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Trade Wars and CO2

March 3, 2010

The Guardian ran this piece the other day on CO2 pricing, trade and competition with nations like China who do not price carbon.

But for me the plant closure rules in the EU ETS have got to be the first area to address before you go for a politically and economically very risky border tax adjustment approach that threaten to provoke a trade war. 

The Guardian reports:

It has emerged that Indian-owned steelmaker Corus, which is closing its Teesside plant, stands to pocket around £250m by selling unused carbon permits. Unions allege that this is why the company does not want to find a buyer for the plant.

Lord Turner said a change of approach was needed. “Business needs a clear and consistent market-based incentive to move towards a low-carbon economy. We can’t solve the problem by giving out emission allowances for free as the only option for internationally trading manufacturing sectors. Border carbon-price levelling should not be excluded, but rather subject to rigorous assessment alongside other options.”

Turner also backed a report out this week from the Carbon Trust, which recommended imposing carbon tariffs on some imports to the EU.

In the words of the Dude: “that’s f’ing interesting, man, that’s f’ing interesting…”.

My first question would be: did they buy them or not?

If they did buy the permits, then that’s good! That is what a carbon price is supposed to do: force structural economic change. Thus wherever it is cheapest to close a plant, they should close and sell permits to other parties who value emitting more highly. Remember, the environmental goal is achieved by the overall cap on permits each year, so exchanges between a closing plant and another emitter are normal and reflect the proper functioning of the carbon market. The effect on carbon leakage is undesireable but unavoidable in a  world where we have different carbon prices in different countries.

However, there is a caveat.  A firm has right to profit from selling its hard earned assets when it closes down. But it shouldn’t reap a windfall gain for receiving permits on the basis that it would stop carbon leakage offshore and then close down because of the free allocation and send emissons offshore anyway.

So what’s the answer, if that’s the case? 

At first blush my response would be that the free-allocation rules for trade-exposed (carbon leakage) industries probably need to be linked to some kind of obligation to continue to produce a minimum quantity of output. A no-shut down condition. But you also want to ensure that that doesn’t distort the efficiency of markets for the produced goods “too much”.

If you were effectively subsidising the continuing output of an industry competing in international markets with non-carbon constrained competitors, by not letting it shut down, then you are  providing reverse carbon leakage: maybe we could call this ‘carbon flooding’. Or better yet: ‘carbon capture and cap-age’? Good for the environment. Bad for free and fair trade, however.

This is one to revisit.

To finish with the Coens: “An interesting economic question…”

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