Oregon Sectoral Competitiveness and Carbon Pricing ... · −Theory −Consequences −Evidence 3. Measuring carbon leakage risk −Determinants −Approaches elsewhere −Our approach

Oregon Sectoral Competitiveness

and Carbon Pricing: Summary of

Results

December 2018

Report prepared for the Oregon Carbon Policy Office

Contents

Oregon Sectoral Competitiveness and Carbon Pricing: Final Results

1. Introduction

2. Carbon leakage and competitiveness

− Theory

− Consequences

− Evidence

3. Measuring carbon leakage risk

− Determinants

− Approaches elsewhere

− Our approach

4. Oregon leakage risk assessment

− Results

− Policy responses

5. Conclusions and recommendations

2

Oregon is proposing a cap-and-trade system to drive decarbonization, and this work aims to determine whether there might be any competitiveness impacts as a result


Oregon’s manufacturing sector has grown strongly in recent years

− Over 2010-17, the sector’s employment grew by almost 19% relative to the national average of 9%

− Oregon’s overall competitiveness is driven by the lack of a general sales tax, relatively low energy costs,

and access to major export markets

However, many industrial activities in the manufacturing sector generate greenhouse gas emissions

− These would be covered under a proposed cap-and-trade system

3

The aim of this work is to determine whether the cap-and-trade could lead to competitiveness impacts on industrial sectors, and how it might be designed to prevent

carbon leakage

Contents


1. Introduction


− Theory

− Consequences

− Evidence


− Determinants


− Our approach


− Results



4

If the cap-and-trade is not designed to safeguard competitiveness, it could risk carbon leakage in covered emissions-intensive and trade-exposed (EITE) sectors

5

Carbon leakage occurs when a carbon price causes production to relocate to jurisdictions

with less stringent carbon pricing

If policy is not designed to prevent carbon leakage, the carbon price could thus impact

domestic competitiveness while also increasing global emissions

Output / Short-term competitiveness channel

Investment / Long-term competitiveness channel


The consequences for competitiveness and the environment associated with carbon leakage make it a major focus for policymakers when introducing a cap-and-trade

Carbon leakage could present a combination of undesirable outcomes for policymakers

As a result, the issue of leakage is always one of the most controversial and important aspects when

considering the design of carbon pricing mechanisms

6

Environmental: Carbon leakage could result in an increase in global emissions

Economic: It implies competitiveness impacts both at the sectoral level and state level

Socio-political: Domestic production and employment would shift to other jurisdictions, with secondary impacts


Low carbon prices in many systems translating to only a small impact of carbon pricing

Policy has successfully prevented leakage, for example through free allocation of allowances

Costs of compliance are relatively minor and are only one factor in the multidimensional production decision

While evidence of carbon leakage is mixed – due to low carbon prices, successful policy design, or low compliance costs – it remains central to cap-and-trade design

Ex ante modelling of carbon leakage risk suggest leakage rates could be high

− Economy wide modelling suggest leakage rates could be 5 - 15%

− Sector specific modelling suggests leakage rates as high as 50 - 100%

However, ex post examinations of actual leakage have not yet found evidence for it, possibly due to:

7Oregon Sectoral Competitiveness and Carbon Pricing: Final Results

Contents


1. Introduction


− Theory

− Consequences

− Evidence


− Determinants


− Our approach


− Results



8

There are two elements – carbon cost exposure and cost pass-through capacity – that determine whether an industrial sector is EITE, and thus at risk of carbon leakage


North American jurisdictions identify EITE sectors in a variety of ways, and most tend to use early stages of their carbon pricing systems to gather data on impact

Oregon Sectoral Competitiveness and Carbon Pricing: Final Results 10

Mexico’s cap and trade is expectedto pilot next year and its processfor EITE identification is likely to bebased on trade and emissionsintensity

Quebec identifies allmanufacturing sectors asEITE, and offers allowances tomining. The process for EITEidentification appears similarto California’s

California uses detailed data ontrade and carbon cost exposureto identify sectors at risk, and itsoutgoing rule identifies sectorson a tiered basis in order toimprove targeting

British Columbia doesnot determine EITEsectors, but exemptscertain sources from thecarbon tax under certainconditions

Alberta uses trade intensity and emissionsintensity in a tiered manner but onlysupport sectors in the High EITE category


Our approach for identifying EITE sectors in Oregon involved both quantitative and qualitative analysis to offer a holistic risk assessment

Contents


1. Rationale for a cap-and-trade


− Theory

− Consequences

− Evidence


− Determinants


− Our approach


− Results



12

Quantitative analysis suggests several sectors with high carbon cost exposure, but even those with low emissions intensities may be at risk of leakage


Final assessment suggests all covered sectors are at least likely at risk of leakage and thus the cap-and-trade should be designed to safeguard their competitiveness

NAICS 4 code Sector Description# Potentially

Covered FacilitiesCarbon Leakage Risk

Assessment

3221 Pulp, Paper, and Paperboard 5 At risk

3273 Cement 1 At risk

3344 Semiconductors 6 At risk

3212 Veneer, Plywood, and Wood Products 2 At risk

3114 Food Manufacturing 5 At risk

3251 Chemicals 2 Likely at risk

3311 Iron and Steel 2 At risk

3211 Sawmills and Wood Preservation 1 At risk

3261 Plastics 2 Likely at risk

3315 Foundries 1 At risk

3274 Lime and Gypsum 1 Likely at risk

3279 Other Non-metallic Mineral Products 1 At risk

3272 Glass 1 At risk

2123 Non-metallic Mineral Mining 1 At risk


Our results suggest that Oregon should nevertheless cover all EITE sectors, as the cap-and-trade can be designed to prevent adverse competitiveness impacts


There are 5 reasons why EITE sectors should not be exempted:

1. Precedence shows that cap-and-trades can be designed to prevent competitiveness impacts

2. Sectors and facilities in Oregon have some opportunities to reduce emissions at the margin

3. For a given emissions reduction target, exempting certain sectors would require an increase in stringency for non-exempted sectors, which could shift rather than reduce leakage risk

4. Some evidence indicates that a cap-and-trade can incentivise new technologies and processes, and can even drive higher revenue growth

5. As more jurisdictions across the US and the world, including China, begin pricing carbon in their industrial sectors, leakage risk to these jurisdictions will decline in the long run

15

To safeguard manufacturing competitiveness while also maintaining an incentive to reduce emissions, most jurisdictions offer a form a free allowance allocation


Contents


1. Introduction


− Theory

− Consequences

− Evidence


− Determinants


− Our approach


− Results



17

Oregon can successfully achieve the twin objectives of reducing industrial emissions and safeguarding competitiveness through appropriate cap-and-trade design

18

Immediate priority recommendations

1. Recognize that all potentially coveredmanufacturing and mining facilitiesare at risk of carbon leakage

2. Prevent leakage risk by providing freeallocation based on current output

3. Determine preferred approach todeveloping emissions efficiencybenchmarks for Oregon

Future priority recommendations

4. Investigate the availability and cost ofemissions reduction options to informfuture cap-and-trade phases

5. Gather more granular trade data to refine the targeting of EITE sectors


Appendix


1. EITE identification

− Metrics

− Methodologies

− Sectoral examples

2. Policy responses and benchmarking

− California and Alberta

− European Union

− Quebec

3. Data sources

19

Emissions intensity and trade exposure are the main identification metrics used in most international methodologies


𝑬𝒎𝒊𝒔𝒔𝒊𝒐𝒏𝒔 𝒊𝒏𝒕𝒆𝒏𝒔𝒊𝒕𝒚 = 𝐷𝑖𝑟𝑒𝑐𝑡 𝑒𝑚𝑖𝑠𝑠𝑖𝑜𝑛𝑠 𝑖𝑛𝑡𝑒𝑛𝑠𝑖𝑡𝑦 + 𝐼𝑛𝑑𝑖𝑟𝑒𝑐𝑡 𝑒𝑚𝑖𝑠𝑠𝑖𝑜𝑛𝑠 𝑖𝑛𝑡𝑒𝑛𝑠𝑖𝑡𝑦

=𝐷𝑖𝑟𝑒𝑐𝑡 𝑒𝑚𝑖𝑠𝑠𝑖𝑜𝑛𝑠 (𝑡𝐶𝑂

2𝑒)

𝐺𝑟𝑜𝑠𝑠 𝑣𝑎𝑙𝑢𝑒 𝑎𝑑𝑑𝑒𝑑 (𝑈𝑆$)+

𝐼𝑛𝑑𝑖𝑟𝑒𝑐𝑡 𝑒𝑚𝑖𝑠𝑠𝑖𝑜𝑛𝑠 (𝑡𝐶𝑂2𝑒)

𝐺𝑟𝑜𝑠𝑠 𝑣𝑎𝑙𝑢𝑒 𝑎𝑑𝑑𝑒𝑑 (𝑈𝑆$)

𝑻𝒓𝒂𝒅𝒆 𝒆𝒙𝒑𝒐𝒔𝒖𝒓𝒆 = 𝑇𝑟𝑎𝑑𝑒 𝑎𝑠 𝑎 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑑𝑜𝑚𝑒𝑠𝑡𝑖𝑐 𝑚𝑎𝑟𝑘𝑒𝑡

=𝐼𝑚𝑝𝑜𝑟𝑡𝑠 𝑈𝑆$ + 𝐸𝑥𝑝𝑜𝑟𝑡𝑠 (𝑈𝑆$)

𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑈𝑆$ + 𝐼𝑚𝑝𝑜𝑟𝑡𝑠 (𝑈𝑆$)

20

𝐼𝑛𝑑𝑖𝑟𝑒𝑐𝑡 𝑒𝑚𝑖𝑠𝑠𝑖𝑜𝑛𝑠 = 𝐸𝑙𝑒𝑐𝑡𝑟𝑖𝑐𝑖𝑡𝑦 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑘𝑊ℎ × 𝐸𝑙𝑒𝑐𝑡𝑟𝑖𝑐𝑖𝑡𝑦 𝑝𝑟𝑜𝑣𝑖𝑑𝑒𝑟′𝑠 𝑒𝑚𝑖𝑠𝑠𝑖𝑜𝑛𝑠 𝑓𝑎𝑐𝑡𝑜𝑟 (𝑡𝐶𝑂2𝑒

𝑘𝑊ℎ)

Direct emissions include emissions captured in Air Quality Permit reporting: all anthropogenic emissions such as combustion of natural gas and fuel oil and most industrial process emission and cover the GHGs: CO2; CH4; N2O; and HGWP3

Indirect emissions included in key international methodologies

Alberta uses trade intensity and emissions intensity in a tiered manner but only support sectors in the High EITE category

Major international methodologies combine emissions intensity and trade intensity measures differently to determine carbon leakage risk


The EU ETS Phase IV metric multiplies trade intensity and emissions intensity and compares against threshold

California* uses trade intensity and emissions intensity but determine leakage risk in a tiered manner

High

Medium

Low

In general, jurisdictions often identify similar sectors as being at risk of carbon leakage


Sector description CaliforniaEU ETS Phase III

EU ETS Phase IV

Alberta QuebecWashington (proposed)

Mining and Quarrying High ✓ ✓

Food Medium ✓ ✓ ✓ ✓ ✓

Sawmills Medium ✓

Wood Products High ✓ ✓ ✓

Pulp and Paper High ✓ ✓ ✓ ✓ ✓

Chemicals High ✓ ✓ ✓ ✓ ✓

Plastics Medium ✓ ✓ ✓

Glass High ✓ ✓ ✓ ✓

Cement High ✓ ✓ ✓ ✓ ✓

Lime High ✓ ✓ ✓ ✓ ✓

Iron and Steel High ✓ ✓ ✓ ✓ ✓

Semiconductors N/A ✓ ✓ ✓

California and Alberta support EITE sectors through output-based free allocation

Oregon Competitiveness and Carbon Pricing: Policy Options 23

Alberta’s CCIR addresses EITE sectors’ risk of leakage through:- Output-based allocation; and- Phase-in and transition support

Alberta categorizes also firms as either low, medium, or high carbon leakage risk but only supports those identified as high risk

California’s cap and trade currently reduces the risk of EITE sector leakage by:- Output-based allocation; and- Tiered transition support

The current mechanism categorizes facilities as low, medium, or high risk of carbon leakage and provides differential support based on leakage risk severity

The EU ETS Phase III developed 52 product benchmarks based on the average efficiency of the 10% most efficient producers in the sector

Oregon Competitiveness and Carbon Pricing: Policy Options 24

The low number of facilities across Oregon sectors poses a challenge to developing sectoral benchmarks, but a range of options exist to overcome this

Quebec identifies the majority of sectors covered under its cap-and-trade as eligible for free allowance allocation using benchmarks


Quebec identifies all manufacturing and mining sectors and some electricity producers as eligible for free

allowance allocation

− Free allocation is offered on an output basis, to reduce leakage risk

− Allocations to covered facilities are determined by facilities’ performance against emissions intensity

benchmarks, which help maintain emissions reduction incentives

− Emissions intensity is either calculated as emissions per unit of product or per unit of fuel input.

Product benchmarks are based on average historical emissions intensity of production, either at the sector

level, or at the individual facility level. Three elements of this approach are noteworthy for Oregon:

1. Most activities use benchmarks developed according to individual facilities’ historical emissions

intensities;

2. Only a few activities are benchmarked using sector-level emissions intensity. These activities are lime

production, cement production, and prebaked anode and aluminum production;

3. Further nuances to this methodology are included for facilities with missing data or those without a simple

output product that can be used as a reference unit.

25

The quantitative EITE identification process uses publicly available data sources from DEQ, the EIA and the US Census Bureau


Data Source Unit GranularityMost recent year

Oregon International Trade

US Census Bureau

US$ NAICS 4 2017

OregonIntra-US Trade

US Census Bureau

US$ NAICS 2 2012

Value AddedUS Census Bureau

US$ NAICS 4 2016

ProductionUS Census Bureau

US$ NAICS 4 2016

Direct emissions DEQ tCO2e NAICS 6 2017

Electricity consumption

EIA* MWhNational level NAICS 4

2016

Carbon intensity of the Oregon’s electricity grid

DEQtCO2e/MWh

State-wide 2016

Assumptions

Exchange rates for each year over 2014-2017

Annual

Period chosen for analysis

2014 – 2017

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Oregon Sectoral Competitiveness and Carbon Pricing ... · −Theory −Consequences −Evidence 3. Measuring carbon leakage risk −Determinants −Approaches elsewhere −Our approach