FREEZING CLIMATE CHANGE

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1 WWF POSITION STATEMENT EU CLIMATE & ENERGY PACKAGE The EU Emissions Trading Scheme and competitiveness concerns: myth and reality June 2008 WWF European Policy Office 168 avenue de Tervurenlaan Box 20 B-1150 Brussels INTRODUCTION The EU Emissions Trading Scheme (EU ETS) is the cornerstone of the EU s climate policy and the robust design of scheme post 2012 will be critical for achieving 2020 and longer term emission reduction targets. However, if it is to fulfill its potential as a fair and cost effective emission reduction mechanism, which promotes investment in low carbon infrastructure within the EU and also contributes appropriate financial support to the developing world, then the design of the scheme must be significantly improved. There are several design features which will be critical for ensuring this potential is achieved - for example the level of the cap, access to emission reduction credits from Clean Development Mechanism projects and pollution allowance allocation methodology 1. One of these features in particular has been the focus of aggressive energy intensive industry lobbying - the auctioning of pollution allowances. Throughout the review of the EU ETS, which began formally in March 2007, industry has continued to argue that the Commission s intention to focus on auctioning as the main method of allocating allowances post 2012 will have a detrimental impact on the competitiveness of industry, driving up the price of their products, reducing their competitiveness in a global market and ultimately forcing companies, and therefore jobs, to leave the EU. Indeed competitiveness losses has recently been green-washed into the term carbon leakage. The pressure from industry has stepped up since the Commission released the revised draft EU ETS Directive in January this year 2. For example Shell recently threatened to halt investment in Europe, arguing that the cost of buying allowances would exceed the profit of the refining sector 3. Similar threats came from the Austrian steel company Voestalpine 4.These are indicative of the emotive and scaremongering tactics being used by some industry sectors as a way to ensure that they keep on benefiting from free allocation of allowances, thereby reducing their environmental obligations under the scheme. This paper seeks to dispel some of the arguments and concerns put forward by industry, many of which lack any robust analysis to support their assumptions. Environmental policies and competitiveness concerns - an old myth which has no basis in reality Competitiveness losses have always been put forward by industry when discussing environmental policies. However, there is no empirical evidence that such policies have resulted in the relocation of polluting industries to a pollution haven, ie. to countries with less stringent environmental policies. Tel: Fax: wwf-epo@wwfepo.org 1 A WWF summary position paper on the Climate and Energy Package proposals can be downloaded here wwf_position_climate_energy package_april_2008.pdf 2 Proposal for a Directive of the European Parliament and of the Council amending Directive 2003/87/EC so as to improve and extend the greenhouse gas emission allowance trading system of the Community COM(2008) 16 final. 23 January climat/emission/pdf/com_2008_16_en.pdf 3 Shell warns Europe on CO2 permits 11 April Austrian steel company delays investments due to EU climate package. 9 April 2008, PointCarbon 1

2 Competitiveness losses have always been put forward by industry when discussing environmental policies. In 2002 for example, the chemical industry portrayed the REACH Directive as an attempt to de-industrialise Europe which would lead to millions of job losses in Germany alone 5. The pollution haven hypothesis, that many economists have tried to confirm by analyzing historic data, is still just that - a hypothesis 6. This is for at least two reasons - few industrial sectors are really internationally mobile and secondly environmental policies are generally of low importance in determining competitiveness. This is backed up by the Stern Review 7 which stated the empirical evidence on trade and location decisions suggests that only a small number of sectors have internationally mobile plant and processes. To the extent that these firms are open to competition this tends to come predominately from countries within regional trading blocs. The EU is such a regional trading block. What s more Stern states - Even where industries are internationally mobile, environmental policies are only one determinant of plant and production location decisions. Other factors ( ) are usually more important determinants of industrial location and trade. These other factors are, for example, quality of workforce, access to technologies, infrastructure, transportation costs, exchange rates, access to raw materials, distance to markets and interest in being located close to consumers to provide better technical assistance or quality, and balance between consumption and production capacity in a given country. The picture is much more complex than that depicted by the industry lobbyists. So complex in fact that, according to a study published in American Economic Review (2001), a prominent scientific journal, globalisation had led to the displacement of polluting activities toward rich and more environmental-regulated countries 8. EU ETS Competitiveness - old myth, same reality So, the negative impact of environmental policies on competitiveness is an old myth. According to recent independent analysis the EU ETS is unlikely to change this state of play. Industry as a whole is not sensitive to competitiveness losses as a result of the scheme. If some sectors are sensitive, these are sub-sectors. But these sub-sectors are generally not the ones who cry wolf and undermine the credibility of the industry as a whole. According to a report released in January 2008 by Climate Strategies 9, of the 159 sectors in the EU ETS the study investigated, it concluded that only 23 may experience a non negligible cost impact, i.e. a cost increase of the order of magnitude of 1%, as a result of the scheme 10. In addition the exposure of these sectors to trade with non EU countries is generally low. This is substantiated by research undertaken by the Öko- Institut which looked at the sectors covered by the scheme in Germany (see figure 1) 11. This study concluded that only a few industrial sectors in Germany simultaneously face a high trade intensity 12 (above 10%) and a high maximum value at stake 13 (above 10%) i.e. that they may be exposed to distortions in competition. In general therefore even sectors which may experience a non-negligible cost impact are still quite likely to pass cost increases of production on to consumer prices as this won t result in a loss in market share to international competitors outside the EU. In summary - the highly energy-intensive industries (which are also CO2 intensive) are generally not very exposed to international competition. Indeed, they face many barriers to trade such as costly sunk investments 14 and transportation costs. 5 Bulldozing REACH - the industry offensive to crush EU chemicals regulation March See for example Jaffe et al., Environmental regulation and the competitiveness of US manufacturing: What does the evidence tell us? Journal of Economic Literature. 7 Stern Review on the Economics of Climate Change, Part III The economics of stabilisation, Chapter 11 Structural change and competitiveness. 8 Antweiler et al., Is free trade good for the environment? American Economic Review. 9 A research network led by the University of Cambridge Defined as the sum of traded goods to total market supply. 13 Defined as the sum of potential direct and indirect costs in relation to the gross value added. 14 Long term investments in plant whose lifetime spans around 50 years making it very costly to relocate. 2

3 Figure 1: Carbon exposure empirical results for Germany (Source: Öko-Institut) What the cement lobbyists don t tell you Cement trade is largely not about small players trying to invade the EU. Cement trade is controlled by a few firms. The ten largest cement firms in the world - most of which are European firms like Lafarge, Holcim or Italcementi - control about 70% of total cement trade 15. The EU imports only 8% of its cement from outside the EU 16, and these imports go predominantly to two countries where production capacity does not meet demand (Spain and Italy). According to a study undertaken by independent economists, cement prices in EU countries are not correlated to prices outside the EU. Even the link between the prices in various EU countries is weak 17. This is backed up by Climate Strategies who cite prices of $US 110 per tonne in France and the UK, and less than $US 60 per tonne in Germany and non-eu countries such as Algeria and Turkey 18. China as well as other countries tax their cement exports 19. China is not interested in becoming an exporter of such an energy intensive and low value added product. 20 In the EU, the profit margins of the cement sector are between 25 and 30%. These margins are much higher than the global average of the industry (under 10%) 21. The EU ETS - from competitiveness to employment and growth - the same old song In order to convince decision-makers, industry often makes the link between their competitiveness losses and the threat this would represent for employment and growth. The former threat is tremendously over stated. Industry also exaggerates its contribution to the economy and to employment and often fails to acknowledge the positive impact climate policies can have on both of these. The 23 sectors identified in the Climate Strategies report as having a non negligible cost impact as a result of the EU ETS represent around 1% of the UK s GDP and only 0.5% of its employment. Indeed carbon intensive industry sectors are generally much less labour intensive than the average for the economy. For example a French study showed that the average amount of direct and indirect full-time jobs resulting in 1 million of turnover is around 15 in France. In the steel, pulp and paper and organic chemicals industries the same amount of turnover translates into 2 jobs, and for refining it is less than 0.5 jobs 22. The EU ETS and climate policies in general will not inhibit growth and employment. Indeed a robust EU ETS and other climate and energy policies will pave the way for an energy efficient low carbon economy with costsavings across all sectors. Security of energy supply will be increased via reduced dependence on foreign 15 IEA, 2007: Sectoral approaches to Greenhouse Gas - Exploring issues for Heavy Industry 16 Differentiation and dynamics of EU ETS industrial competitiveness impacts, Climate Strategies, Available at 17 Gerald, J.F., Scott, S., The market structure and sector vulnerability. Working paper for the COMETR Research Project EBITDA (Earnings Before Interest Taxes Debt and Amortization) divided by turnover. 21 Eurostat tatistiques annuelles détaillées sur les industries manufacturières sous-sections DF-DN et total pour l industrie manufacturières (NACE D) (partie de l Annexe 2) 22 Philippe Quirion, Calcul du contenu en emplois nationaux, directs et indirects, de la demande adressée aux différentes branches de l économie française. CIRED CNRS. 3

4 energy sources. For example the European Commission estimate that meeting a greenhouse gas reduction target of a 20% cut (below 1990 levels) by 2020 and the 20% renewables target alone would result in savings of 50 billion in 2020 from reduced oil and gas imports 23. Indeed, this is based on an oil price of around US$60 per barrel so the savings are likely to be much higher if the oil price remains at its current value (of over US$100 per barrel) or continues to rise. In addition an increase in the contribution of renewable energy sources will boost the EU s technological lead, creating domestic jobs and large export potentials. Reduced dependence on fossil fuels will also provide health benefits and reduced health costs through improved technology and cleaner energy sources. Again, the Commission estimate that by 2020 air pollution control costs will have fallen by approximately 10 billion 24. What the steel lobbyists don t tell you Half of the steel manufactured in the EU is produced through electric arc furnaces for which competitiveness is not an issue. These products are quite difficult to transport and need to be near to their main raw material - scrap steel. Within the EU Basic Oxygen Furnace (BOF) Steel is still a regional business. 80% of EU imports are intra-eu trade 25. The EU imports roughly 20% of its consumption of steel from outside the EU and exports as much steel as it imports, despite its much higher production costs (40% higher than in Brazil or Russia) 26. Steel is a very profitable business nowadays. The average steel price is around US$500 per tonne whereas it was around US$300 until Part of this rise is attributed to huge mergers which led to more market power (vis-à-vis raw material suppliers and consumers) 27. Steel is a more and more concentrated sector, i.e. with a few international firms dominating the market. Independently of the existence of the EU ETS some of them plan to relocate the production of BOF semi-finished steel to where there is an easy access to raw materials such as iron ore. A 1999 cartel in Seamless steel tubes resulted in one of the largest cartel fines 28. Auctioning versus continued free allocation of pollution allowances EU ETS requires full auctioning of allowances to be effective WWF welcomes the proposal of the European Commission to make auctioning the main methodology used to allocate pollution allowances to sectors in the EU ETS post Within a trading scheme auctioning allowances is a key design feature which helps to ensure that the progression towards a low carbon economy takes place in the fairest and economically most efficient way. By increasing the cost of producing goods according to the carbon embedded in their production, auctioning pollution allowances provides the best incentives for EU industries to develop low carbon technologies for the production of particular products. This will give a first mover advantage to EU industries operating in an increasingly carbon constrained world. Full auctioning also provides the best incentive for EU consumers to choose the lowest carbon products by making less carbon intensive products more economically attractive. For example, second hand steel or a new binder may substitute cement used in construction. Moreover, auctioning of allowances can raise significant revenues which will be required to support climate mitigation and adaptation activities. The illusion of free allocation What would be the alternative to auctioning? The answer to this question from most industrial sectors is straightforward - to continue allocating allowances for free according to historic emissions (grandfathering). Some innovative sectors would like to base free allocation on historic production using benchmarks but in both cases, the result of free allocation would be the same - windfall profits 29. In addition displacement of industrial activity outside the EU, if there is any, would likely be the same as under full auctioning. 23 Impact assessment document accompanying the package of implementation measures for the Eu s objectives on climate chagne and renewable energy for 2020 January energy/climate_actions/doc/2008_res_ia_en.pdf See for example D ly and Quirion, CO2 abatement, competitiveness and leakage in the European cement industry under the EU ETS: grandfathering vs. output-based allocation., Climate Policy

5 When faced with a carbon price the rationale behavior of a company seeking to maximize profit is to make consumers of the product pay for the emissions embedded in their product, regardless of whether pollution allowances are received for free or if they are bought 30. Such behavior has already been observed in the power sector which reaped massive windfall profits in phase I of the scheme (2005 to 2007) as a result of free allocation 31. Indeed the sector looks set to repeat this performance in phase II (2008 to 2012) 32. Most industrial sectors in the EU ETS will succeed in passing the opportunity cost on to consumers without loosing significant market shares vis-à-vis non EU competitors. Free allocation, as we have seen in the power sector, will hence likely result in the accumulation of windfall profits to the tune of billions. Essentially, by continuing to promote free allocation to the detriment of auctioning, revenues - which the European Commission estimates could be 50 billion per year by 2020 from auctioning 33 - are transferred from governments to the pockets of the private sector. The EU must apply rationality to the debate The contrast between what the economists say and what the industry claims is striking. WWF thinks it is time to put some rationality in the competitiveness debate. We consider that the completion of a robust post 2012 international agreement on climate change at the UNFCCC conference in Copenhagen at the end of 2009 should remove competitive distortions associated with the EU ETS. As such any discussion about support measures should take place in the event of an international agreement not being concluded. In light of this we welcome the European Commission s decision to identify, by 2010, the sectors sensitive to relocation and for which measures to address this should be considered. The identification process should be based on robust scientific analysis, instead of unverified facts and data provided by the industry. Contrary to industry claims, there is no need to speed up the assessment process due to the uncertainty about the long term stability of key investments. The leaders of sectors who are confident in their competitiveness arguments will have no trouble in establishing their sensitivity to relocation to countries outside the EU. Instability will concern only the representatives of sectors who harbor doubts as to their ability to prove their sensitivity to relocation. By calling on the Commission to speed up the assessment process they likely hope to avoid a proper scientific review which would expose their lack of evidence. The EU must not be fooled. What these sectors fear is not competition from outside the EU. Rather, they perceive that they have a low ability to adapt to a low carbon economy, compared with other EU sectors they compete with. Their call is to maintain the status-quo, whereas in order to tackle climate change, the EU and the world clearly need to change. FOR FURTHER INFORMATION: Delia Villagrasa EU Climate Project Coordinator WWF European Policy Office Tel: dvillagrasa@wwfepo.org 30 Indeed, for every tonne of CO2 a company emits it looses the opportunity to sell an allowance worth one tonne of CO2 on the market. Each tonne of CO2 now has a cost, which is an opportunity cost. 31 Indeed, during phase I this was widely reported in the media. In the UK alone it was estimated that this resulted in profits of billion in 2005 (as mentioned in the partial regulatory impact assessment that accompanied the draft UK Government s Climate Change Bill 32 EU ETS phase II the potential and scale of windfall profits in the power sector March Boosting growth and jobs by meeting our climate change commitments. European Commission press release 23 January mat=html&aged=0&language=en&guilanguage=en 5