Eurofer Background Paper General Leakage Issue

Leakage risk is a pivotal aspect of the revised Emissions Trading Directive 2003/87/EC. Only if leakage risk is addressed properly in the implementation of this Directive, the objectives of the Community's Climate Change policies can be met. In this respect the effects of both direct CO2-costs and CO2-cost pass-through in electricity prices must be addressed. Shortcomings in this respect will not foster but retard global emission reductions and at the same time impact negatively on the Community's economic competitiveness as well as political credibility.

This paper highlights some aspects of leakage risk, which are of utmost importance for the functioning of the Community's Emissions Trading Scheme and which are most pronounced in energy intensive manufacturing industries. In the following it will be explained that

  • leakage risk assessment should be performed under a scenario of 100% auctioning,
  • operators receiving 100% of the benchmarks for free will have to face considerable compliance costs (in order to achieve their respective benchmarks),
  • the incentive for CO2-abatement does not increase with the stringency of benchmarks,
  • long investment cycles introduce leakage risk in the start up phases of a benchmarking scheme.

For the purposes of establishing leakage risk it is not possible to refer to observed leakage. Currently, it is also not possible to quantify leakage by quantitative models, since such are not developed to the extent needed. Therefore, both the procedure and the thresholds of Directive 2003/87/EC for leakage risk assessment were linked to the fundamental character of the sectors evaluated. Consequently, leakage risk evaluation was performed under the assumption of 100% auctioning, because only then the fundamental characteristics of each sector (described by CO2 costs incurred and trade intensity) are matched with the relevant fundamental characteristics of Directive 2003/87/EC - namely auctioning as a rule with temporary exceptions. This is a logical consequence of the implementation of this Directive. Not applying a full auctioning scenario is neither a mandatory consequence from the Directive nor advisable because this will create some collateral difficulties: It will

  • provide an argument to challenge the thresholds used,
  • will disincentive investments because certainty and thus the risk-management function of the sector list is removed,
  • introduce the notion to prepare a list for each year from 2013 onwards, which is not in line with the Directive (which defines a list).

The majority of installations in sectors to which leakage risk would be assigned will not be exempted from CO2 reduction costs, but on the contrary will have to shoulder huge investment programs. In all sectors CO2 data collection programmes are under way. First results already indicate significant spreads in CO2-intensity within most of the sectors.

As a consequence only few installations out of several tens of thousands will be in a position to receive free allowances to the extent of their actual emissions (most probably due to favourable and lucky combination of circumstances). The majority of installations in each sector will have to invest significantly to come closer to their benchmarks. Therefore, leakage risk in combination with benchmarking is not a free ride.

Against this background it also is only obvious that the incentive towards emission reduction can not be increased by setting very low benchmark values. Such an incentive is already introduced by the existence of a CO2 price in itself. From an economic point of view there is no difference between CO2 costs avoided by meeting a benchmark and income generated from sales of allowances created by overachieving compared to a benchmark. From a psychological point of view, the latter even provides the better incentive, because investment will have a positive pay-back, whilst in the first case only loss of capital will be avoided. Decreasing the benchmark values below the achievable (as identified by the best performers) will only introduce leakage and so acts against the objectives of Directive 2003/87/EC instead of supporting them.

For the energy intensive industries' investments in carbon lean processes and technologies are rather high and need long periods of implementation and start-up. There are no readily available technologies, which only have to be installed and the on-switch to be pressed. Therefore, even if a benchmark is defined at a balanced level leakage risk persists initially, because there is some considerable time lag between the identification of best performance and the eventual operation in other installations. In this intermediate period the investing operator has to bear the costs of the investment and the costs for allowances to be bought because unavoidably he will be short due to the applied benchmarks whilst respective investment will need additional time to bear fruit. Although linked to leakage, this is an aspect which could not be addressed in the leakage risk assessment conducted to produce the list.

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