Carbon leakage and capacity-based allocations. Is the EU right?

Carbon leakage and capacity-based allocations. Is the EU right? / Guy Meunier, Jean-Pierre Ponssard, Philippe Quirion. Ecole Polytechnique ParisTech, Feb 2012, 31 p. (Cahier de recherche n° 2012-05)

Countries which currently are, or are in the process of, implementing a national or regional cap and trade CO2 scheme are following alternatives routes in a number of ways: coverage, cap/target, allocation of allowances, measures to manage price volatility, offsets, measures to address competitiveness and leakage. This last issue more specifically concerns “sensitive sectors”, i.e. internationally traded carbon intensive sectors (aluminium, cement, steel, refined petroleum…). Three main approaches have been proposed: output based allocation (Aus- tralia, California, New Zealand), capacity based allocation (EU) and auctioning with border adjustment. This paper investigates what the best policy should be in this setting. The analysis suggests that, if a border adjustment is not available, a combination of output and capacity based allocation is socially optimal. Demand uncertainty and international competition play a key role in the analysis since the interaction between these two factors makes the difference. A calibration of the model is used to evaluate the EU scheme for the cement sector in the third phase of the EU-ETS (2013-2020). It is shown that (i) an output based scheme would perform better than the proposed scheme, that (ii) if output-based allocation is chosen, allocation should be much less generous than the current EU benchmark, and that (iii) full auctioning with border adjustment would perform even better.

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