The UK Department of Business Innovation and Skills has published a new report, written by AEA and project partners CE Delft, on the increasing impacts of energy and climate change policies on carbon leakage.

Carbon leakage occurs when climate change policy aimed at reducing carbon dioxide emissions in one country leads to an increase in carbon dioxide emissions in a country that is not bound by these policies. Given that climate change is a global issue, carbon leakage impacts upon the effectiveness of climate change policies and can also affect the competitiveness of industries that have to comply with unilateral climate policies.

This study reviewed a wide range of literature examining the estimated rates of carbon leakage, the parameters and assumptions driving these results and the policy options for mitigation. It provides new insight on estimates and methods used to measure carbon leakage and competitiveness impacts.

AEA's Adarsh Varma commented: “This study is unique in that it not only identified the main causes of carbon leakage – investment leakage, trade leakage and less demand for fossil fuels - but also clearly examined the methodological issues for estimating it. The various assumptions, hypothesis and models used showed that estimates for carbon leakage with free allocation of EU ETS permits range from 0.5% to 50% with an average of 18%.”

The report is particularly useful for understanding the sectors that are most highly impacted by carbon leakage. According to the literature, the cement and clinker and the iron and steel industries are most at risk of carbon leakage with estimates of up to 70% and 26% respectively. Generally, it is found that carbon leakage occurs most severely in energy intensive industries with high indirect emissions, especially in industries in which the cost pass through rate is close to zero.

There are several important assumptions that drive the level of estimated carbon leakage. However, the report also identifies a lack of sensitivity analysis of assumptions which makes it difficult to assess how the assumptions affect estimates of carbon leakage. Because of this, it is not possible to directly compare studies that use different assumptions.

Potential policy options to mitigate carbon leakage are discussed in the report and the literature suggests that a range of policy options are necessary to address reduced competitiveness and carbon leakage as a result of climate change policy. However, the preferred option suggested by the literature is to create a level playing field among countries in conjunction with free allocation or border tax adjustments.

For more information, contact Adarsh Varma.

The report can be downloaded here.

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