Carbon leakage or desirable abatement? The curious case of aluminium

It has faced a carbon price, indirectly, since 2005, because production is very electricity intensive and generators have passed through the new carbon price in electricity prices in many countries. Moreover, since direct aluminium emissions were not covered by the EU ETS in Phases I & II, the sector has not received free allowances to compensate for its carbon costs. We recently analysed this sector for evidence of carbon leakage and found the following results.

First, data on trade of primary aluminium products between EU27 and non-EU27 countries from 1999 to 2010 show that there was indeed a large jump in imports from non-EU countries, and a corresponding decline in exports from the EU, since roughly 2005. At first glance, it appeared that the carbon price may have driven this loss in competitiveness.

However, the competitiveness of European aluminium is affected by more than just carbon prices. Thus, as a second step, we estimated an econometric model of the effect of EUA prices on EU net exports of primary aluminium to non-EU ETS countries. We controlled for the effects of coal and gas prices, domestic demand and exchange rates. After controlling for these factors we found no evidence that EUA prices have had an impact on the international competitiveness of EU primary aluminium production. Conversely, high domestic demand and the sharp rise in primary energy prices from the mid-00s – which forced up electricity prices in the EU – showed up as significant factors explaining the observed decline in international competitiveness during this period.

But the data also revealed another, more interesting finding. While the sharp rise in primary energy prices from 2005 to 2008 clearly reduced the competitiveness of EU aluminium producers in the global market, the countries who gained market share almost all produce a large share of their aluminium with electricity from hydro-powered plants. Thus, countries like Norway, Iceland, Russia, Brazil and Canada account for over 75% of the growth in EU imports since 1999.

An interesting implication of this last finding is that, for EU aluminium, losses of competitiveness to large non-EU producers almost certainly imply net global reductions in CO2 emissions for the sector as a whole. This highlights an important difference between the policy goals of mitigating carbon leakage versus maintaining competitiveness in the face of carbon pricing. Carbon leakage is a genuine concern for some sectors. However, losses of competitiveness could just be economically desirable abatement in disguise. If so, then attempting to stop them from happening implies higher carbon prices and thus a higher cost burden on everyone else in the EU ETS.

In the coming months, the European Commission will develop benchmarks for State-aid in respect of the indirect emissions of electricity intensive industries, such as aluminium, in keeping with Article 10a(6) of the ETS Directive. It will be interesting to see to what extent these benchmarks reflect the goal of preventing carbon leakage, as opposed to protecting against potential competitiveness losses.