The issue of ‘cost pass-through’, in combination with its impact on market share, is a critical component in the proper understanding of exposure to the risk of ‘carbon leakage’. In this context, EUROFER has asked NERA Economic Consulting to investigate what conclusions can be drawn from the existing literature on this subject, and how this relates to the conclusions of the Impact Assessment carried out by the European Commission for the review of the European Union Emissions Trading System (EU ETS) Directive.
NERA found that most of the existing literature does not address cost pass-through in conjunction with market share or that, when it does (Vivid 2014), it is subsequently misinterpreted in the Commission’s Impact Assessment. Furthermore, the (very limited) literature shows the pitfalls of trying to measure cost pas through – even when ignoring potential impacts on market share.
In particular, the latest study by CE Delft-Oeko Institut suffers from several critical flaws concerning input data and methodological approach. The authors determine the cost pass-through rate by comparing the average EU carbon price in the period 2008-2014 with the production costs of a Japanese plant in March 2015 (which is used as a proxy for European product prices). This means that neither the geographical location nor the time period are coherent with the rest of the data.
A qualitative analysis carried out by NERA using the criteria identified by the EC’s impact assessment (trade exposure, market structure, elasticities) suggests that high cost pass-through would likely result in loss of market share and would likely be detrimental to the European steel industry (which already suffers from low margins, dumping behaviour, most notably from Chinese steel producers, and fierce competition from other less environmentally stringent producers).
Reducing carbon leakage protection based on poorly justified estimates of ability to pass through costs will also be contrary to the objective pursued by the EU ETS Directive of limiting CO2 emissions, which would merely be relocated and not reduced.