1. Damien DEMAILLY EU ETS: allocation of CO2 allowances and competitiveness ETUC: What jobs in a low carbon European economy? 20 & 21 Feb 2007

2. Introduction ETUC: What jobs in a low carbon European economy? 20 & 21 Feb 2007 EU ETS review: how to improve the system? EU harmonization Long term visibility Competitiveness : 2 aspects in the short run Market share : market share / employment losses, relocation, CO2 leakage ? Profitability : windfall profit ? Cost Efficiency The methodology to allocate allowances is crucial for the last two points  What are the possible methodologies in the future ?  What are their impacts on competitiveness and their cost efficiency

3. Cost-efficiency in a closed economy Auctioning (AU) and Grandfathering (GF) ETUC: What jobs in a low carbon European economy? 20 & 21 Feb 2007 GF : the amount of allowances given for free is independent on current firms behaviour AU : allowances are auctioned Two effects : 1/ Incentive to invest in low CO2 technologies 2/ Prices increase according to the CO2 embedded in production GF : opportunity cost & windfall profits AU : revenue for States / EU and eventual double dividend  Consumers and manufacturers switch toward low CO2 products

4. Cost-efficiency in a closed economy Output-based allocation (OBA) ETUC: What jobs in a low carbon European economy? 20 & 21 Feb 2007 OBA : firms get an amount of allowances proportional to their production 1/ Incentive to invest in low CO2 technologies 2/ The cost of CO2 emission is not internalised in prices (No opportunity cost)  No incentive to switch toward low CO2 products. Important loss of cost-efficiency In a closed economy, GF and before all AU are more cost-efficient than OBA. Current allocation methodology : “impure” GF: stands somewhere between OBA and GF NB: Pre-existing distortionary taxes make GF worst

5. Real world Analysis Competitiveness impacts ETUC: What jobs in a low carbon European economy? 20 & 21 Feb 2007 Real world: all countries are not CO2-constrained, goods are traded, firms may relocate. “ Except for electricity, markets are global. We are not able to pass any cost increase to consumers because of international competition. Hence no windfall profits under GF and huge collapse of our margins under AU. In the long run, we will have to relocate to the detriment of EU employees and of climate (CO2 leakage)” lobbyist analysis (caricatured…)

6. Real world Analysis Competitiveness impacts ETUC: What jobs in a low carbon European economy? 20 & 21 Feb 2007 There are elements softening the “lobbyist analysis” 1/ Significant ability of EU manufacturers to reduce their CO2 intensity, at least in the medium term 2/ Trade with non EU countries is not that high for various reasons : transportation costs, product differentiation, service differentiation…  positive pass-through without huge market share losses 3/ Relocation : A medium term issue Long term investment vs. uncertainty surrounding the future international regime

7. Trade-off Competitiveness & Cost efficiency ETUC: What jobs in a low carbon European economy? 20 & 21 Feb 2007 Option 1: Rely on previous elements / most economics studies  AU for power sector, partial AU for trade open sectors. Option 2: Rely on the lobbyist speech  “impure” GF or OBA at least for trade open sectors Option 3: Be ambitious but cautious  AU + Border Tax Adjustments My guess: might be designed to be WTO compatible and to prevent its use for protectionist purpose. It’s up to the EU.

8. ETUC: What jobs in a low carbon European economy? 20 & 21 Feb 2007