Modelling the Impact of Policy Interventions on Carbon Leakage - Assessment with the E3MG Model

In 2009, the European Commission undertook an impact assessmen to identify the sectors at risk of carbon leakage as a result of to the EU 20% EU GHG emissions reduction target.  Carbon leakage is the relocation of production as a result of unilateral climate policy which creates cost differentials in the industrial production process across countries.  The EC’s impact assessment identifies 164 sectors at risk of carbon leakage.  However, research by Climate Strategies and Cambridge Econometrics suggests that far fewer sectors are at genuine risk. This paper follows this insight and focuses on three sectors widely considered to be at risk of carbon leakage: Iron and Steel, Aluminium, and Cement. 

To reduce the risk of carbon leakage, the European Commission has proposed, in Directive 2009/29/EC three measures to address the adverse effects from carbon pricing: free allowances, inclusion of importers into the ETS, and binding sectoral agreements. In this paper we analyse how the inclusion of importers into the ETS would help to offset the impact of increased EU carbon costs. Moreover, this paper seeks to explore the impacts of a shift to a 30% EU GHG emissions reduction and the subsequent impacts of a border measure for the sectors under the spotlight.

Research questions:

Broadly, this paper addresses three questions:

1) What is the impact on the EU ETS allowance price of a shift from 20% emissions reduction target to a 30%?  We consider two different ETS and non-ETS splits to reach the 30% emissions reduction target.

2) What impact does this have on carbon leakage as a result of the relocation of Basic metals and Non-metallic mineral (as proxies for Aluminium and Iron & Steel, and Cement, respectively) production to outside of the EU?

3) To what extent is this offset by the implementation of a border adjustment?

The analysis has been conducted using the E3MG model of the world economy.  The data used in the E3MG model is limited to a NACE 2 digit level of industry detail.

Other papers on this topic are also available to download from our "International Industry Competitiveness, Carbon Leakage, and Approaches to Carbon Pricing" section.