Roundtable discussion - 28 June 2010

Free allowances, Trade and Developing Countries

 

You will find below the summary of the discussions which took place at the roundtable on 28 June 2010 at the WTO. Please find herewith the program of this event and a concept paper prepared for the debate.

 

The purpose of the meeting was to provide a space for open discussion on the topic of ‘Free allowances, trade and developing countries”, and to link it with the previous roundtable which focused on Border Carbon Adjustments and potential consequences for poor developing countries.

 

The meeting was divided into two sessions:

- Competitiveness and Carbon leakage: what are the main issues?

- Emissions Allowance Allocation designs under EU Emission Trading System

 

This brief summary reviews some of the highlights of the meeting, both from invited speakers and from public comments. 

1. Professor Pauwelyn presentation on “Competitiveness and Carbon leakage: what are the main issues?” focused on four main points:

 

1) What is the definition of carbon leakage? 

  • Carbon leakage and competitiveness are the two sides of the same coin. Carbon leakage occurs because of competitiveness and open trading system.
  • Carbon leakage is an environmental problem and by necessity a trade issue but you have to look at it sector by sector. Sectors at risk of competitiveness and leakage impacts are typically sectors with high carbon content and trade openness such as cement, iron, steel, aluminium etc…   For sectors which are fully protected and not exposed to international trade, such as the EU electricity sector, Carbon leakage is not a problem and cost increases can be passed through consumers.
  • Carbon leakage may mean more carbon emissions (this is particularly true in the case of products which have high carbon content such as cement, iron and fertilizers). If the price of cement goes up in a country due to environmental regulations (e.g. in the EU), the demand for the same product will go down. Another country (like China or Brazil) may take this opportunity to start producing fertilizer but with more carbon emissions than in the EU.

2) Options for dealing with carbon leakage

  • The carrot and stick approach: using sets of carrots and sticks to force other countries to enact climate change legislation. Examples of positive incentives (carrots) include giving money or carbon credits to producers who are able to cut their GHG emissions or giving incentives for clean technology transfers. The stick or trade sanction approach would consist in imposing trade measures to force other countries to enact climate change legislation. (Important note: trade measures are very different from Border Carbon Adjustments (BCAs) measures. Trade measures are used as an instrument to force other countries to enact climate change legislations whereas BCAs are only designed to ensure that products entering the market pay the same cost as locally produced goods. The objective is not to ensure that the targeted country reduces its emissions overall.)
  • Free allowances: for those sectors where carbon leakage may arise, lower the price of carbon on your sensitive products by granting free allowances
  • Sectoral agreements: as we have seen, Carbon leakage may mean more carbon emissions. This is why one of  the options for dealing with Carbon leakage may be to have sectoral agreements

3)      Free allowances: EU and US Approaches

While BCAs should not constitute a threat in the near future, the question of free allowance is real. The tool is currently being used within the European Union‘s Emission Trading Scheme (EU ETS) and it will be in the US as of the first or second year of US enactment.

 

Free allowances under EU ETS system

In the EU, free allowances are based on past performance/historical outputs. There are 3 possibilities for getting free allowances. If as a result of the implementation of EU directive:

-         your production cost increase of at least 5% and your  trade intensity is at least 10%; or

-         your production cost increase of at least 30% or;

-         your trade intensity increases of at least  30%;

 

then installations would be awarded free allowances up to the level of the average of the 10% of best EU performers.

 

The European Commission has identified no less than 164 sectors (three-quarters of manufacturing emissions under the EU Emissions Trading Scheme (ETS) – that are at risk of carbon leakage in case of a CO2 emission price of 30 Euros per tonne. 146 of the 164 sectors considered to be at risk of carbon linkage are only trade exposed sectors (wine, underwear, rugs etc…). In other words they have been selected because they are trade intensive and not so much because they are carbon intensive.

 

In many sectors where the EU will grant free allowances there is no case for protection. This may lead to sectors being granted too many free allowances and could be seen as a form of subsidy that could affect LDCs exports to the EU.

 

US Emission Allowance Rebate (not in place yet):

A major alternative to granting free allowances on an absolute basis is to grant free allowances as a function of a firm’s output (output based allocation program)

Under this program, owners or operators of entities that are energy intensive can obtain rebates from the US government for their GHG costs under two conditions:

-         If GHG intensity thresholds are at least 5 % and their trade intensity of at least 15%

-         If GHG intensity thresholds are at least 20 %

 

The approach taken in the Waxman-Markey legislation is quite different than under the EU ETS. One first point that should be noted is that in the US you don’t speak about free allowances but about rebates. Another major difference is that the rebates are based on actual outputs (total emissions at the end of the year.)  Finally under US legislation an operator would never get a rebate on trade intensity alone. In the EU, being trade intensive gives you a free allowance whereas in the US you always have to show GHG sensitivity.

 

Legal issues related to free allowances

From the point of view of countries which are competing with the EU or the US, there is the question whether these rebates or free allowances are a subsidy.

Legal assessment of free allowances under the subsidy agreement: under the WTO ASCM (The Agreement on Subsidies and Countervailing Measures), free allocation would be a subsidy if 1) there is a financial contribution by a government, (2) a benefit is thereby conferred, and (3) the subsidy is specific to an enterprise or industry, or group of industries.

 

To the extent that a free allowance scheme is adopted as a program to assist a few targeted industries within the context of a broader auctioning system, free allowances appear to be an actionable subsidy under WTO rules.

 

Simply because a subsidy is actionable, however, does not mean that countervailing duties or trade retaliation is permitted against the subsidized goods. Under WTO rules, only prohibited subsidies (those conditioned on export performance or import substitution) or those that are found to cause adverse trade effects (e.g., injury to another WTO member's domestic industry).

 

According to Prof. Pauwelyn, it will be quite a tough test for LDCs to demonstrate the adverse effect of free allowances, in particular in the middle of an economic crisis. One element that could facilitate showing that free allowances or rebates are prohibited subsidies is the trade intensity criteria (a self standing criteria under EU ETS for obtaining free allowances) which is defined in such a way that it’s linked to the exports (the more you export, the more likely you are to receive free allowances) thereby constituting an export subsidy.

 

4)      How to refrain the challenges LDCs will face:

In the US, the most recent attempt at national climate change legislation (the American Power act APA) was released in May 2010-.The released draft APA is lighter on costly carbon reduction strategies and heavier on incentives for those who have traditionally opposed forceful action to slash greenhouse gases.

The threat of BCAs is quite far remote. In the draft APA, the idea of BCAs has been postponed to as early as 2020. Furthermore, even if applied, there will be carve outs:

-         if you are an LDC

-         if you are a low emitter or a low producer(less than 5% of Global GHG emissions)

-         If you have sectoral agreements with the US

-         If you have ratified the Kyoto protocol

-         If the country has an annual energy or greenhouse gas intensity for the sector that is equal to or less than the energy or greenhouse gas intensity for such industrial sector in the United States

 

BCAs is basically saying “if you emit, you will have to pay at the US border, if you cut your GHG emissions, you will not have to pay BCAs”.

 

Recommendations:

LDC should follow closely US and EU legislation developments as they will influence whether a given country will be able to sell to the US and at what price

 

2. Presentation by Jorge Vittorino

 

1) Free allowances under EU ETS system

  • Phase 3 of the EU ETS (covering the period 2013-2020) proposes to allocate allowances for free to the best 10% of technologies within the EU, for sectors considered at risk of leakage. The European Commission has identified 164 sectors deemed to be exposed to carbon leakage. These installations are not exempted from the ETS; they will however receive a greater share of free allowances than those not exposed to carbon leakage.
  • In the future, auctioning will be the main instrument for overcoming Carbon leakage (eg the electricity sector will not receive any allowances as of 2013). The amount of free allowances will be based on a benchmark fixed by the 10 best performing installations. Sector exposed to Carbon leakage will have to meet very high targets
  • Regarding the list of sectors considered to be at risk of carbon leakage. A lot of competition prevents companies from passing the costs on producers. The EU has a preference for free allowances because they are considered to be a less trade restrictive measure than BCAs. The preferred way for addressing climate change issues remains an international agreement.

Main message: there is no 100% free allowance under ETS. ETS objective is to limit GHG emissions over time.

 

2) Questions

  • What is the difference between ex-post and ex-ante system? Under the EU system, free allowances are based on the 10 best performing installations (ex-post) whereas the US rebate program (ex ante) looks at GHG intensity
  • Why is trade intensity a stand alone criterion for obtaining free allowances? Trade intensity has to do with the fact that the more you are trade intensive the more difficult it is for the producer subject to emission reductions to pass on the costs to consumers. Receiving free allowances does not change their competitive position since the producer still has to adapt to the 10 most performing industries

3. Concluding words (Nicolas Imboden)

Whether free allowances are an effective tool, whether they should be considered as a subsidy or whether the argument of Carbon leakage is real, all these questions do not help much the discussion. This is a political discussion. ^

 

In the absence of an international agreement on climate change, major players such as the EU and the US will implement their own schemes and take unilateral actions to curb GHG emissions and address competitiveness and carbon leakage concerns.

 

These national schemes will influence the multilateral system. For this reason, best practices to offset the comparative disadvantage of poor countries need to be identified.

 

The questions that should be addressed are:

-          How do free allowances impact LDCs? May it lead to a comparative disadvantage in the future? If free allowances work industries will become less carbon intensive and will compete with industries that have not applied the same reductions. Through free allowances you have a development incentive which is technology and which is not present for LDCs.

 

4. Next steps

Next steps include: 

·        Organization of two roundtables on climate-linked subsidies and standards (end of 2010 and beginning of 2011) along the same lines as the two previous roundtables;

·        Prior to Climate change talks in Cancun (December 2010), a meeting will be organized in Geneva to prepare constituency members for the Cancun summit;

·        Following Cancun, a meeting to take stock of the situation and agree on next steps will be organized;

·        A set of initial observations on the various domestic policy options debated in national legislation will be elaborated (what are the risks associated with each policy). These observations will help constituency members build a common position and defend their interests;

·        A proposal containing Guiding principles for the elaboration and implementation of Climate-linked policies will be elaborated;

·        Lobbying in major countries which are considering “corrective” measures in their national legislation to inform them of the potential impacts and spill over effects of such measures on LDCs and by proposing alternative measures which are less distortive.

 

Roundtable discussion - 12 November 2009

Toward International Agreement on Border Measures for Climate Change

 

You will find below the summary of the discussions which took place at the roundtable on 11 november 2009. Please find herewith a paper prepared by Aaron Cosbey for this event: Border Carbon Adjustments: Questions and Answers

 

Definition

The choice of focusing on Border carbon adjustment (BCA) is deliberate and has been based on three assumptions: i) They would impact exports of Developing countries, ii) there is a consensus among experts that they will inevitably be put in place, iii) they are still in the definition stage and it is not too late to influence the debate. Aaron Cosbey defines the BCA as is the practice of levying charges at the border on imported goods based on the carbon emitted during the production of those goods.  These might come either in the form of adjustments to a domestic carbon tax regime, or requirements to buy into domestic cap and trade systems. 

 

Speakers’ main points

The three speakers of the roundtable were Aaron Cosbey, Associate and Senior Advisor, International Institute for Sustainable Development; Peter Holmes, Department of Economics, University of Sussex and Dominique van der Mensbrugghe, Lead Economist, World Bank. Nicolas Imboden, Executive Director, IDEAS Centre, moderated the session.

 

A large part of the presentations focused on the current status of the debate in the United States (US) and in the European Union (EU) to give clarifications on how BCA measures could look like, what they do imply and where do the definition and decision processes stand. In the US there is a debate whether the BCAs should be based on carbon content in domestic production or on content in imports on all sectors, or on carbon content in imports on a selection of carbon intensive sector. The latter is most probably the one that will be chosen and, according to the speaker, this option would have limited trade effects. The speakers also advised developing countries to avoid regulations in the first 2 options and use the third as a safety valve in any future negotiations.

 

As part of the broader debate there is the question of whether to have a consumption based carbon charge or a production based charge; the latter was preferred by the speakers.

 

The speakers also brought up the fact that BCA can be analyzed using a competiveness angle or an environmental angle. A competitiveness angle as BCA can be seen as protectionists measures and thus go against free-trade and the WTO principles. An environment angle as BCA can be justified measures to mitigate climate change and thus be legitimate in the framework of the Kyoto Protocol or fall under the WTO article 20 g). The debate among experts and among defenders and opponents of the measures use either angle to defend their point. According to the speakers this distinction is crucial in the question whether BCA are WTO compatible in particular as it is possible that the Dispute Settlement Mechanism would be used to challenge the use of those measures by any member unilaterally.

 

This brought the issue of which multilateral forum would be the most appropriate for dealing with the matter in general and for defining common best standards? The problem is that UNFCCC sets the international framework and agreements on emission reduction while states remain sovereign on how they apply measures to comply with the commitments. This excludes the possibility of dealing with international standards as BCA would be one of those measures that can be undertaken. As for the WTO – which could also be seen as a potential forum – it does not have the mandate to deal with this issue.

 

In relation to developing countries, US most probable scheme foresees exemption for Least Developed Countries (LDCs) as well as for countries that are under the threshold set for the conditions of applying BCA. However, LDCs need to be concerned since part of their major exports (though not carbon intensive products) are in carbon intensive sectors (mining). While they will most probably exempt under the US scheme, LDCs may be integrated under other schemes in the future. As for emerging countries, the speakers have highlighted which countries and which sectors could potentially be concerned (for more details please check the roundtable presentations: "Border Carbon Adjustments: an excuse for Murky Protection?" by Peter Holmes, Tom Reilly, & Jim Rollo; Presentation by Dominique van der Mensbrugghe; "BCAs and LDCs: Key issues" by Aaron Cosbey).

 

Issues raised in the open discussion

During the questions and answer part, participants raised several important points revealing developing countries’ concerns. The principle of “common but differentiated responsibility”, Kyoto Protocol’s key principle regarding developing countries, was addressed and how it would be compatible with BCA. There has been concern over the “practicability” of this scheme in particular regarding the measurement of carbon level, the selection of product and the necessity to take into account the carbon use in the different stage of the supply chain.

 

The need of dealing with this issue multilaterally has been agreed by every participant but the central question remains regarding which forum to use considering that the WTO would not be the appropriate one. Participants also pointed out the need to expand the scope of analysis and include the question of subsidies and cap and trade system. An LDC representative came back to the principle of exempting LDCs from the scheme which could have the consequence of excluding them from the debate and the negotiations.

 

3.      Next steps

v     Re-evaluate the urgency of activities in this field after Copenhagen, namely the need to discipline the use of BCAs at the international level.

v     Elaborate Guiding principles for the elaboration and implementation of unilateral BCA measures according to the interests of LDCs.

v     Lobbying in major countries which are considering BCAs by informing them of the potential impacts and spill over effects of such measures on LDCs and by proposing alternative measures which are less distortive.

 

4.      Further reading

 For more information on the issue of trade and climate change, please read Aaron Cosbey's study “trade and climate change: issues in perspective”.