Economic policy for low-carbon transition

and the role of carbon leakage

Tsinghua University 4.9.2008

Karsten NeuhoffFaculty of EconomicsCambridge University

www.electricitypolicy.org.uk/tsec/2

www.climate-strategies.org

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Outline

• The challenge for low-carbon policies

• Provide for the needs of different investors

• Provide for different technologies

• Leakage concerns

• European package – a consistent framework?

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1

2

3

4

5

2007 2020 2050

Gt CO2

in EU-27

Assumed emission growth business as usual 1%/year

2012

Linear 75% reduction trajectory

The challenge for emission reductions

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Upward bias of ex-ante estimates (bottom up)

* Upper estimate >£8000 million.Source: AEA Technology Environment, 2005, An Evaluation of the Air Quality Strategy,Report to DEFRA, available at: http://www.defra.gov.uk/

Cost estimates of UK Policies during 1990-2001

0

1000

2000

3000

4000

5000

6000

Lead Free

Petrol

Euro I petrol

Cars*

2000 fuel

standards

2005 fuel in

2000/1

Flue Gas De-

Sulphurisation

(FGD)

Low NOX

burners

Co

sts

(£M

)

ex anteex post

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Effective climate policy for EU industry

• The challenge for low-carbon policies

• Provide for the needs of different investors

• Provide for different technologies

• Leakage concerns

• European package – a consistent framework?

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Allowance prices – important for project investment

EU ETS Price Development

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

EU

A P

ric

e (E

uro

s)

Phase I Allowances

Phase II Allowances (2011)

Phase II Allowances (2008)

• Risk of very low carbon prices hampers investment• Use reserve price in government auctions to create price floor

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Eur

opea

n C

O2

emis

sion

s ye

ar

2020today 2050

Conventional coal

Oil

Gas

Illustrative

Future carbon targets – determine strategic choices

BAU

Energy Efficiency

RenewablesCCS/ additional nuclear

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Create clear emission reduction trajectories

• Define clear (& small) CDM inflow volumes– CDM for diffusion of technologies / removal of

barriers• Use auction revenue for international cooperation• Avoid leakage (emissions moving outside cap)

-> Visibility for investment and corporate strategies

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Effective climate policy for EU industry

• The challenge for low-carbon policies

• Provide for the needs of different investors

• Provide for different technologies

• Leakage concerns

• European package – a consistent framework?

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Empirical evidence – experience reduces cost

Source IEA

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Technology policy complements carbon pricing

Low carbon technology

Conventional technology

Learninginvestment

Future savings

Learninginvestment

Future savings

Cos

t

Experience (e.g. installed capacity)

Carboncost

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Effective climate policy for EU industry

• The challenge for low-carbon policies

• Provide for the needs of different investors

• Provide for different technologies

• Leakage concerns

• European package – a consistent framework?

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C

ost

incr

eas

e r

ela

tive

to v

alu

e a

dde

d

Ce

me

nt

Ba

sic

iron

& s

tee

l

Lime

Fertilisers & Nitrogen

Alu

min

ium

Other inorganicbasic chemicals

Pulp &Paper

Malt

Coke oven

Industrial gases

Non-wovens

Refined petroleum

Household paper

Hollow glass

Finishing of textiles

Rubber tyres & tubes manufact.

Copper

Casting of ironImpact from direct emissions

Impact from indirect emissions (electricity)

Flat glass

Veneer sheets

0%

10%

20%

30%

40%

0.0% 0.2% 0.4% 0.6% 0.8%1.0%

4%2%

Starches& starch products

Preparation of yarn

Other textile weaving

Retreading/rebuilding tyres

Commodities with significant carbon cost

Share of GDP of UK

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Three approaches address leakage for exposed sectors

Price level

CO2

costs

Price levelPrice level

CO2

costsCO2

costs

Cos

t

Cos

tC

ost

Government ledsectoral agreement

Export taxes Border adjustment

Cos

t

Export taxes Border adjustmentExport taxes Border adjustment

Conditionalfree allocationState aid

•Little substitution to low carbon products/services

•Distorts investment•Bureaucratic constraints for innovation

•Risk of lock-in

•Has to be aligned with international climate engagement

•Requires at least informal international cooperation

•Requires strong policies of developing countries

•Risk of low common denominator

Initial evaluation

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Summary leakage

• Potential issue only for 1-2% of economic activity– Materiality to be assessed on sub-sector level– Relevance only if there will no strong global deal 2009

• Instruments exist to avoid leakage – sub-sector by sub-sector– State aid, free allocation, border adjustment– Side effects: lower efficiency / international complications

• In Europe decide on instrument in 2010/2011– Focus first on international deal– Cooperate in parallel internationally on instruments to address leakage– Ensure transparent approach – no special provisions in Directive

• This creates maximum investment security– Industry & environment interest coincide -> we will avoid leakage– Investments that would be viable under global deal remain viable

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Effective climate policy for EU industry

• The challenge for low-carbon policies

• Provide for the needs of different investors

• Provide for different technologies

• Leakage concerns

• European package – a consistent framework?

Karsten Neuhoff

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0

1

2

3

4

5

2007 2020 2050

Gt CO2

in EU-27

Assumed emission growth business as usual 1%/year

2012

Linear 75% reduction trajectory

Contribution from new low carbon technology portfolio

Renewable target

Kyo

to t

arge

t

Trajectory

20%

with

out

inte

rnat

. ac

tion

How does it all fit together?

Contribution from energy efficiency

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Effective climate policy for EU industry

Emission trading – share target across sectors• Short-term – address ‘risk’ from low carbon prices• Long-term – clear European and National targets

Technology policy• Support deployment of low carbon technologies• Ensure a portfolio of renewables is available by 2020

Beyond Europe• For few sectors, work internationally on leakage policies• Lead by example in implementation and technology

www.electricitypolicy.org.ukwww.climate-strategies.org