EU ETS: allocation of CO2 allowances and competitiveness

1
EU ETS allocation of CO2 allowances and
competitiveness

Damien DEMAILLY
ETUC What jobs in a low carbon European
economy? 20 21 Feb 2007
2
Introduction

• 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

ETUC What jobs in a low carbon European
economy? 20 21 Feb 2007
3
Cost-efficiency in a closed economy Auctioning
(AU) and Grandfathering (GF)

• 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

ETUC What jobs in a low carbon European
economy? 20 21 Feb 2007
4
Cost-efficiency in a closed economy Output-based
allocation (OBA)

• 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

ETUC What jobs in a low carbon European
economy? 20 21 Feb 2007
5
Real world AnalysisCompetitiveness impacts

• 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)

ETUC What jobs in a low carbon European
economy? 20 21 Feb 2007
6
Real world AnalysisCompetitiveness impacts
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
ETUC What jobs in a low carbon European
economy? 20 21 Feb 2007
7
Trade-off Competitiveness Cost efficiency

• 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.
  Its up to the EU.

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

ETUC What jobs in a low carbon European
economy? 20 21 Feb 2007