CO2 abatement, competitiveness and leakage in the European cement industry under the EU ETS: Grandfathering versus output-based allocation

A recurring concern raised by the European GHG Emissions Trading Scheme (ETS) is the fear of losses to EU industry through competition: both loss in domestic production and loss in profits. This article analyses how production and profits in the European cement industry may be affected by different approaches to the allocation of emissions allowances. We analyse two contrasting methods for the allocation of free allowances. With 'grandfathering', the number of allowances a firm gets is independent of its current behaviour. With 'output-based allocation', the number of allowances is proportional to the firm's current production level. Whereas almost all the quantitative assessments of the EU ETS assume grandfathering, the real allocation methods used by Member States, notably because of the updating every 5 years and of the special provisions for new plants and plant closings, stand somewhere between these two polar extremes. We study the impacts of these two contrasting allocation methods by linking a detailed trade model of homogeneous products with high transportation costs (GEO) with a bottom-up model of the cement industry (CEMSIM). The two allocation approaches have very different impacts on competitiveness and emissions abatements. Grandfathering 50% of past emissions to cement producers is enough to maintain aggregate profitability (EBITDA) at its business-as-usual level, but with significant production losses and CO2 leakage. For an output-based allocation over 75% of historic unitary (tCO2/tonnecement) emissions, the impact on production levels and EBITDA is insignificant, abatement in the EU is much lower, but there is almost no leakage. Policy makers need to recognize to what extent different allocation approaches may change the impacts of emissions trading, and adopt approaches accordingly. © 2006 Earthscan.