Carbon Leakage Is It Art

Or Can We Get Rid Of It?

Whats the current state, the way forward and the
potential impact of the revision
Published: 29/07/2013
Analysts: Philipp Ruf

Benjamin Schmitt

Yann Andreassen

Carbon Leakage Is It Art Or Can We Get Rid Of It?

Executive Summary
This report intends to bring the reader up to speed on the carbon leakage
discussions and especially the revision of the first carbon leakage
list in 2014.
First, the report summarises the legal background of the carbon leakage list, the methodology behind the calculations,
the assumptions used for the first list and the results. Second, upcoming revision is highlighted by analysing the necessary
legislative steps, the potential changes and the timeline of the revision. As a third point, the impact of a revision on
fundamental volumes as well as the traded market balance is shown by utilising three different scenarios.

Key points:
It is legally unclear whether the carbon price assumptions (30/tonne) made for the determination of the first list can
be changed when revising the list.
The auctioning factor, the emission factor for electricity and countries to be considered as non-third countries are
assumptions that should be based on available data of the three most recent years.
A trimmed carbon leakage list would decrease the free allocation volumes, but at the same time increase the
auctioning volumes.
In the traded market, a trimmed list would have a counterintuitive impact, as
the traded market balance would be longer;
the accumulated traded market balance would consequently also be longer; and
the banked volumes would decrease.
These effects are observable because of three reasons:
1. Additional demand entering the market due to less free allocation is partly covered through additional liquidation of
banked allowances.
2. The increased auction volumes exceed the additional demand which is covered via the market by far.
3. Auction supply is entering the market for sure and cannot directly end up as banked volumes as it might be if industry
is over-allocated.

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Carbon Leakage Is It Art Or Can We Get Rid Of It?

Introduction
Carbon leakage describes the increase of emissions in
one country as a result of an emissions reduction due to
the climate policy by a second country. Since industry in
the second country is not subject to comparable carbon
constraints, production costs for the industry, which is
affected by the climate legislation in the first country, might
be higher. If companies are unable to pass on these
additional costs to their customers without losing a significant
market share, the climate legislation results in an economic
disadvantage and no emission reductions when considering
both countries together.
To address this potential competitive disadvantage for
industrial installations covered by the EU emissions
trading system (EU ETS) and to prevent the relocation of
installations to countries outside the EU, carbon leakage
exposed production receives a higher share of free allocation
in the third trading period.
The European Commission adopted in 2009 a list on
which all sectors and sub-sectors deemed to be exposed
to a significant risk of carbon leakage are listed. In order to

determine the sectors, an assessment was done (more on

criteria and methodology in the next section of this report).
The installations, which produce in the specific sectors or
subsectors, receive free allowances for 100% of the productspecific benchmark throughout the third trading period
(excluding the application of the cross-sectoral reduction
factor). Industry installations, which are not included in the list,
will receive only 80% in 2013 and a linearly reduced share
every year to reach 30% in 2020. Since the benchmarks
are based on the most efficient installations, it might be that
some installations on the carbon leakage list do not receive
all allowances they need for free.
However, the list adopted in 2009 is applicable for 2013-2014
only. Therefore, a new list has to be adopted for 2015-2019.
This report gathers together the legal basis of the carbon
leakage list, the criteria and methodology of the calculations
as well as information about the first carbon leakage list.
Furthermore, a scenario analysis of the market impact of the
potential revision of the list for 2015-2019 is done.

Technicalities of the
Carbon Leakage List
Legal Base, Criteria & Methodology
The carbon leakage issue, especially the methodology of
the determination, is mainly handled in Article 10(a) of the
ETS Directive (Directive 2003/87/EC).
Paragraph 13

This paragraph clarifies that every carbon leakage list

is valid for five years. Consequently, the list which was
adopted in 2009 is valid for 2013-2014 only. After the
expiry of a list, a new list (then valid for the following five
years) has to be prepared according to the criteria in
paragraph 14-17 of the ETS Directive. Within one period,
sectors or subsectors can be added to the list every year

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by request of the commission or a member state (MS), but

not deleted. The commission should furthermore consult
MS, the carbon leakage exposed sectors or subsectors as
well as other relevant stakeholders when preparing a new
list. Furthermore, this paragraph rules that an adoption of
a new list is done via the comitology procedure, meaning
that the commission introduces a proposal to the Climate
Change Committee (CCC) in which MS representatives
decide on it. The European Parliament has then a threemonth scrutiny period to object to the decision. However,
this is only a no decision. The parliament can only reject
the decision entirely; there is no possibility to adopt it or to
propose changes.

Carbon Leakage Is It Art Or Can We Get Rid Of It?

Paragraph 14

Paragraph 14 clarifies that the assessment which

determines the sectors exposed to a significant risk of
carbon leakage are based on an average carbon price
[] and, [], trade, production and value-added data from
the three most recent years for each sector or subsector.
Ultimately, this assessment determines the extent to
which it is possible for sectors or subsectors [] to pass
on the direct cost of the required [carbon] allowances and
the indirect costs from higher electricity prices resulting
from the implementation of this Directive [the EU ETS
Directive] into product prices without significant loss of
market share to less carbon efficient installations outside
the Community.
Paragraph 15 & 16

These paragraphs establish two quantitative indicators

which are used to evaluate the risk of carbon leakage
trade intensity and carbon cost. A sector is deemed to
be exposed to a significant risk of carbon leakage, if one
of the following three criteria applies (additional definitions
in table 1):
1. The additional carbon costs would increase the
production costs of a sector or subsector by at least
30% Paragraph 16(a)

2. The trade intensity with third countries is above 30%

Paragraph 16(b)
3. The additional carbon costs would increase the
production costs of a sector or subsector by at least 5%
and the trade intensity with third countries is above 10%
Paragraph 15
Paragraph 17

Next to the quantitative criteria laid down in paragraphs

15 and 16, paragraph 17 specifies qualitative criteria
which may be applied to determine whether a sector or
subsector is deemed to be exposed to carbon leakage,
though the quantitative criteria are not entirely fulfilled.
1. The potential to reduce emission levels and electricity
consumption of individual installations
2. Current and projected market characteristics
3. Profit margins as potential long-run investment indicator
Paragraph 18

This paragraph rules that international developments, e.g.

if third countries which represent a decisive share of
global production in the sectors or subsectors in question
commit to reducing emissions, have to be taken into
account when determining the carbon leakage list.

Table 1 Calculation Methodology of Carbon Leakage Criteria

Criteria

Definition & Formula

Direct Costs

Is calculated by multiplying the direct emissions from the sector/subsector in question with the auctioning
factor and the carbon price.
Formula
Direct Cost=Direct Emissions*Auctioning Factor*Carbon Price

Indirect Cost

Is calculated by multiplying electricity consumption of the sector/subsector in question for own use with an
emissions factor for electricity and the carbon price.
Formula
Indirect Cost = Electricity Consumption*Emission Factor*Carbon Price

Carbon Costs

Is the sum of Direct and Indirect Costs calculated as a proportion of gross value added.
Formula

Carbon Cost = DirectCost+Indirect Cost

Gross Value Added
Trade Intensity

Defined as the ratio between the total value of exports to third countries plus the value of imports from third
countries and the total size for the Community (annual turnover + total imports from third countries).
Formula
Trade Indesity = Imports+Exports
Turnover+Imports

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Carbon Leakage Is It Art Or Can We Get Rid Of It?

The First Carbon Leakage List (2013-2014)

Adoption of the Second Carbon Leakage List

The first carbon leakage list was initially adopted by the

commission in December 2009 (Commission Decision
C(2009) 10251) and extended in November 2011
(Commission Decision C(2011) 8017), August 2012
(Commission Decision C(2012) 5715) and June 2013
(with no official document published yet). Currently, 175
sectors and sub-sectors are listed on the first carbon
leakage list.

As outlined in the previous chapter, the commission is

obliged to produce a new carbon leakage list for the 20152019 period. The commission organised a stakeholder
consultation on 23 May 2013 in Brussels to gather the
opinion of MS, industry, non-governmental organisations
(NGOs) and academia on the matter. Furthermore, the
commission launched a public consultation where all
citizens, organisations and authorities are encouraged to
express their views and to contribute to the discussion.
The consultation is launched online and contributions can
be handed in until 30 August 2013.

In terms of data, the assessment of the first carbon

leakage list was based on an average carbon price of 30/
tonne. This price was derived from the impact assessment
accompanying the EU 2020 climate and energy package.
The assessment of the indirect cost was based on a
union-wide average emission factor for electricity of 0.465
tonnes carbon dioxide (CO2)/MWh. For the auctioning
factor, an industry-wide value of 75% was applied.
In regards of countries which are considered as third
countries, only Norway, Iceland and Switzerland made an
international commitment comparable with the EU. These
three countries together did not represent a decisive share
of global production in carbon leakage exposed sectors or
sub-sectors.

Legislative Procedure
According to the commission roadmap (which is
published online), the appropriate proportionate legislative
instrument to determine the new list is a Commission
Decision. Article 10a (13) of the ETS Directive regulates
the procedure for such a Commission Decision related
to the carbon leakage list by stating that amending the
list and producing a new one is done via the Comitology
procedure.

Table 3 - Definitions
Term

Definition

Auctioning Factor

The auctioning factor is the share of direct emissions for which a sector needs to buy allowances in the
market if it was not exposed to a significant risk of carbon leakage

Commission Decision

Decisions are (a) EU laws relating to specific cases, (b) addressed to specific parties (unlike
regulations) and (c) full legally binding. Decisions can either come from the EU Council or, as in this case,
from the commission

Comitology

Comitology refers to a legislative procedure in which the European Parliament and the Council delegate
legislative power to the commission. In the procedure, the commission introduces a proposal for a law in
a Comitology Committee (chaired by the commission). In terms of climate legislation, this committee is the
Climate Change Committee (CCC). The committee is composed of member state (MS) representatives and
has to adopt the proposal of the commission by qualified majority. After the CCC adopts the measure, the
parliament has a three-month scrutiny period to veto the proposal.

Qualified Majority

The voting system in the European Council and in Comitology Committees is a weighted voting system
based on the populations of MS. In total, 352 votes are distributed among MS and 260 votes are necessary
to reach a qualified majority.

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Carbon Leakage Is It Art Or Can We Get Rid Of It?

Potential Changes to the Indicators

As the criteria with which the carbon leakage exposure
is determined would stay the same in the new list and
the ETS Directive does not strictly define all input data
which is used, the commission might change the following
assumptions:
carbon price;
auctioning factor;
emission factor for electricity; and
countries to be considered as non-third countries.
For the first point the average carbon price used for the
calculations it is not clear if an adjustment is possible
from a legal point. The ETS Directive clarifies that an
average carbon price according to the commissions
impact assessment accompanying the package of
implementations measures for the EUs objectives on
climate change and renewable energy for 2020 should
be used. The commission might therefore be legally
forced to utilise the same assumed average carbon
price of 30/tonne for the second list as they had used
for the first list. In the latest presentation on stakeholder
consultation, the commission announced that a legal
assessment on whether a change of the carbon price is
possible is still ongoing.
For the other input factors, the Directive states that data
from the three most recent years for each sector or
subsector shall be the basis for the assessments, if such
data is available.
The assumption for the auctioning factor for the first
carbon leakage list was based on a best estimate of
the free allocation (including the cross sectoral reduction
factor) in 2013 and 2014. This estimate was that noncarbon leakage exposed sectors would have to buy 75%
of their allowances in the market. This estimation seems
rather high for the second list after production dropped
significantly in some sectors during the recession in
the EU. It might be even possible that some sectors or
subsectors are still over-allocated in 2015-2019 with
the regular free allocation which would then result in an

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auctioning factor of zero. Therefore, these sectors or

subsectors would not face any direct carbon costs.
Another assumption which could alter is the list of
countries to be considered as non-third countries. In the
assessment for the first list, only Norway, Iceland and
Switzerland were recognised as countries that made
an international commitment comparable with the EU.
However, these countries together did not represent a
decisive share of global production in carbon leakageexposed sectors or sub-sectors. In the light or emerging
emissions trading schemes in Australia, California and
China, it is possible that the list of countries considered
as non-third countries grows and that this time countries
which are included have a decisive share
of global production.

Timeline
As mentioned before, the deadline for handing in
contributions for the online stakeholder consultation is
on 30 August 2013. The commission has announced
that they intend to hold additional stakeholder sessions
and discussions based on preliminary results in the
fourth quarter of 2013 in the form of bilateral and
multilateral meetings.
After consulting with the stakeholders, the commission
will draft a final decision and launch an inter-service
consultation within the commission to enable every
Directorate General (DG) to express their opinion.
Once the inter-serve consultation is finished, the
commission will introduce the new list to the CCC for
voting. If the CCC adopts the new list, the parliament
has a three-month scrutiny period to object.
At the moment, it is not possible to predict a timeframe
in which the abovementioned events take place
since there are too many uncertainties. However, the
commission has always confirmed that the new list will be
ready during 2014.

Carbon Leakage Is It Art Or Can We Get Rid Of It?

Potential Impact of a Revised

Carbon Leakage List
This chapter provides three scenarios in order to show the
impact of a possible carbon leakage revision.
In the first scenario, the Current Regulation scenario, we
assume the same sectors and sub-sectors as in the first
list are deemed to be carbon leakage-exposed; 92% of
the National Implementation Measures (NIM) application
of industry. The second scenario (60% Leakage scenario)
implies that 60% of the NIM application is deemed to be
carbon-leakage exposed. In the third scenario (20% Leakage
scenario), we consider an even deeper cut and assume that
the new carbon leakage list contains only 20% of the NIM
application of industry. All three scenarios are hypothetical
and are not a forecast of how the second list looks like; we
simply want to show the possible impact of a revision of the
list on future allocation and auctioning volumes. To calculate
the impact on different industry sectors, we distributed the
share of NIM application, which is carbon-leakage exposed,
equally to all sectors in the second and third scenarios.

Impact on Fundamental Volumes

In the 60% Leakage scenario, the allocation would
decrease by around -81m tonnes (-11%) in 2015 compared
with the Current Regulation scenario. A reduction of
allocation would further rise to 147m tonnes in 2019
and thus industry would lose -22% of its envisaged free
allocation. Since the cap is fixed in the EU ETS, all volumes
which are not allocated for free are transferred to the
auction pot. Therefore, the auction volumes in 2015-2019
would increase by the same amount as the allocation
volumes decrease. The increase in 2015 represents a +9%
increase compared with the Current Regulation scenario,
while in 2019 this increase reaches +15%.
The impact on industry in the 20% Leakage scenario would
be more severe and the industry would face a reduction of its
free allocation of -188m tonnes or -25% in 2015 compared
with the Current Regulation scenario. This drop in allocation
volumes equals -327m tonnes (-48%) in 2019. On the
auctioning side, the respective increase of volumes equals
+20% in 2015 and rises to +34% in 2019. All respective data
can be found in Table 4.

Table 4 Impact of Carbon Leakage Scenarios on Fundamental Volumes

2015

2016

2017

2018

2019

Current Regulation (92% of NIM application is carbon leakage exposed)

Allocation

Total

747.1

730.3

713.6

697.0

680.6

Auctions

Total

938.7

947.1

955.4

963.8

973.9

60% Leakage Scenario (60% of NIM application is carbon leakage exposed)

Allocation

Auctions

Total

665.7

631.5

597.9

565.4

533.4

[m tonnes]

-81.4

-98.8

-115.7

-131.7

-147.2

[%]

-11%

-14%

-16%

-19%

-22%

Total

1020.1

1045.9

1071.1

1095.5

1121.1

[m tonnes]

+81.4

+98.8

+115.7

+131.7

+147.2

[%]

+9%

+10%

+12%

+14%

+15%

20% Leakage Scenario (20% of NIM application is carbon leakage exposed)

Allocation

Auctions

Total

559.9

506.2

453.6

403.3

354.1

[m tonnes]

-187.3

-224.1

-260.0

-293.7

-326.5

[%]

-25%

-31%

-36%

-42%

-48%

Total

1126.0

1171.2

1215.4

1257.5

1300.4

[m tonnes]

+187.3

+224.1

+260.0

+293.7

+326.5

[%]

+20%

+24%

+27%

+30%

+34%

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Carbon Leakage Is It Art Or Can We Get Rid Of It?

The first scenario, Current Regulation, assumes no changes

to the carbon leakage list. As can be seen in Graph 1, the
estimated traded market balance remains long until 2015
(+38m tonnes) and turns increasingly short thereafter. In
2019, the balance reaches -64m tonnes on a yearly basis.
Graph 2 shows the accumulated traded market balance
and indicates that it remains long until 2019 (+121m tonnes)
mainly because of an overhang of +258m tonnes build-up in
2012-2014. In regards to banked volumes (see Graph 1), the
model results show a slight cutback of banked volumes from
+778m tonnes in 2015 to +621m tonnes in 2019.
The situation, however, differs if the carbon leakage list is
trimmed. Intuitively, one would expect that additional demand
arises from the industry since more sectors need to cover
their allowance shortage via the market and therefore the
market would be shorter. However, Graph 1 and Graph 2
clearly show that this can neither be expected for the 60%
Leakage scenario nor for 20% Leakage scenario. This is
because of three reasons.

Graph 2 - Accumulated Yearly Traded

Positions of the Different Carbon Leakage
List Scenarios; Source: Tschach Solutions
800
600
[m tonnes]

Impact on Traded Positions

400
200
0
2014

2015

2016

2017

2018

2019

Acc. Traded Position - Current Regulation

Acc. Traded Position - 60% Leakage Scenario
Acc. Traded Position - 20% Leakage Scenario

150

1500

100

1000

50

500

-500

-50

-100

2014

2015

2016

2017

2018

2019

Yearly Traded Volumes - Current Regulation

Yearly Traded Volumes - 60% Leakage Scenario

Yearly Traded Volumes - 20% Leakage Scenario

Acc. Banked Volumes - Current Regulation

Acc. Banked Volumes - 60% Leakage Scenario

Acc. Banked Volumes - 20% Leakage Scenario

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-1000

Acc. Banked Volumes [m tonnes]

Yearly Traded Volumes [m tonnes]

Graph 1 - Yearly Traded Positions and Accumulated Banked Positions of the Different Carbon
Leakage List Scenarios; Source: Tschach Solutions

Carbon Leakage Is It Art Or Can We Get Rid Of It?

1. Although more market players are short if the carbon

leakage list is trimmed, part of this additional demand is
covered through additional liquidation of banked positions
which were built up in 2008-2014. If industrial players are
able to cover their additional demand through formerly
banked volumes, this additional demand has no impact on
the traded market balance.
2. The auction volumes are significantly higher if the carbon
leakage list is trimmed. The additional demand which can
be expected to enter the market will be exceeded by far
from additional auction volumes.
3. Some of the sectors that are currently on the carbon
leakage list are expected to be long in the 2015-2019
period. Since some of this surplus of allowances would end
up directly on industry accounts as banked volumes, this
supply would not affect the traded balance.

Graph 1 and Graph 2 quantify this additional surplus in the

market due to a trimming of the carbon leakage list. The
graphs show clearly that the traded balances yearly and
accumulated of both leakage scenarios exceed the ones of
the Current Regulation scenario. If the carbon leakage list is
modestly trimmed (60% Leakage scenario), the accumulated
traded market balance is at around +319m tonnes, while
it can be expected to surpass +600m tonnes in the 20%
Leakage scenario. The banked volumes, however, are
significantly reduced in both leakage scenarios to +399m
tonnes in the 60% Leakage scenario and 123m tonnes in the
20% Leakage scenario.

Conclusion
The current carbon leakage list, which was initially adopted in
December 2009, is up for a review in 2014. The commission
is legally obliged to adopt a new list for 2015-2019.
As outlined in this report, the criteria for carbon-leakage
exposure will stay the same for the second list. However,
adjusted input factors (expected average carbon price,
auctioning factor, emission factor for electricity and countries
to be considered as non-third countries) could change the
composition of the list. One of the key questions in regards
to input factors is whether it is legally feasible to change
the expected average carbon price that is used for the
calculations. The latest statement from the commission on
this issue indicates that a change might not be possible.

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The three analysed scenarios in the chapter before illustrate

the impact a revision might have. Although the cap is
untouched, and while a trimmed carbon leakage list results in
lower free allocation and higher auction volumes, the traded
market balance could be severely affected. A trimmed list
does not have the intuitively expected impact more short
market actors result in a shorter market but an adverse
effect: the additional demand is overcompensated by
additional supply and therefore the traded market balance is
longer if the list is trimmed. This effect would most likely result
in price pressure in 2015-19.

Carbon Leakage Is It Art Or Can We Get Rid Of It?

10

Disclaimer
The graphs, tables and data provided in this report were
prepared by Tschach Solutions. The report is meant to
provide additional information to the professionals in the
carbon and power market. Tschach Solutions obtains
data and information only from sources Tschach Solutions
considers reliable, but Tschach Solutions cannot make
any representation or warranty, express or implied, to the
accuracy or completeness of the data and information
provided.
Estimates cannot provide exact predictions and can prove to
be misleading. Thus, any estimates or predictions provided
in this report are merely opinions and views of Tschach
Solutions and might change without notice, and Tschach
Solutions has no obligation to update the information
provided in the report.
The information provided in the report is no advice or
recommendation for any trading decision. All users of
the report should make up their mind using a variety of
information sources.
This report is produced by Tschach Solutions and published
on a subscription basis. Neither the report nor any of the
information provided is issued at the request of any client of
Tschach Solutions.

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Copyright
Copyright 2013 by Tschach Solutions
All rights reserved by Tschach Solutions. No part of this
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