economies do not behave like companies

competing in markets for ordinary goods.

The reality is more complex. Our readers

may usefully refer to the key figures

page, compiled by Salim Bouakline and

Oliver Sartor, which helps to illustrate this

complexity, using national and sector-

based evidence, notably with respect to the

United Kingdom and steel production.

For political decision-makers,

an important aim is to encourage

technological innovation while avoiding the

risk of companies moving their operations

abroad. Such moves could lead to

“carbon leakage”, as emissions are simply

moved from a carbon-constrained region

to regions where no carbon constraints

apply, resulting in a potential increase in

emissions. Decision-makers have a tool kit

at their disposal to plumb the leak, which

Oliver Sartor has also described. That kit

is not very extensive, and, unfortunately,

it only contains double-edged swords! It

must, therefore, be handled with care.

ClimatSphereThe newslet ter on the economics of c l imate change

Emilie Alberola shows us how to use the

tool kit: the benchmark-based allocation

that will be applied from 2013 onwards

within the EU ETS is a kind of free allocation

which enables the risk of carbon leakage to

be reduced.

The debate on EU ETS, competitiveness

and innovation in Europe is far from over.

The final details of Phase III (2013-2020) will

be decided in late 2011 at best – assuming

that European institutions adhere to these

ambitious deadlines. Moreover, the US

Congress’ discussions about defunct draft

laws intended to create a CO2 allowance

system have shown that the Europeans

are not the only ones to ask themselves

questions about competitiveness.

Meanwhile, the emerging powers, especially

China and Brazil, will not be outdone: they

will make their voices heard in international

circles, regardless of whether they it is a UN

forum. The choices made by the European

Union in this regard will be influential. We

have the first shot: naturally, this situation

may seem uncomfortable, but it also gives

the European Union an opportunity to

regain its leadership in the international

negotiations. l

Benoît Leguetbenoit.leguet@cdcclimat.comTel: 33 (0) 1 58 50 98 18

Implementing climate change policies

by putting a price on carbon boosts

demand for “green” assets. Specifically,

setting up the European Union Emissions

Trading Scheme (EU ETS), by imposing

restrictions on European industries, gives a

boost to technological innovation in Europe

and elsewhere. This is a first step, even if

additional policies to support innovation

will be required. This is precisely the point

that Felix Matthes and Matthieu Glachant

make in their interview. I would like to thank

them both for answering our questions.

Encouraging technological innovation

at home is viewed quite positively by

political and economic decision-makers;

encouraging technological and economic

improvements “elsewhere” less so:

this is what introduces the notion of

competitiveness, a term that has many

meanings. However, the notion of national

competitiveness is not much help in the

climate change policy debate: as Oliver

Sartor reminds us in an initial article, national

New markets for innovators: new investment* growth in sustainable energy

Competitiveness & innovation in a decarbonising world

N°19 • 3rd quarter 2010

Spurring low-carbon innovationInterview with Dr Felix Matthes and Prof Matthieu Glachant

Competitiveness 101: separating feelings from facts

Oliver Sartor

Carbon leakage: emissions without borders

Oliver Sartor

Raising the bar: emissions performance benchmarks in EU ETS Phase III

Emilie Alberola

Key figures

Salim Bouakline and Oliver Sartor

Contents

E ditorial

There has been a rapid growth in demand for investment in sustainable energy technologies, which reflects growing markets for competitive innovators in the sector. New public and private spending growth averaged close to 50% a year before the global financial crisis struck in 2008. The largest investors globally are Europe, North America and China, while China and Brazil are the fastest growing (from a low base). * Includes both private and public sector project-based investment and R&D, New Energy Finance (2009)

0

20

40

60

80

100

120

Billi

ons

USD

Europe North America Asia &Oceania

Middle East& Africa

Brazil

2004 2008

China India Total

492%

617%633%

1200%5300%

1633%

429%

600%

Data Source: New Energy Finance, UNEP, SEFI (2009) “Global Trends in Sustainable Energy Investment 2009”

2

I nterview

Spurring low carbon innovation Responding to climate change presents opportunities for innovators to take advantage of demand for new kinds of goods. Felix Matthes1 and Matthieu Glachant2 explain how we can make the most of such opportunities.

We often hear about how carbon pricing may have a negative impact on the international competitiveness of some manufacturing sectors. But can carbon pricing have benefits for other industries like renewable technologies, etc?

M. Glachant: Carbon pricing is an

emissions cost for carbon emitters – I

don’t really believe in the existence of a

mine of profitable reduction initiatives,

– but it is also a growth opportunity

for companies that provide solutions to

the problem: wind turbine and insulation

materials manufacturers, energy service

companies, etc. The real question is

whether the gains outweigh the losses, a

question that is hard to answer, in theory.

F. Matthes: In practice, after six years

of carbon pricing under the EU ETS,

there is almost no evidence of significant

negative impacts for EU industries. Plus

the current debate in China and other

regions shows that there is only a low

probability that major economies will

remain without carbon pricing. However,

there are mechanisms like targeted

compensation to deal with the few cases

where leakage could emerge as a serious

problem. On the other hand, we should

never forget that carbon pricing drives

innovation and creates future markets for

frontrunner industries. Evidence of this is

growing rapidly.

What other measures do you think are important for encouraging the necessary innovation to create a low carbon economy?

FM: Adequate climate policy in the

context of ambitious long term targets (80

to 95% reduction in emissions by 2050)

will need a smart policy mix. Carbon

pricing is the central pillar. But we will

need standards, incentive programs and

other approaches for those fields where

price signals do not work properly or

will not be sufficient to drive radical

innovation (energy efficiency, transport

sector, etc). We have to deal with very

long-life capital stocks, and the period

of time over which markets can deliver

scarcity signals is still an open question.

Many emission reduction options depend

on highly regulated infrastructures which

are not only driven by price signals.

However, complementary policies must

be subject to transparent and careful

justification and pass the relevant cost-

benefit tests.

MG: I would like to underline that

carbon pricing is there to create a

demand for green goods and solutions.

The additional measures must target

the supply side through supporting

innovation, partnering green start-ups and

improving training in the environmental

professions.

In terms of promoting Europe’s innovation and competitiveness in low carbon goods markets, how important is the current discussion about moving its 2020 emissions goal from -20% to -30% below 1990 levels?

FM: Strengthening the EU’s efforts

would send a clear signal to the

markets that the ultimate goal is an

almost decarbonised economy by mid-

century. The -20% by 2020 target is not

really consistent with this objective, so

the accounting of the decarbonisation

pathway is therefore questionable at best.

A clear and quantified vision, like full

decarbonisation, is essential in order to

trigger the radical innovation required.

Moving towards the 30% reduction target

would also be a trust-building measure,

and would signal to emerging and

developing countries that the EU takes the

2°C target seriously and so they should

also increase their climate policy efforts.

MG: Moving to a 30% reduction target

cannot rest on the European innovation

argument alone. As the European Union

is a very open economy, moving from

-20% to -30% will increase local demand

for green assets and solutions, as well as

the related supply of, and innovations in,

such products, but not only in Europe.

China, for example, is the leading

global manufacturer of solar panels.

The country’s output is exported almost

entirely to Europe, the United States and

Japan and it is constantly innovating. l

Interview by Nicolas Stephannicolas.stephan@cdcclimat.comTel.: +33 1 58 50 77 72

1. Dr Felix Matthes is a Researcher and Co-ordinator of Energy and Climate Policy at the Institute for Applied Ecology (the “Oeko” Institute) in Berlin

2. Prof. Matthieu Glachant is Director of the Centre for Industrial Economics (CERNA) & Professor of Economics at Mines Paris-Tech in Paris

Hey big spender: leading economies’ clean energy RD&D budgets

0.005

0.006

0.007

0.004

0.001

0.002

0.003

0

RD&D

Bud

get -

% G

DP

France Germany Italy* United Kingdom Japan Canada United States Europe**

2000 2008

National public expenditure on sustainable energy technologies RD&D (energy efficiency, renewables, carbon capture and storage, and hydrogen & fuel cells) in the world’s largest economies increased sharply between 2004 and 2008, with the exception of Germany, which is starting from a high base. The growth was faster in Europe than in the US. Accurate figures for China were not available.

*2007 data was used for Italy instead of 2008 data. **Includes Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, Turkey and UK. Data Source: International Energy Agency RD&D statistics; World Resources Institute

350,000 20,000

18,00016,000

14,000

12,000

10,0008,000

6,000

4,000

2,0000

300,000

250,000

200,000

150,000

100,000

50,000

0

cons

umpt

ion/

prod

uctio

n (th

ousa

nds

of to

nnes

)

Impo

rtat

ion/

expo

rtat

ion

Cement consumptionCement imports

Cement productionCement exports

2000 2001 2002 2003 2004 2005 2006 2007 2008

K ey concepts

Competitiveness 101: separating feelings from facts

3

The potential economic “competitiveness impacts” of climate policy is an issue that arouses strong feelings. But much of their emotional sting can be dulled with an understanding of the economic facts.

There are three main ways in which

the issue of “competitiveness” arises

in climate policy debates; here is a

quick introduction to the issues and

economics underlying each one:

Competitiveness of low-carbon alternatives

Firstly, at its most fundamental

level, the question of “competitiveness

impacts” arises in climate policy

because greatly reducing emissions

requires policies that can improve the

competitiveness of ‘low-carbon’ goods

and technologies in existing markets. For

example, there is now solid evidence that

the carbon emissions price created by

the European Union Emissions Trading

Scheme (EU ETS) has helped electricity

generators using less carbon-intensive

fuels (gas, renewable, nuclear) become

more cost-competitive1. This has helped

them gain a greater share of the market

for power generation, taking it away

from more emissions intensive coal-fired

power. In the same way, changing the

competitive status quo of low-carbon

products and technologies is critical

for driving transformational change in a

range of markets for emissions intensive

goods.

Carbon leakageSecondly, the issue of competitiveness

arises with respect to “carbon leakage”.

Carbon leakage is the idea that if one

country is making its industries pay a

carbon price, but rival overseas producers

are not, then the resulting higher costs of

domestic producers may see them lose

competitiveness in global markets. In many

cases this may simply mean lower profits,

however in the worst case scenario, they

may either suffer a loss of market share

to overseas rivals, or shift production,

employment and emissions, offshore.

But, while carbon leakage sounds scary,

it must be kept in perspective. For the

average EU country, the genuinely concerned

sectors typically represent not much more

than 1% of GDP and only a small portion

of that is seriously at risk of going offshore.

In fact, the EU – which has priced carbon

since 2005 with the EU ETS – has so far seen

little evidence of carbon leakage among the

handful of manufacturing industries most at

risk – although policies to address this risk,

like free allocation of emissions allowances,

were in place2. It should also be kept in

mind that policies to prevent leakage can

also cause competitiveness distortions in

domestic markets if not well harmonized:

hence the EU’s move to a harmonized

system of free allowance allocation for the

EU ETS starting in 2012.

National economic competition: not what it seems

Finally, there’s the often cited

importance of low-carbon innovation – e.g.

in renewable energies, energy efficiency,

clean transport, etc – on national economic

competitiveness. The claim is made that,

if entrepreneurial industries are given a

head start in embryonic export markets

for low-carbon goods, this will make the

whole economy more “competitive” in

future. However, while such innovation

is important to reducing emissions and

can promote the growth of new industries

and jobs, there is solid empirical evidence

that whole economies do not compete

with each other for future prosperity via

international markets3. On the contrary, the

evidence suggests that, for the world’s big

economies, national productivity growth

is much more important for economic

living standards than having competitive

exports. Thus, while promoting low-

carbon innovation and new industries is

an important enterprise, we should keep a

healthy skepticism for such claims about

national economic competitiveness. l

Oliver Sartoroliver.sartor@cdcclimat.comTel: +33 1 58 50 85 20

1. E.g. Buchner et al. (2008): Over-allocation or Abatement?, Environmental & Resource Economics, 41:2

2. E.g. Ellerman et al. (2009): Carbon Pricing: The EU Emissions Trading Scheme, Cambridge

3. E.g. Krugman (1994): Competitiveness: A Dangerous Obsession, Foreign Affairs, 73 :2

EU27 Cement sector: any sign of a leak?

Data Source: Eurostat ; Cembureau

The EU cement sector is often cited as at risk of carbon leakage. However, the graphic shows the extent to which both production and imports remains, for the most part, a function of local consumption demand, even though the EU introduced carbon pricing in 2005. The small rise in extra-EU imports and drop off in extra-EU exports over this period is most probably due to capacity reductions (for other reasons) in traditional producer countries close to ports: particularly Italy and Spain.

Comparing options for addressing carbon leakage

Source: adapted from Neuhoff, K. Tackling Carbon (2008)

C arbon Leakage

Emissions without borders: options to mitigate carbon leakage In a world of “common but differentiated responsibilities” for addressing climate change, policy makers will want to make sure they have mitigated the risks of carbon leakage. What are the options for doing so?

Carbon leakage is the idea that some

local industries may have an incentive to

shift production and emissions offshore

if they face carbon costs due to domestic

climate policies which do not exist in

countries in which their market rivals

produce. There is an argument that, for

certain highly competitive markets, such

risks are real and should be contained.

But how?

Three viable optionsPolicy makers have four basic

alternatives: take no action; exempt

vulnerable sectors from paying their full

share of carbon costs domestically; adjust

for differences between the carbon costs

paid by domestic and foreign producers

at the border; or get domestic and foreign

producers to agree to equalize the carbon

costs they pay.

We can rule out doing nothing.

Even if the risks of carbon leakage

are small in terms of lost jobs and

emissions, policy makers will always

want to reassure themselves that they

are not shipping jobs and emissions

overseas. Carbon leakage is as much

a political reality as an economic one;

and especially so if we hope to set more

ambitious emissions targets.

Exempting domestic industries

from paying the full costs of the carbon

they emit, e.g. through free emissions

allowances, is currently the preferred

approach of policy makers. This route is

preferred largely because of its relative

political tractability, both at home and

internationally. However, exemptions can

be hard to remove, sometimes create

perverse incentives, and involve the

‘necessary evil’ of transferring a public

good, i.e. rights to the atmosphere, to

industry for less than its cost. If such

exemptions are not well harmonised

within an economy they can risk creating

competitiveness distortions within local

industries.

Border adjustments and sectoral mechanisms: co-operation required

Border adjustments and sectoral

agreements for carbon costs constitute the

two main alternatives to free allocation.

Unlike free allocation, border adjustments

impose the full carbon price on domestic

industry. But, when its products are

exported, the exporter receives a refund for

the carbon cost of producing them, so that

he can resell the goods in global markets

without the carbon cost included in the

price. When the product is imported, the

customs office charges the importer for the

carbon emitted in its production based on

the local carbon price. Thus there would be

no competitiveness distortion in the local

market either.

Sectoral agreements apply a similar

principle, but cut out the middle-man. They

require countries to agree on a common

carbon price for individual sectors. They

therefore cannot be imposed unilaterally

like border adjustments. However the

carbon price signal is passed on to all global

consumers, creating a more consistent

global price signal.

In practice both options could be a

less helpful than anticipated. Some point

out possible legal and practical (e.g.

measurement and verification) barriers to

both mechanisms. But at present the most

significant hurdle is probably their political

aspects. Developing countries still ardently

believe that such mechanisms violate the

principle of “common but differentiated

responsibility” between rich and poor

countries for addressing climate change.

Protecting against carbon leakage could thus

antagonize key parties to the international

negotiations. Or is there, perhaps, a more

co-operative route to be found? l

Oliver Sartoroliver.sartor@cdcclimat.comTel: +33 1 58 50 85 20

4

InsideEU

1) Free allocation:Levelling down carbon cost

Part of thecost linked

to the price of CO2

Cancels outcost of CO2

Internationalagreementfor a uniqueCO2 price inconcernedsector(s)

Adjust costsof goods atthe border:i.e. addcarbon costto importsand removecarbon costfrom exports

Productioncost of the

good withoutthe CO2 cost

2) Sectoral Agreement:Levelling up carbon cost

3) Border tax adjustment:Levelling in the both directions

OutsideEU

InsideEU

OutsideEU

InsideEU

OutsideEU

E U ETS

5

and mix of the production process for each

product. The activity level per installation

will need to be determined according to

the average production over a reference

period – currently under discussion –

stretching from 2005 to 2008 or to 2009,

excluding the lowest level, and for new

market entrants, according to the highest

production level between 2005 and 2009.

Shared and harmonised rulesThe European Directive (2009/29/EC) is

foresees the allocation of free allowances

to be harmonised on an EU scale, in

order to reduce competition distortions

within the EU as much as possible. The

development of efficient benchmarks

requires not only the existence of common

definitions but also the availability of

reliable data and adequate measurement,

reporting and checking systems. In order

to meet these expectations, the European

Commission Environment-Climate DG

has co-ordinated working groups to

define the benchmark methods used for

each product.

Data gathering: a complicated exercise

As the emission levels drawn from the

central European register, the CITL, are not

sufficient for developing benchmark curves,

it is necessary to use new environmental

and industrial data. In addition to the

availability and the confidentiality of the

data, which vary significantly depending

on the sector, the level of complexity also

increases when the same product can be

manufactured from different raw materials

or when the manufacturing procedures

apply to more than one product: in that

case, benchmarks for intermediate goods

will be necessary.

The European Commission has

developed 51 benchmarks in total, which

will be published in the course of the

coming months so that they can be

discussed by Member States and then

by the European Parliament. Most of

these benchmarks are based on the most

efficient 10% benchmark. Six others

(three for the refining sector and one each

for steel, iron and coke production) are

defined according to the environmental

performance of the best technology

available in the sector. The final adoption

of the free allocation of allowances on

a benchmark basis is scheduled for

September 2011. l

Emilie Alberolaemilie.alberola@cdcclimat.comTel: 33 (0) 1 58 50 41 76

The benchmark-based free allowance

allocation is not a new development

within the EU ETS. Although most free

allowance allocations between 2005 and

2012 were based on the installations’

historical emissions (“grandfathering”),

several governments used benchmarks

based on the best available technology

in the sectors in question to allocate free

allowances to new market entrants.

Now, from 2013 onwards, benchmarks

will determine all free allowance allocations.

Those free allowances will involve 80%

of the 2013 allowance allocation for

industrial sectors, excluding the electricity

generation sector, and will gradually

decrease, falling to 30% in 2020, before

their abolition in 2027. For installations

in 164 sectors and sub-sectors exposed

to international competition, and for new

market entrants, their free allocation share

will only decrease in line with the overall EU

ETS cap. Benchmarks were preferred to a

calculation based on historic emissions

in order to reward installations’ efficiency

and provide an additional incentive for

reducing their emissions.

Towards greater energy efficiency

Within every sector, and for every

product, a benchmark will set the

reference CO2 emission level for a given

production level, which is based on the

average CO2 emission factors for the

most efficient 10% of installations. Then,

benchmark allocations will be calculated

as the product of the activity level (tonnes

produced per year) and the emission

benchmark (tCO2 per tonne produced)

determined based on the energy efficiency

Raising the bar: emissions performance benchmarks in EU ETS Phase III From 2013 onwards, to maintain their competitiveness in international markets, certain European Union Emission Trading System (EU ETS) installations will benefit from a temporary allocation of free emissions allowances determined according to performance benchmarks. This system will be harmonised across Europe, to avoid intra-EU competitiveness distortions.

Based on their emissions intensity performance, the most efficient 10% of installations will be granted the highest percentage of free allowances for the production of products at risk of carbon leakage. The remaining 90% will thus have incentives sharpened to improve their performance in order to meet or surpass the performance level of the benchmark.

Source: Authors

How allocative benchmarks work

Allocation freeallowances per unitof production (relative to rest of industry)

Average intensity of best 10% of installations

Emissions intensity of production

(relative to rest of industry)

High (worst)

Low (best)

Low

High

10 50% of installations in relevant sector

100

Source: Neuhoff (2008) “Tackling Carbon”; originally published

in Climate Strategies (2007): “Differentiation and Dynamics of

EU ETS Industrial Competitiveness Impacts”

6

CDC Climat Research is the research department of CDC Climat, a subsidiary of the Caisse des Dépôts dedicated to the fight against climate change. CDC Climat Research provides public research on the economics of climate change. Head of publications: Benoît Leguet, tel: +33 (0)1 58 50 98 18.CDC Climat Research – 16 rue Berthollet – 94113 Arcueil Cedex, France – ISSN : 1952-7659

Salim Bouaklinesalim.bouakline@cdcclimat.com - Tel: 33 (0) 1 58 50 98 19

Oliver Sartor oliver.sartor@cdcclimat.com - Tel: 33 (0) 1 58 50 85 20

K ey figures

Sizing up the risks of carbon leakage

Maximum value at stake from carbon pricing: UK industries

Easy come, easy go: the example of steel

0.0%0%2%4%

10%

20%

30%

40%

0.2% 0.4% 0.6% 0.8% 1.0% UKGDP

Pote

ntia

l Max

imum

Val

ue a

t Sta

ke (M

VAS)

and

Net V

alue

At S

take

(NVA

S)

Cem

ent

Basi

c iro

n &

stee

l

Alum

iniu

mRefined petroleum Pulp &paper

Fertilisers & Nitrogen MaltCoke oven

Industrial gasesNon-wovens

Household paper

Finishingof textiles

Hollow glass

Rubber tyres& tubes

Veneer sheetsFlat glass

Copper

Casting of ironOther inorganic

basic chemicals

Lime

Allocation dependent (direct) CO2 costs / GVAElectricity (indirect) CO2 costs / GVA

0%

20%

40%

60%

80%

100%

Pulp Chemicals Non-metalicmineral products

Basic Metals

Rest of World

China

Japan

US

EU

Fabricated MetalProducts

180

160

140

120

100

80

60

40

20

0EU Exports

toEU Imports

fromAmerica Exports to

America Imports from

AsiaExports to

AsiaImports from

Others

Asia

America

EU

Mill

ions

of T

onne

s of

Ste

el

Which manufacturing sectors are impacted and how much?

The graphic shows the maximum

percentage of UK manufacturing industries’

value added that could theoretically be

lost due to carbon pricing, assuming a

carbon price of 20€/tCO2 and electricity

cost increase of 10€/MWh. The 24 sectors

with the most value at stake from carbon

pricing in the UK represent around 1% of

GDP and 13% of emissions. Only a portion

of this is directly at stake.

The Big Four For many energy and emissions

intensive manufacturing sectors, between

70 and 90% of global markets are shared

between just 4 players: the EU, US, Japan,

& China. While some countries may be

able to grow their market share rapidly,

this result implies that tools like sectoral

mechanisms or border tax adjustments

might only need agreement between a

small number of countries to be effective.

Data source: European Commission (2010) “EU Manufacturing Industry: What are the challenges and opportunities for the years ahead?”, DG Enterprise and Industry

Trade gravity Trade has a tendency to cluster in

regions of the globe. Factors like

transport costs, customer relationships,

consumption/capacity utilisation, import

restrictions, risks of disrupted trade-flows,

product and service differentiation, can all

be reasons to privilege geographically close

suppliers. Additional costs from carbon

pricing must outweigh these advantages to

run a risk of large-scale delocalisation by

local firms.

Source: Adapted from Demailly (2007); based on 2004 trade data from IISI.

Share of global markets for some key emissions intensive manufactures