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Paris climate talks add pressure to reconsider carbon leakage rules

A leaked European Commission document suggests that pollution subsidies to industry under the EU’s Emissions Trading Scheme will increase to around €150 billion after 2020. The subsidy is under consideration because some industry sectors claim that the EU’s carbon market puts them at a competitive disadvantage, when in fact carbon pricing has been successfully introduced in many other regions as well. The proposal to shield industry from Europe’s main climate instrument sends the wrong signal ahead of the climate summit in Paris in December where countries are expected to sign a global climate agreement applying to all sectors and regions.

Under the revised EU Emissions Trading System (ETS) for the period 2021-2030 a staggering 6.3 billion free pollution permits could be handed out to industry deemed to be at risk of carbon leakage according to the draft impact assessment. Carbon leakage [in EU] is the theoretical situation in which, as a result of stringent climate policies, companies move their production abroad to countries where there are no such climate standards. But the list of regions where carbon can leak to is shrinking by the minute, as around 40% of the global economy is already covered by some form of carbon pricing and often experiencing higher carbon prices than in the Europe.

The proposed €150 billion pollution subsidy to industry prejudges the outcome of the UN climate agreement to be signed in Paris at the end of this year, since it is based on the premise that other countries are not moving on climate change. The draft analysis thus sends exactly the wrong signal to the international climate negotiations at a time when countries are gathering in Bonn to negotiate the details for the global climate deal. With all eyes focusing on the UN 2015 climate deal which is expected to be the first joint global effort to tackle climate change, the EU’s proposal to hand-out carbon subsidies to its industry does not send a very convincing signal of European climate integrity to the rest of the world.

The leaked analysis underpins the review of the EU ETS for the 2021-2030 period, which the European Commission will publish by early September at the latest, and finds no evidence for the risk of carbon leakage. The continuation of pollution subsidies thus appears like a last-ditch effort by the EU to shield its industry from any carbon pricing and some observers have indicated that there is a risk that other countries will start taking counter carbon leakage measures against the EU.

The draft impact assessment also examines the ability of manufacturers to pass through the “cost” of emission allowances they received for free, which apparently seems to be possible for most (if not all) carbon-intensive sectors. The steel sector for example passes through all of the carbon costs to its consumers even though the carbon permits where initially given to the sector for free. This not only shows that industrial sectors are able to gain substantial windfall profits at the expense of their customers, it also means that the approach of free allocation of pollution permits is inherently unsuccessful.

As is the case with any subsidy, someone needs to pick up the bill. In this case EU taxpayers need to fill up the loss of public funds equal to the foregone auctioning revenues of governments. Implementation of the recent commitment by G7 leaders to eliminate fossil subsidies, including those to industry in the form of free pollution permits, is hence crucial to help ensure a fair transition to climate-friendly societies, in which not only taxpayers but also polluters start paying a price for carbon.


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