Why does emissions trading under the EU Emissions Trading System (ETS) not affect firms’ competitiveness? Empirical findings from the literature

ABSTRACT

Environmental policies may have important consequences for firms’ competitiveness or profitability. For the European Union Emissions Trading System (EU ETS) the empirical literature documents that significant emissions reductions have resulted from it. Surprisingly, however, the literature shows that there have been hardly any concurrent negative effects on firms’ competitiveness during the first two phases of the scheme (2005–2012). We show that the main explanations for the absence of negative impacts on competitiveness are a large over-allocation of emissions allowances leading to a price drop and the ability of firms to pass costs onto consumers in some sectors. Cost pass-through combined with free allocation, in turn, partly generated windfall profits. In addition, the relatively low importance of energy costs indicated by their average share in the budgets of most manufacturing industries may have limited the impact of the EU ETS. Finally, small but significant stimulating effects on innovation have been found so far. Several factors suggest that over-allocation is likely to remain substantial in the upcoming periods of the scheme. Therefore, we expect to see no negative competitiveness effects from the EU ETS in Phases III and IV (2013–2030).

Key policy insights

• Empirical literature on the EU ETS shows that there have been hardly any effects on firms’ competitiveness or profitability.

• One main explanation is a large over-allocation of emissions allowances leading to a price drop. This reduced incentives for innovation.

• Moreover, firms were able to pass costs on to consumers in some sectors which partly generated windfall profits.

• Innovation effects have so far been small but positive.

• We expect to see no negative competitiveness effects on regulated firms in the near future suggesting that no further reliefs for regulated firms are required.

KEYWORDS:

• Cap and trade system
• EU ETS
• firm-level competitiveness

JEL-CODES:

• Q52
• Q58
• D22

Acknowledgements

We thank Ulrich Wagner, Aleksandar Zaklan and seminar participants at ZEW for helpful comments, in particular Robert Germeshausen, Kathrine von Graevenitz, Peter Heindl, Benjamin Lutz and Philipp Massier, as well as three anonymous reviewers and the editor. Financial support by ZEW within the project ‘Employment Effects of Environmental Regulation’ is gratefully acknowledged. All errors remain the authors’ responsibility.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 Country specific National Allocation Plans (NAPs) were used to define the cap as well as the distribution of allowances across individual installations in Phase I and II. Since Phase III, an EU wide cap has been replacing the NAPs system thus centralizing the allocation system (Ellerman et al., 2016; Kruger, Oates, & Pizer, 2007).

2 The benchmark value is product-specific and equals the average CO2 emissions of the best performing 10% of installations for this product (EU Commission, 2015b, p. 40).

3 We use the definition of the European Parliament for carbon leakage: ‘an increase in greenhouse gas emissions in third countries where industry would not be subject to comparable carbon constraints’ (i.e. constraints imposed by the EU ETS; Directive 2009/29/EC, Paragraph 24).

4 According to Directive 2009/29/EC (Article 10a), a sector or sub-sector is deemed to be exposed to a significant risk of carbon leakage if it meets one of the following criteria:

1. direct and indirect costs induced by the implementation of the directive increase production cost, calculated as a proportion of the gross value added, by at least 5%; and the sector's trade intensity with non-EU countries is above 10%.

2. the sum of direct and indirect additional costs of the regulation is above 30%.

3. the non-EU trade intensity is larger than 30%.

5 These sectors are defined according to the NACE classification, i.e. the statistical classification of economic activities in Europe, at the four-digit level, which is the most detailed level of classification.

6 E.g., firms may buy new equipment to adopt an eco-friendly production process and to control their level of pollution (Gray, 2015).

7 Energy cost shares are calculated in basic prices (excluding taxes and margin) as a percentage of gross output.

8 Alternatively, this trend could be an outcome of the regulation where energy intense firms move outside the EU but these aggregated numbers are not sufficient to judge whether this dynamic behaviour has indeed taken place.

9 NACE is the statistical classification of economic activities used in the EU. It goes from a 1-digit detail (aggregated sectors) to a 4-digit level (more detailed sectors). A 2-digit level is therefore a low level of disaggregation of sectors, meaning that the authors of the European Competitiveness report could not go very deep in analysing sectors’ heterogeneities and have rather measured an average impact.

10 When excluding coke, refined petrol & nuclear fuels.

11 Cement; Chemicals, rubber, plastic; Iron and steel; Metal products; Paper products; Petroleum and coal products; Other metals; Other minerals.

Additional information

Funding

This research was conducted at the Centre for European Economic Research (ZEW), L7, 1, 68161 Mannheim, Germany.