Carbon leakage repercussions

Water leaks. carbon or, rather, carbon dioxide, does it too. The principal greenhouse gas (GHG) is no longer the only gas regulated under directive 2003/87/EC, the Emissions Trading Scheme Directive (ETS). This legislative instrument has been amended as part of the EU Climate and Energy Package to include, for certain categories of activities, nitrous oxide and perfluorocarbon emissions. The ETS establishes a cap-and-trade mechanism whereby each EU member state is allocated a definite amount of greenhouse gas allowances, each allowance representing one tonne of CO2 equivalent to be distributed among its entities listed in Annex I of the directive.

Apart from power generation plants, Annex I entities or “categories of activities” include the bulk of the chemical industry – metal processing, ceramic, lime and cement production, the manufacture of nitric acid and ammonia, organic chemicals, the production of hydrogen, sodium carbonate and sodium bicarbonate, carbon capture and storage installations and, as from January 1, 2012 the aviation industry.

It occurs therefore that, conventional power generation installations apart, the ETS exerts a considerable hold on the wider span of the chemical industry, a major power consumer and GHG generator in the EU and across the world. INEOS ChlorVinyls (2009) refers to Badische Anilin- und Soda-Fabrik (BASF) as the world’s largest chemical company with an estimated sales amounting to $65 billion for 2007. Global turnover for the chemical industry is of the order of trillions of US dollars.

The chemical industry makes the world go round, as the saying goes; it is one of the world’s major employers. Yet, its associated environmental pollution problems are well known and, thankfully, Malta does not face the hassle of having to deal with the mess. At least, not directly and only to a very small extent in our own backyard!

Unless nuclear power is available, the chemical industry is fossil fuel driven and it is obviously desirable to curtail its huge carbon footprint. The mechanism under the ETS directive is such that the industry has to surrender its carbon allocations, or permits, by a stipulated date to cover its carbon emissions. Any excess emissions beyond the original allocations will require the industry to purchase carbon permits from an international carbon market, as if CO2 and, now, some other GHGs were a standard commodity. This comes at a cost, over and above the penalty set by law for each extra tonne of CO2 equivalent emitted.

Despite the perhaps higher initial capital costs, the incentive for industry is therefore to invest in cleaner technology or research for more environmentally friendly production modes, designed to diminish the industry’s carbon footprint as much as possible. Any surplus carbon allocations can then be sold at a profit.

In theory, at least, the economic rationale looks fine. However, since the ETS has entered into force, a number of problems have emerged and this is to be expected. The so-called “carbon market” is probably the latest market to be invented! During the first trading period, for example, between January 1, 2005 and December 31, 2007, a glut in emissions allocations to some member states, notably Germany, had brought about a steep decline in the price of carbon and, at one point in April-May 2006, prices closed at about €5 per tonne (Stern Review, 2007). The carbon market had effectively collapsed, making it more convenient for the industry to pollute in business-as-usual mode and pay the fines plus purchase any necessary permits to cover emissions than adopting less energy consumptive production modes or retrofitting less carbon intensive technology.

The carbon market, however, is a market like all others – it fluctuates depending on circumstances that are often very complex. By August of that same year, the price of carbon had already recovered to above €15 per tonne and throughout 2005-2007 it had also hovered around the €25 per tonne.

Carbon leakage occurs when ETS-bound industry decides to relocate elsewhere outside the EU bloc, where there is no capping whatsoever on carbon emissions and, therefore, environmental standards tend to be lower and it is judged that this maximises profits. A rise in carbon emissions in the new host country, usually a developing country, is then to be expected, effectively defeating the purpose of the ETS and, in the longer term, undermining any potentially successful Kyoto protocol outcome. In lowering its costs, however, the industry tends to pollute more as a result of utilising older, cheaper technology and this often comes to the detriment of human health.

Carbon leakage also brings about one other serious repercussion – job losses in the country from which the industry had migrated and which, in the lack of an expanding and flexible market economy, would ultimately contribute to a lowering of the gross domestic product.

The best remedy to carbon leakage is the expansion of emissions trading outside the parameters of the EU27 through the global community developing policies and measures facilitating the rapid development of a global carbon market. It is unlikely that the weaker developing economies can afford to set some form of carbon tax, which would only hamper their ability to increase GDP and lose the opportunity to attract foreign investment and provide more job opportunities.

Australia and New Zealand had set up their own carbon emissions trading schemes in 2007 and 2008 respectively. The original intentions were that a global carbon market would develop throughout the Kyoto commitment period, 2008-2012 but, in 2010, mid-way through the period, this generic scenario remains a bit far-fetched.

For any post-Kyoto international climate legislative regime to be considered successful, there must be stronger provisions allowing for the development of a global carbon market, which should reduce carbon leakage to a minimum.

sapulis@gmail.com

The author specialises in environmental management.