Carbon leakage and the future of the EU ETS market

Carbon leakage has been an important argument in the design of the Third Phase of the EU ETS. By giving free allowances to industries prone to carbon leakage, the EU ETS tried to combine a restrictive climate policy with the goal of shielding energy-intensive industry from high carbon costs that would affect their competitiveness. As we approach the Mid-Term Review of the carbon leakage list in 2014, it appears that many of the core assumptions used to define the current list of sectors receiving free allowances are outdated.
The 2009 assessment assumed:

• a carbon price of € 30 by 2020, although it is now unlikely to exceed € 12; 
• exposed sectors would exceed their benchmarked free allowances by 60%. Although as yet uncertain, a figure of 20% now seems more likely; 
• non-EU countries were not part of the EU ETS. However, currently Croatia, Iceland, Norway and Liechtenstein participate, with planned linkages with Australia and Switzerland by 2015. 

This study shows that applying more realistic assumptions regarding price, supply and trade conditions would imply a drastic reduction of the number of sectors eligible for additional free allowances. A revised assessment indicates that if the 2009 allocation had been based on more realistic assumptions, the sectors deemed at risk of carbon leakage would have fallen from the current 60% of sectors, representing 95% of industrial emissions, to a mere 33% of sectors, accounting for only 10% of emissions.