Carbon Budgets - Environmental Audit Committee Contents

5  Carbon leakage

60. 'Carbon leakage' occurs when there is an increase in emissions in one country as a result of industries relocating there from a second country with a stricter climate policy. Concerns have been raised that, without protection, industries in the UK could be at risk from carbon leakage due to European and UK policies and taxes being more stringent than those elsewhere. The Government consider that this could actually lead to an increase in emissions overall,[140] and impact disproportionately on certain areas of the UK.[141] When announcing the Government's decision to accept the CCC's recommended fourth carbon budget, the Secretary of State also announced that a package of measures would be decided by the end of the year, to 'help energy intensive industries adjust to the low-carbon industrial transformation while remaining competitive'.[142] The Secretary of State told us:

It is not in our interest as a Department dealing with climate change to introduce rules that merely relocate carbon-emitting industries from the UK to somewhere else, because the amount of carbon emitted into the atmosphere would be exactly the same, and frankly the impact on global warming would be exactly the same, whether the carbon is coming from Calcutta or from the UK.[143]

The extent of the carbon leakage risk

61. The risk of carbon leakage, and its extent, varies across industries and businesses. The EU adopted a list of 164 sectors it deemed to be 'at risk of significant carbon leakage'[144] which member States might seek to protect under the EU Emissions Trading System (e.g. by free allocation of emissions allowances).[145] Research by the Carbon Trust in 2010 concluded that the EU's list included many sectors that the Trust's work has shown are unlikely to suffer significant leakage. It concluded that the 'scale of any leakage will actually be small, but concentrated in a few sectors', illustrating that:

... implementing the current EU ETS Phase III targets to 2020 without any free allocation of allowances or protection would drive less than 2% of emissions abroad, but this average disguises that, for instance, 5-10% of cement or steel emissions (and production) might leak, and leakage from coastal areas may be greater than those that are landlocked.[146]

62. The Secretary of State told us that he knew of "no economic work that had suggested the reason for a substantial shift of manufacturing production from Europe and the United States to China was energy costs, or anything to do with the climate change agenda", and that "we must not concede the point that somehow carbon leakage is the massive driver of what has been an enormous globalising trend towards relocating production".[147] In a similar vein, some witnesses were concerned that the risks to energy intensive industries were overplayed. The Aldersgate Group said that the Government 'must take into account that claims of carbon leakage are often exaggerated and are only a genuine threat in a very limited number of sectors'.[148] Friends of the Earth were of the opinion that 'energy intensive users already receive substantial help ... which [has] led to multi-million pound windfall profits for some companies'.[149] Research by Sandbag indicated that a number of companies had accrued 240 million surplus EU ETS allowances, worth around €4.1bn, which meant that 'only the weakest pressure [is exerted] on participants to invest in a low carbon future'.[150]

63. We questioned the Energy Intensive Users' Group and the British Ceramic Confederation as to whether the risks of carbon leakage had been overplayed. Jeremy Nicholson from the Energy Intensive Users' Group told us: "I very much agree that the problem is concentrated in a relatively small number of sectors",[151] and that:

... the Emissions Trading Scheme has been working exactly as intended ... nobody expected was that we would go through one of the most savage industrial recessions in recent decades, which has necessarily meant that the emissions ... are considerably less than anyone could reasonably have foreseen when the allowances were set out for phase II.[152]

Laura Cohen from the British Ceramic Confederation stressed that the impact in the UK was from the "cumulative range of taxes, some of which are unilateral in the UK ... and the predictability and consistency of regulatory measures".[153] Jeremy Nicholson told us that a proper assessment of the impact of policies on energy intensive users is needed to tackle concerns that the risk is being overplayed.[154] The lack of a robust impact assessment was a source of frustration.[155]

Potential impact of carbon leakage

64. In 2008, before a number of UK climate policies were introduced, the Committee on Climate Change estimated that less than 1% of UK GDP could be lost as a result of carbon leakage, but noted that the impacts could be pronounced in certain areas with significant impacts for the local economy (e.g. iron and steel in Wales).[156] Jeremy Nicholson told us that up to 225,000 direct jobs in energy intensive industries such as steel, aluminium, ceramics, glass, paper, cement chemical and other mineral products industries could be affected and "probably about another two or three times that in terms of co-dependent, less intensive industries".[157] (In comparison, low carbon industries in the UK are estimated to employ 910,000 people.[158])

65. Laura Cohen told us that unilateral taxes in the UK and regulatory uncertainty was holding back investment in the UK[159]:

... our members are finding it quite difficult to ... get investment from overseas parents, because there isn't a track record of consistent regulatory measures. Within 18 months, there was the possibility of a Fossil Fuel Levy to fund the Renewable Heat Incentive. That was dropped, and a few months later there was a Carbon Price Floor. There was no impact assessment for energy intensive industries. These are very substantial taxes indeed, that affect fuel choice and manufacturing strategy. Parent companies are not seeing this level of policy volatility and complete lack of [impact assessment] costing for energy intensive industries in other European countries. [160]

She cited an example of a ceramics company where the parent company will not invest to grow in the UK. [161] It was difficult, however, to untangle the risk of carbon leakage as a result of UK climate policy from other factors.[162] The Carbon Trust suggested that product quality and long-term customer relations make some recovery of carbon costs possible without losing market share, and that sunk costs in existing facilities 'may be a further important factor in delaying leakage'.[163]

66. Laura Cohen told us that when ceramic factories close or companies 'off-shore' production it is difficult to pin-point one particular reason and companies are often "not willing to make their reasons for closure or off-shoring public as it can be very share price sensitive". However, as an energy intensive industry, energy costs can make up a major cost of production.[164]

67. We requested evidence of investment being withheld from the UK or going overseas, or any examples of factories closing in the UK and relocating overseas as a specific result of UK climate polices. Four ceramic companies provided written submissions to us explaining that a combination of increasing regulatory burden and carbon taxation (compared to other countries in the EU) is pushing up the price of energy, making the UK an unattractive place to invest.

68. When setting carbon budgets the Government needs to be mindful that strong action on climate change may result in some production and jobs moving abroad to countries with less stringent policies or carbon-related taxes. Without care, this could harm UK industry and could increase global emissions. However the Government has given little priority to generating hard evidence of this 'carbon leakage', including the cumulative impact of climate policies and environmental taxes on energy intensive industries. A lack of transparency and hard information on the risks to energy intensive industries, and how these should be tackled, need to be resolved to allay fears of lobbying dictating policy. We recognise the importance of policy measures to help energy intensive industries, but before any are introduced a comprehensive and robust assessment of the actual risk to each sector affected, on a case by case basis, should be made.

Reducing the risk of carbon leakage

69. Any measures to tackle carbon leakage should reflect the need to keep a strong incentive to reduce emissions. The Carbon Trust concluded that the available approaches to tackling carbon leakage carried 'serious drawbacks'. It preferred an approach where the price of imports is adjusted to reflect embedded carbon ('border levelling'). This was 'both more effective and more efficient than free allocation of [EU ETS] allowances'.[165]

70. An Energy Intensive Working Group has been set up by DECC and BIS and is leading the development of a prospective package of measures. At the time we took evidence for our inquiry, the working group had met once.[166] Laura Cohen would have liked to have seen "broader representation across a range of industries affected ... to ensure that the ideas are being taken on board, and that they are sufficiently comprehensive and being evaluated".[167] The Secretary of State indicated that a broad range of factors will be considered in developing the package of measures, including macro-economic factors such as the changes in competitiveness from changes in the exchange rate.[168]

71. Jeremy Nicholson considered that assistance to industry to help them decarbonise was a gap in Government policy:

At the moment there is no strategy for that from Government, there is no funding for it; there is merely the stick of higher energy prices. There is no carrot, or support, to kick-start those technologies in industry in the same way as there is in the power sector.[169]

72. The Carbon Trust had previously provided interest-free loans to some smaller companies for energy efficiency measures. It also had a programme exploring future technologies for decarbonising industrial processes called the Industrial Energy Efficiency Accelerator, but funding had been cut in the 2010 Spending Review.[170] Some suggested to us that the Green Investment Bank could have a role here.[171] Any measures the Government introduce to help energy intensive industries should be fair and tailored to each sector affected, on a case by case basis, reflecting hard evidence on the scale and likelihood of the risk of carbon leakage. Measures should focus on providing incentives to invest in lower carbon infrastructure and should keep a strong incentive to reduce emissions.

140   HM Government, Implementing the Climate Change Act 2008: The Government's proposal for setting the fourth carbon budget, May 2011. Back

141   Carbon Trust, Tackling carbon leakage: Sector-specific solutions for a world of unequal carbon prices, March 2010. Back

142   HC Deb, 17 May 2011, col 176 -178. Back

143   Q 4 Back

144   Industries were listed as 'vulnerable' if the EU Emissions Trading System would increase their costs by more than 5% and if they faced a defined high level of imports, and therefore competition, from rival industries outside the EU. This is referred to as the sector's 'trade intensity'. Back

145   Commission Decision c(2009) 10251. Back

146   Tackling carbon leakage: Sector-specific solutions for a world of unequal carbon prices, op citBack

147   Q 22  Back

148   Ev w9 Back

149   Ev w37 Back

150   Sandbag, Carbon Fat Cats 2011: The Companies profiting from the EU Emissions Trading Scheme, June 2011. Back

151   Q 60 Back

152   Q 69 Back

153   Q 59 Back

154   Qq 61, 63 Back

155   Qq 63, 64; Ev 23, Ev w14. Back

156   Committee on Climate Change, Building a low-carbon economy - the UK's contribution to tackling climate change, December 2008. Back

157   Q 60 Back

158   HC Deb, 17 May 2011, col 180. Back

159   Q 62 Back

160   Q 59 Back

161   Q 63  Back

162   Qq 66, 67  Back

163   Tackling carbon leakage: Sector-specific solutions for a world of unequal carbon prices, op citBack

164   Q 65 Back

165   Carbon Trust, Tackling carbon leakage: Sector-specific solutions for a world of unequal carbon prices, March 2010. Back

166   Qq 74, 75 Back

167   Q 78 Back

168   HC Deb, 17 May 2011, col 189. Back

169   Q 71  Back

170   Qq 70, 81-83 Back

171   Ev 23; Ev w1. Back

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Prepared 11 October 2011