Assessing carbon leakage in the EU Emissions Trading System

adelphi was part of a team of researchers asked to assess the extent to which carbon leakage occurred during the third phase of the EU Emissions Trading System. Furthermore, the team was tasked with identifying industrial sectors that may be vulnerable to carbon leakage in the 2020s under a stricter reduction target of 50 to 55 percent instead of the current 40 percent.

Differences in carbon pricing across countries can leave businesses in places with higher carbon costs at a competitive disadvantage. This can lead to both economic activity and emissions shifting to countries that are not subject to such constraints. The phenomenon, known as carbon leakage, can hamper the effectiveness of carbon pricing in reducing global emissions and result in environmental, social, and economic harm in countries with more stringent climate policies.

Emissions Trading Systems and the risk of Carbon Leakage

The European Union, like all governments that have established emissions trading systems (ETSs), has addressed the risk of carbon leakage by granting energy-intensive, trade-exposed sectors a share of emission allowances for free. However, this approach will face increasing constraints because the number of allowances available for free will decline significantly in line with a revised EU ETS cap, particularly under the more ambitious 2030 reduction target.

This study in part assesses the effectiveness of free allocation in preventing carbon leakage as well as limitations to this approach going forward.

EU impact assessment on higher climate ambition

Key industrial sectors in Europe could face increasingly high costs for their emissions in the coming decade, which may require new approaches to safeguard competitiveness while driving mitigation.

This research was undertaken to inform the EU impact assessment on higher climate ambition. A final report to EU Commission consisted of both backward- and forward-looking analyses of carbon leakage. It included factsheets on key industries covering a range of economic and climate metrics during Phase III of the EU ETS, as well as a quantification of potential allowance shortages and an assessment of each sector’s vulnerability to carbon leakage based on factors such as their expected abatement potential and costs during Phase IV.

We also presented policy options to address identified risks of carbon leakage for vulnerable sectors. Specifically, we assessed border carbon adjustments (BCAs), consumption charges, tiered approaches to free allocation, and innovation support.