Economic policy for low-carbon transition and the role of carbon leakage Tsinghua University Karsten Neuhoff Faculty of Economics Cambridge University

Karsten Neuhoff Outline The challenge for low-carbon policies Provide for the needs of different investors Provide for different technologies Leakage concerns European package – a consistent framework?

Karsten Neuhoff Gt CO 2 in EU-27 Assumed emission growth business as usual 1%/year 2012 Linear 75% reduction trajectory The challenge for emission reductions

Karsten Neuhoff Upward bias of ex-ante estimates (bottom up) * Upper estimate >£8000 million. Source: AEA Technology Environment, 2005, An Evaluation of the Air Quality Strategy, Report to DEFRA, available at: Cost estimates of UK Policies during Lead Free Petrol Euro I petrol Cars* 2000 fuel standards 2005 fuel in 2000/1 Flue Gas De- Sulphurisation (FGD) Low NOX burners Costs (£M) ex ante ex post

Karsten Neuhoff Effective climate policy for EU industry The challenge for low-carbon policies Provide for the needs of different investors Provide for different technologies Leakage concerns European package – a consistent framework?

Karsten Neuhoff Allowance prices – important for project investment Risk of very low carbon prices hampers investment Use reserve price in government auctions to create price floor

Karsten Neuhoff European CO 2 emissions year 2020today 2050 Conventional coal Oil Gas Illustrative Future carbon targets – determine strategic choices BAU Energy Efficiency Renewables CCS/ additional nuclear

Karsten Neuhoff Create clear emission reduction trajectories Define clear (& small) CDM inflow volumes –CDM for diffusion of technologies / removal of barriers Use auction revenue for international cooperation Avoid leakage (emissions moving outside cap) -> Visibility for investment and corporate strategies

Karsten Neuhoff Effective climate policy for EU industry The challenge for low-carbon policies Provide for the needs of different investors Provide for different technologies Leakage concerns European package – a consistent framework?

Karsten Neuhoff Empirical evidence – experience reduces cost Source IEA

Karsten Neuhoff Technology policy complements carbon pricing Low carbon technology Conventional technology Learning investment Future savings Learning investment Future savings Cost Experience (e.g. installed capacity) Carbon cost

Karsten Neuhoff Effective climate policy for EU industry The challenge for low-carbon policies Provide for the needs of different investors Provide for different technologies Leakage concerns European package – a consistent framework?

Karsten Neuhoff Cost increase relative to value added Cement Basic iron & steel Lime Fertilisers & Nitrogen Aluminium Other inorganic basic chemicals Pulp & Paper Malt Coke oven Industrial gases Non-wovens Refined petroleum Household paper Hollow glass Finishing of textiles Rubber tyres & tubes manufact. Copper Casting of iron Impact from direct emissions Impact from indirect emissions (electricity) Flat glass Veneer sheets 0% 10% 20% 30% 40% 0.0%0.2%0.4%0.6%0.8% 1.0% 4% 2% Starches& starch products Preparation of yarn Other textile weaving Retreading/ rebuilding tyres Commodities with significant carbon cost Share of GDP of UK

Karsten Neuhoff Three approaches address leakage for exposed sectors Price level CO 2 costs Price level CO 2 costsCO 2 costs Cost Government led sectoral agreement Export taxes Border adjustment Cost Export taxes Border adjustment Export taxes Border adjustment Conditional free allocation State aid Little substitution to low carbon products/services Distorts investment Bureaucratic constraints for innovation Risk of lock-in Has to be aligned with international climate engagement Requires at least informal international cooperation Requires strong policies of developing countries Risk of low common denominator Initial evaluation

Karsten Neuhoff Summary leakage Potential issue only for 1-2% of economic activity –Materiality to be assessed on sub-sector level –Relevance only if there will no strong global deal 2009 Instruments exist to avoid leakage – sub-sector by sub-sector –State aid, free allocation, border adjustment –Side effects: lower efficiency / international complications In Europe decide on instrument in 2010/2011 –Focus first on international deal –Cooperate in parallel internationally on instruments to address leakage –Ensure transparent approach – no special provisions in Directive This creates maximum investment security –Industry & environment interest coincide -> we will avoid leakage –Investments that would be viable under global deal remain viable

Karsten Neuhoff Effective climate policy for EU industry The challenge for low-carbon policies Provide for the needs of different investors Provide for different technologies Leakage concerns European package – a consistent framework?

Karsten Neuhoff Gt CO 2 in EU-27 Assumed emission growth business as usual 1%/year 2012 Linear 75% reduction trajectory Contribution from new low carbon technology portfolio Renewable target Kyoto target Trajectory 20% withoutinternat. action How does it all fit together? Contribution from energy efficiency

Karsten Neuhoff Effective climate policy for EU industry Emission trading – share target across sectors Short-term – address ‘risk’ from low carbon prices Long-term – clear European and National targets Technology policy Support deployment of low carbon technologies Ensure a portfolio of renewables is available by 2020 Beyond Europe For few sectors, work internationally on leakage policies Lead by example in implementation and technology