads of states first clinched an agreement on reforming the EU emissions trading scheme (EU ETS; see EURACTIV LinksDossier) during a summit in December 2008 (EURACTIV 12/12/08). A central bone of contention during the negotiations was the treatment of manufacturing sectors subject to competition from countries which do not regulate CO2 emissions, such as China.

Franco-German tango on border tariffs

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).

The then-French President Nicolas Sarkozy at one point pushed for a carbon tariff at the EU's borders in order to restore fair competition with Chinese manufacturers (EURACTIV 18/09/09).

Ahead of the Copenhagen climate conference in December 2009, German Chancellor Angela Merkel and Sarkozy wrote a joint letter to UN Secretary General Ban Ki-Moon calling for the possible introduction of "appropriate adjustment measures" against countries that do not make sufficient commitments on climate change (EURACTIV 18/09/09).

But the carbon tariffs idea have had limited uptake so far, for fear of retaliatory measures from EU trading partners. Karel de Gucht, the EU's new trade commissioner, rejected the idea during a hearing in the European Parliament, claiming it "will run into many practical problems" and risks triggering a trade war (EURACTIV 13/01/10).

Exemption from emissions trading

To address competition concerns, EU leaders defined criteria for determining which industries would be eligible to receive free CO2 pollution permits after 2013, when the revised ETS comes into force. The guidelines are defined in an annex to the conclusions endorsed by EU leaders at their December 2008 summit. 

Under the agreement, industrial sectors can be considered 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 Addedand;
  • 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 Addedor;
  • if the total value of its exports and imports divided by the total value of its turnover and imports exceeds 30%.

Fatal blow to EU emissions trading scheme?

Critics say 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 order to benefit from the free permits, factories will be obliged to upgrade to the best-technology benchmarks, rewarding companies investing in the cleanest technology (EURACTIV 16/12/08).

List of industries at risk of carbon leakage

National experts from the 27-country bloc met in September 2009 to agree on a list of sectors that could be considered to be at risk of carbon leakage.

The agreed list took 164 industrial sectors on board, representing 77% of the total manufacturing emissions under the ETS. It covered the most energy-intensive industries such as steel, cement and chemicals but also plastics, food processing and weapons manufacturing.

Free permits were delivered to the 10% most efficient factories, according to a performance benchmark determined in 2010 (EURACTIV 21/09/09). But Eurofer, the steel association launched a legal action against the EU two years later, claiming that the benchmark had been unfairly set.

On the other hand, environmentalists and some member states have argued that the proposals are too weak, with France and Germany leading calls for further measures to be adopted to prevent carbon leakage (EURACTIV 18/09/09).

Global climate deal could make exemptions unnecessary

The European Commission says exemptions may prove unnecessary if a stringent global climate deal is reached at UN level. EU industries would then have assurances that international competitors would also respect strict climate rules. So far though, this has proved elusive. (EURACTIV 19/12/09).

Meanwhile, if energy-intensive industries in China and India follow the EU's example, manufacturers worldwide could apply for similar derogations, leading to runaway carbon emissions. Details of how emissions reductions will be monitored and enforced on an international scale remain to be sorted out.

One alternative could be to forge separate global emission reduction agreements specific to each industrial sector such as cement or steel. 'Sectoral agreements' were proposed by EU lawmakers after the weak outcome of the Copenhagen negotiations (EURACTIV 04/03/10).

EU business leaders and commissioners in the EU's High Level Group (HLG) on Competitiveness, Energy and the Environment have supported the idea. 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".

But the extent to which 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).

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.

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 GreenpeaceOxfam, the WWFFriends 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".

  • Jan. 2008: European Commission makes proposal to revise the EU's CO2 emissions trading scheme (EU-ETS) for the period 2013-2020.
  • Dec. 2008: EU heads of state agree that industries which are exposed to "a significant risk of carbon leakage" will be granted free CO2 permits under the revised ETS (EURACTIV 12/12/08).
  • 21 Sept. 2009: EU experts agree on a list of 164 industrial sectors that will be eligible to receive free CO2 pollution credits under the revised ETS. Free permits will be delivered only to the 10% most efficient factories, according to a performance benchmark that is to be determined by the end of 2010 (EURACTIV 21/09/09).
  • Dec. 2009: UN Copenhagen summit fails to complete negotiations on a post-2012 international climate change treaty, leading to renewed calls for tackling the threat of carbon leakage (EURACTIV 08/01/10).
  • 24 Dec. 2009: European Commission formally adopts list of industrial sectors which are deemed to be exposed to a significant risk of carbon leakage. This includes chemicals and agro-chemicals, iron and steel, plastics, textiles, paper, cement and many others, including weapons manufacturing.
  • By June 2010: European Commission to submit assessment and proposal on carbon leakage in light of the outcome of global climate talks.
  • By end 2010: EU to decide performance benchmarks that will determine which factories will be eligible for free emissions credits under the revised ETS.
  • By 31 Dec. 2010: European Commission to propose modification of environmental state aid guidelines which determine under which conditions EU countries can help specific industrial sectors on environmental grounds.
  • 2011: Number of free allowances to sectors vulnerable to carbon leakage to be decided.
  • 2014: EU to revise list of industries exempted from buying pollution credits under the ETS.

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