The EU Emissions Trading Scheme: the perrenial issue of carbon leakage

Take a look at the UK government’s statement on strategy and reform for the EUETS – https://www.gov.uk/eu-emissions-trading-system-the-future-of-the-system

The proposed reform involves setting up a strengthened Market Stability Reserve (MSR). The MSR is supposed to act as a kind of overflow for excess allowances, limiting the number of excess permits in circulation and stabilising the price of Carbon in the EU.

Sandbag.org.uk have an interactive model which shows what effect different calibrations of the Market Stability reserve (MSR) should have on the ETS – http://www.sandbag.org.uk/data/msr

It looks like a strong deployment of the MSR can prevent the situation with excess allowances getting totally out of control but without further reform we’re unlikely to see a significant increase in the price on carbon.

Hardly an inspiring situation. Is the best we can do for this supposedly world-leading scheme to keep it limping on, “mildly annoying industry and dismally disappointing everyone else”?

What I want to do here is highlight a fundamental flaw in the DECC’s reform proposals, and indeed with the ETS itself.

Say the MSR and further reforms raise the price of carbon…

An increased price on carbon would lead to carbon leakage becoming a problem…

Some of the wording in DECC’s proposal for reform suggests this is a concern. Talk of “adequately protecting [energy intensive industries] from the risk of carbon leakage so that they can adjust over the longer term,” for example.

The DECC’s statement seems to propose that the MSR can function as a mechanism to deal with carbon leakage.

This is flawed thinking.

As far as I can see the only way the MSR can be used to address carbon leakage is by allowing more permits into the ETS and lowering the price of emissions, thereby undermining the usefulness of the ETS in driving down emissions. In a worst case scenario we would end up back in the current situation where the price of carbon is way too low to be of any use.

This would in fact be a case of history repeating itself. The ETS has never had a workable mechanism for dealing with carbon leakage. It’s always tried to use the same mechanism to pursue the contradictory aims of driving down emissions and ‘protecting industry from the risk of carbon leakage’. Driving down emissions necessitates a high carbon price. ‘Protecting industry from the risk of carbon leakage’ has involved giving out large numbers of free permits, thereby depressing the price of carbon.

What’s needed is a mechanism for dealing with carbon leakage that doesn’t rely on lowering the price of emissions.

This is where border adjustments come in.

Some initial work has been done exploring border adjustments and the EUETS –

http://www.cepii.fr/PDF_PUB/wp/2013/wp2013-34.pdf

http://www.cccep.ac.uk/Publications/Working-papers/Papers/90-99/Trade-climate-change-game-theory-carbon-adjustments.pdf

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About hughchapmansblog

Poet and performance maker based in Cambridge and London

5 responses to “The EU Emissions Trading Scheme: the perrenial issue of carbon leakage

  1. nicola1terry

    Politically we can’t abandon the ETS. But there are ways to improve it, if we fix the carbon leakage with border adjustments first – see http://energy-surprises.blogspot.com/2014/12/how-we-can-stop-exporting-carbon.html In his book Planetary Economics, Michael Grubb seems to recommend a price floor and cites hybrid systems such as the Californian cap and trade system which has price floor and ceiling. http://www.arb.ca.gov/cc/capandtrade/capandtrade.htm

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