Industrial competitiveness impacts of the EU ETS EU ETS Review - - PowerPoint PPT Presentation

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Industrial competitiveness impacts of the EU ETS EU ETS Review - - PowerPoint PPT Presentation

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Em bargoed until publication 2 0 Novem ber 2 0 0 7 Industrial competitiveness impacts of the EU ETS EU ETS Review Seminar, Stockholm, 11 Oct 2007 Professor Michael Grubb Chief Economist, the Carbon Trust and Director, Climate Strategies Senior

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Industrial competitiveness impacts of the EU ETS

EU ETS Review Seminar, Stockholm, 11 Oct 2007 Professor Michael Grubb Chief Economist, the Carbon Trust and Director, Climate Strategies

Senior Research Associate, Faculty of Economics, Cambridge University And Visiting Professor, Imperial College

Drawing on research convened by

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Presentation of results from Climate Strategies study

The Differentiation and Dynamics of EU ETS Competitiveness impacts

Karsten Neuhoff, Misato Sato and Michael Grubb EPRG, Faculty of Economics, Cambridge Convened by:

Faculty of econom ics

Jean-Charles Hourcade & Damien Demailly, CIRED, Paris Additional contributions from:

Felix Matthes, Oeko-Institute, Berlin and Joachim Eichammer, Fraunhofer ISI Karlsruhe

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Competitiveness is a sector/ product issue

At aggregate sector level (using 3 digit (Standard Industrial Classification 92), energy and metals production stand out

Textiles Food & tobacco Pulp, Paper, Printing & Publishing Coke oven, refined petroleum & nuclear fuel Chemicals Cement, lime& plaster Basic Metals (incl. Iron & Steel) Wood Electricity Plastic & rubber Glass & Ceramics Non-Ferrous Metals Fabricated metal Machinery Electrical & optical equipment Transport equip. 0% 5% 10% 15% 20% 0% 10% 20% 30% 40% 50% UK trade intensity from Non-EU Potential maximum and net gross value added at stake MVAS: Max.GVA at stake (no free allocation) NVAS: Net GVA at stake (100% free allocation; exposure to electricity price only)

Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/mwh

Vertical range gives insights on:

  • Marginal cost

increase (top end

  • f bar)
  • Impact of electricity

price pass through (bottom end of bar) Combined with horizontal axis gives insights on:

  • possible dynamics
  • f impacts
  • Scope for

auctioning? Note: Process emissions and onsite emissions included

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.. And trade intensity within EU is bigger than international trade intensity even for the UK

Textiles Food & tobacco Pulp, Paper, Printing & Publishing Coke oven, refined petroleum & nuclear fuel Chemicals Cement, lime& plaster Basic Metals (incl. Iron & Steel) Wood Electricity Plastic & Rubber Glass & Ceramics Non-Ferrous Metals Fabricated metal Machinery Electrical &

  • ptical

equipment Transport equipment 0% 5% 10% 15% 20% 0% 10% 20% 30% 40% 50% 60% UK trade intensity from within the EU Potential maximum and net gross value added at stake MVAS: Max.GVA at stake (no free allocation) NVAS: Net GVA at stake (100% free allocation; exposure to electricity price only)

Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/mwh

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Presentation of results from Climate Strategies study

The Differentiation and Dynamics of EU ETS Competitiveness impacts

Convened by:

Subsector analysis (4-digit SIC code level)

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‘Construction’ sector: cement production dominates emissions, high MVAS, relatively low NVAS, accounts for c.10% of aggregated sector value-added

Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/MWh

0% 5% 10% 15% 20% 25% 30% 35% 0% 20% 40% 60% 80% 100% Non- EU Trade Intensity Potential maximum and net gross value added at stake (MVAS/ NVAS)

  • Man. of cement
  • Man. of concrete products

for construction purposes

  • Man. of plaster products for

construction purposes

  • Man. of ready0mixed

concrete

  • Man. of other articles of

concrete, plaster and cement Cutting, shaping and finishing of stone Production of abrasive products

  • Man. of other non0metallic

.mineral products n.e.c

  • Man. of lime

Manufacture of cement (SIC 26.51); GVA £409 million (2004) Total sector GVA in 2004 £3,359 million Manufacture of lime (SIC 26.52); GVA £26 million (average 1997-1999) MVAS 126%

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Iron and Steel: Basic Iron & Steel production (blast furnace) dominates emissions, MVAS c.25% , c.10xNVAS, accounts for half sector value-added

Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/MWh

0% 5% 10% 15% 20% 25% 30% 0% 20% 40% 60% 80% 100% Non-EU Trade Intensity Potential maximum and net gross value added at stake (MVAS/ NVAS)

&Man.of basic iron steel and of )ferro0alloys (ECSC

  • Man. of cast iron tubes
  • Man. of steel tubes

Cold draw ing Cold rolling of narrow strip Cold forming or folding Wire draw ing Casting of iron Casting of steel

Manufacturing of basic iron and steel (SIC 27.10); GVA £1,064million (2004) MVAS 27%. Total Sector GVA in 2004 £2,139 million

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Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/MWhh

0% 2% 4% 6% 8% 10% 12% 0% 20% 40% 60% 80% 100% Non-EU Trade Intensity

Manufacturing of refined petroleum (SIC 23.20); GVA £2,300 million (2005)* Potential maximum and net gross value added at stake (MVAS/ NVAS) Total sectoral GVA for 2004 £2,627 million Manufacturing of coke oven products (SIC 23.10); GVA £10 million (average of 1998- 2002).

Energy processing dominated by refineries

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Other sectors tend to more complex substructure with more product diversity & lower carbon intensity of most processes

Food, beverage tobacco Textiles & leather Wood, paper and pulp Chemicals Plastics and rubber Glass and ceramics Non-ferrous metals (high electricity intensity) Total of 1 5 9 product categories exam ined

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Potential maximum gross value added at stake (MVAS) and net gross value added at stake (NVAS) Cement Basic iron & steel Lime Fertilisers & Nitrogen Aluminium Other inorganic basic chemicals Pulp & Paper Malt Coke oven Industrial gases Non-wovens Refined petroleum Household paper Hollow glass Finishing

  • f textiles

Rubber tiers & tubes Copper Casting of iron UK GDP Allocation dependent (direct) CO2 costs / GVA Electricity (indirect) CO2 costs / GVA Price increase assumption: CO2 = €20/t CO2; Electricity = €10/MWh Flat glass Veneer sheets

0% 10% 20% 30% 40%

0.0% 0.2% 0.4% 0.6% 0.8% 1.0%

4% 2%

Potential maximum gross value added at stake (MVAS) and net gross value added at stake (NVAS) Cement Basic iron & steel Lime Fertilisers & Nitrogen Aluminium Other inorganic basic chemicals Pulp & Paper Malt Coke oven Industrial gases Non-wovens Refined petroleum Household paper Hollow glass Finishing

  • f textiles

Rubber tiers & tubes Copper Casting of iron UK GDP Allocation dependent (direct) CO2 costs / GVA Electricity (indirect) CO2 costs / GVA Price increase assumption: CO2 = €20/t CO2; Electricity = €10/MWh Flat glass Veneer sheets

0% 10% 20% 30% 40%

0.0% 0.2% 0.4% 0.6% 0.8% 1.0%

4% 2% CO2 cost screen: Sectors potentially exposed under unilateral CO2 pricing

Hourcade et.al. Differentiation and dynamics of EU ETS industrial competitiveness impacts.

Cement & BOS steel stand out, in total, 23 product categories representing c.1% of UK GDP have MVAS> 4% or NVAS> 2% at €20/ tCO2

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Presentation of results from Climate Strategies study

The Differentiation and Dynamics of EU ETS Competitiveness impacts

Convened by:

I ntepretation of subsector analysis

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Cem ent and Basic I ron and Steel

MVAS in the range 25-35% of total value added implies EU ETS will have significant impact on sector economics NVAS of c.2% (cement) – 3.5% (steel) implies that 100% free allocation will keep the gross cost impact “within the noise” compared to other temporal and geographical influences on costs Both have carbon-intensive intermediate product: clinker (for cement), coke (for steel) With fixed allocation: – Huge tension in pricing decisions between short-run profit maximisation, and long-run market share protection – Strong incentive for leakage: import the finished or intermediate product, and sell the surplus allowances

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Constraints on refining sector likely to make any trade & relocation impacts trivial

No new refining capacity under consideration in Europe Cost of trade in refined products is much higher than crude (specialised transport and containment requirements, etc) Existing trade of refined products is largely a transatlantic swap of diesel for gasoline driven by the chemistry of crude set against intrinsic market differences

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Other sectors (other than non- ferrous metals)

A few individual product sectors may have high MVAS or NVAS

– Chemicals very complex (seeking deeper analysis), preliminary suggests that most of the carbon- intensive products are not very amenable to international trade (e.g. as industrial gases); fertilizer the biggest potential exception – Pulp a complex issue (UK not a big player)

Com petitiveness concerns for EU ETS Phase I I I can be confined to product-specific analysis of betw een 2 -5 m ain products, dom inated by cem ent, and basic iron & steel

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Presentation of results from Climate Strategies study

The Differentiation and Dynamics of EU ETS Competitiveness impacts

Convened by:

Deeper Dive

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Som e principles for addressing leakage and com petitiveness concerns

Focus on sector specifics not generalised solutions Focus on leakage, not competitiveness per se:

– Much sharper focus on EU ETS-related impacts rather than generalised pleas for protection – Aligns environmental with economic concerns

For the period 2012-2020, acknowledge case for concern in cement and BOS Steel, that may be (imperfectly) addressed through free allocation if other avenues are not developed Other key sectors (mainly basic chemicals, pulp&paper, refining) should be monitored for evidence-based assessments of impacts, not driven by projections Political judgement may be needed on whether to trouble for a few other specific subsectors/ products, that are macroeconomically trivial (< < 0.1% GDP)

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Cement already faces widely divergent domestic prices

Climate Strategies – IDDRI Meeting 13th September 2007

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.. So analysis of potential EU ETS trade impacts needs needs to understand the intrinsic trade barriers (& drivers)

Climate Strategies – IDDRI Meeting 13th September 2007

Road cost, sea cost, storage facility Anti-competitive behaviours. Balance on the markets abroad (& domestic) Risk: retaliation, market immaturity… Colour, strenght, workability, consistency… Availability, vertical integration, price stability… International Pressure on EU market

Difference in operating costs between the EU and the RoW

Transport Consumption / Capacity Import restriction Cost of instability Product differentiation Service differentiation

Trade Barriers

NB: Barriers are lower for EU transnational firms

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What about relocation?

Climate Strategies – IDDRI Meeting 13th September 2007

Currently, there are no (few) export capacities.

15 25 35 45 55 10 15 20 25 30 35 South East Asia-US Gulf Handymax Transatlantic US East Coast-US Gulf Handysize Freigth Rates in $/to : Asia to USA Freigth Rates in $/to : Europe to USA

Asian route Spot rate is 34$/t above historical average of 17$/t European route Spot rate is 18$/t above historical average

  • f 12$/t

2004 2003 2002 2001 2000

Source: Exane $/t cement

15 25 35 45 55 10 15 20 25 30 35 South East Asia-US Gulf Handymax Transatlantic US East Coast-US Gulf Handysize Freigth Rates in $/to : Asia to USA Freigth Rates in $/to : Europe to USA

Asian route Spot rate is 34$/t above historical average of 17$/t European route Spot rate is 18$/t above historical average

  • f 12$/t

2004 2003 2002 2001 2000

15 25 35 45 55 10 15 20 25 30 35 South East Asia-US Gulf Handymax Transatlantic US East Coast-US Gulf Handysize Freigth Rates in $/to : Asia to USA Freigth Rates in $/to : Europe to USA

Asian route Spot rate is 34$/t above historical average of 17$/t European route Spot rate is 18$/t above historical average

  • f 12$/t

2004 2003 2002 2001 2000

Source: Exane $/t cement

Cement sea costs Euro exchange rate vs US Dollars

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Is the picture changing? Some EU firms are considering the relocation of part of their activity. Relocation barriers ≈ trade barriers + an important « cost of instability » New long run investments, made sensitive to fluctuations in tariffs (see export taxes in Turkey

  • r China in 2007), exchange rates, or transport

costs.

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Industrial competitiveness impacts of the EU ETS

EU ETS Review Seminar, Stockholm, 11 Oct 2007 Steel sector analysis

Drawing on research convened by

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A world market fragmented? Confirmation by trade data

Climate Strategies – IDDRI Meeting 13th September 2007

The world market appears fragmented into regional markets partially interconnected through price.

20 40 60 80 100 120 140 160 180 EUROPE EUROPE AMERICA AMERICA ASIA ASIA Export to Import from Export to Import from Export to Import from MT Others ASIA AMERICA EUROPE

Steel trade across Regions

Source: IISI (2007)

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Trade barriers in steel

Climate Strategies – IDDRI Meeting 13th September 2007

International Pressure on EU market

Difference in operating costs between the EU and the RoW

Transport Consumption / Capacity Import restriction Cost of instability Product differentiation Service differentiation

Trade Barriers

Import and export tariffs, standards Proximity with consumers, different stages of tech developments… Just in time delivery, technical assistance… Balance on the markets abroad (& domestic)

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Future Challenges

Climate Strategies – IDDRI Meeting 13th September 2007

  • 1. Does the 2006 surge in imports signal the start of a continuous decline of

trade barriers? Further analysis would be required as part of this rise may be attributed to:

  • The apparition of (transitory) excess capacities abroad, notably in China.
  • The EU rise in consumption (+10% between 2005 and 2006), especially in Italy.
  • 2. Internationalisation of firms: better ability of taking advantage of cost

differences Relocation?

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Steel: Relocation issues

Climate Strategies – IDDRI Meeting 13th September 2007

Nowadays most of steel plants are built to supply the local markets. The sustainability of this situation is not guaranteed for BOF semis: high cost differences across countries, relatively low product differentiation. What scale of relocation for BF semis? Controversial. Relocation barriers:

  • Social viscosity, sunk costs and current boom slow down process;
  • Semis are differentiated products;
  • Countries are reluctant to host export plants;
  • The production chain is made sensitive to risks.
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Industrial competitiveness impacts of the EU ETS

EU ETS Review Seminar, Stockholm, 11 Oct 2007 Modeling analysis of im pacts on steel and cem ent

Drawing on research convened by

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Sector impacts: modeling analysis (cement and steel)

Climate Strategies – IDDRI Meeting 13th September 2007

Three cost increase:

  • The electricity cost increase due to the rise in electricity prices;
  • The abatement cost due to the efforts made to reduce the unitary emissions;
  • The emission cost: depends on the allocation methodology and the behaviour of

firms vis-à-vis the opportunity cost of free allowances. Three extreme scenarios for the allocation methodology:

  • Full auctioning (labelled AU);
  • Full free allowances with opportunity cost (Free Eco)
  • Full free allowances without opportunity cost (Free Ind)

Three CO2 prices tested: 15 (Phase 2 expectations), 30 and 45€/t.

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Cost Impact From the modelling work

Climate Strategies – IDDRI Meeting 13th September 2007

CO2 price (€/t) Cost increase (€/t) 15 30 45 10 20 30 40 Cost increase (%) 20 40 60

Auction or Free Eco Free Ind Electricity Abatement Emission

CO2 price (€/t) Cost increase (€/t) 15 30 45 10 20 30 40 Cost increase (%) 20 40 60

Auction or Free Eco Free Ind Electricity Abatement Emission

EU ETS impact on average EU cement costs

  • The emission cost dominates

under AU or Free Eco

  • The cost impact is very high.
  • Under Free Ind, the emission

cost is positive (we assume a 10% emission reduction target) and non negligible.

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Cost Impact From the modelling work

Climate Strategies – IDDRI Meeting 13th September 2007

CO2 price (€/t) Cost increase (€/t) 15 30 45 20 60 Cost increase (%) 5 10 15

Electricity Abatement Auction or Free Eco Free Ind Emission

40 CO2 price (€/t) Cost increase (€/t) 15 30 45 20 60 Cost increase (%) 5 10 15

Electricity Abatement Auction or Free Eco Free Ind Emission

40

EU ETS impact on average BOF steel costs

  • The emission cost dominates

under AU or Free Eco

  • The cost impact is high.
  • Under Free Ind, the emission

cost is negative. The overall cost is negligible. We focus on BOF as EAF is identified as much less sensitive:

  • Generally less exposed to international competition;
  • Relatively low CO2 intensity.
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Industrial competitiveness impacts of the EU ETS

EU ETS Review Seminar, Stockholm, 11 Oct 2007 SUPPORTI NG MATERI AL

Drawing on research convened by

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Presentation of results from Climate Strategies study

The Differentiation and Dynamics of EU ETS Competitiveness impacts

Convened by:

Subsector analysis (4-digit SIC code level)

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4 digit: Food, Beverage and Tobacco Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/mwh

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 0% 20% 40% 60% 80% 100% Non - EU Trade Intensity Potential maximum and net gross value added at stake (MVAS/ NVAS)

Production and preserving of meat Production and preserving of poultrymeat Production of meat and poultrymeat products Processing and preserving of fish and fish products Processing and preserving of potatoes M an. of fruit and vegetable juice .Processing and preserving of fruit and vegetables n.e.c M an. of crude oils and fats M an. of refined oils and fats M an. of margarine and similar edible fats Operation of dairies and cheese making M an. of ice cream M an. of grain mill products M an. of starches and starch products M an. of prepared feeds for farm animals M an. of prepared pet foods M an. of bread; fresh pastry goods and cakes M an. of rusks and biscuits; preserved pastry goods and cakes M an. of cocoa; chocolate and sugar confectionery Processing of tea and coffee M an. of condiments and seasonings .M an. of other food products n.e.c M an. of distilled potable alcoholic beverages M an. of beer M an. of malt Production of mineral waters and soft drinks M an. of tobacco products

Total Sector GVA for 2004 £22,516million Manufacturing

  • f malt (SIC15.97);

GVA £64million (2004)

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4 digit: Textiles and Leather Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/MWh

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 0% 20% 40% 60% 80% 100% Non-EU Trade Intensity Potential maximum and net gross value added at stake (MVAS/ NVAS)

Preparation & spinning of worsted0type fibres Preparation & spinning of flax0type fibres Throwing,preparation&texture of silk,synthetic/artificial filament yarn M an. of sewing threads Cotton0type weaving Woollen0type weaving Worsted0type weaving Silk0type weaving Other textile weaving Finishing of textiles M an. of made0up textile articles, except apparel M an. of carpets and rugs M an. of cordage, rope, twine and netting M an.of non0wovens& articles made from non0wovens except apparel .M an. of other textiles n.e.c M an. of knitted and crocheted hosiery M an. of leather clothes M an. of workwear M an. of other outerwear M an. of underwear .M an. of other wearing apparel and accessories n.e.c Dressing &dyeing of fur; man. of articles of fur Tanning and dressing of leather M an. of luggage, handbags and the like, saddlery& harness

Finishing of textiles (SIC 17.30) GVA £230million (2004) Total sector GVA in 2004 £4,150 million Manufacturing of non- wovens; (SIC 17.53) GVA £45million (2004) Other textile weaving (SIC 17.25) GVA £6million (2004)

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4 digit Wood, Paper and Pulp Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/MWh

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 0% 20% 40% 60% 80% 100% Non-EU Trade Intensity Potential maximum and net gross value added at stake (MVAS/ NVAS)

Saw milling & planing of w ood; impregnation of w ood ,Man.of veneer sheets,plyw ood, laminboard particle board, fibre board etc

  • Man. of builders' carpentry and joinery
  • Man. of w ooden containers
  • Man. of other products of w ood
  • Man. of articles of cork, straw and plaiting

materials

  • Man. of pulp, paper and paperboard

Man.of corrugated paper, paperboard, containers Man.of household and sanitary goods & of toilet requisites

  • Man. of paper stationery
  • Man. of w allpaper

.Man.of other articles of paper & paperboard n.e.c

  • Publish. books
  • Publish. new spapers
  • Publish. journals and periodicals
  • Publish. sound recordings

Other publishing .Printing n.e.c Composition and plate0making

Total Sector GVA for 2004 £22,428million Manufacturing of pulp, paper and paper borad (SIC 2111 and 2112); GVA £788 million, (2004) Manufacturing of household sanitary goods (SIC 21.22); GVA £554 million (2004). Manufacturing of veneer sheets, plywood

  • etc. (SIC 2020); GVA £275 million (2004)
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4 digit Chemicals Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/MWh

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 0% 20% 40% 60% 80% 100% NON EU trade Intensity Potential value at stake (GVAS / MVAS under 0 to 100% free allocation

M an. of fertilizers and nitrogen compounds M an. of other organic basic chemicals M an. of other inorganic basic chemicals M an. of dyes and pigments M an. of industrial gases M an. of plastics in primary forms M an. of synthetic rubber in primary forms M an. of pesticides and other agro0chemical products M an. of paints,varnishes, similar coatings, printing ink and mastics M an. of basic pharmaceutical products M an. of pharmaceutical preparations M an. of perfumes and toilet preparations M an. of explosives M an. of glues and gelatines M an. of essential oils M an. of photographic chemical material M an. of prepared unrecorded media .M an. of other chemical products n.e.c M an. of man0made fibres M an. of soap and detergents, cleaning and polishing preparations

Manufacturing of fertilisers and nitrogen compounds (SIC 24.15); GVA £169 million (2004) Total Sectoral GVA in 2004 £16,060 million Manufacturing of inorganic basic chemicals (SIC 24.13); GVA £393million (2004) Manufacturing of industrial gases (SIC 24.11); GVA £450million (2001)

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4 digit Plastic and Rubber Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/MWh

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 0% 20% 40% 60% 80% 100% Non-EU trade Intensity Potential maximum and net gross value added at stake (MVAS/ NVAS)

Manufacture of rubber tyres and tubes Retreading and rebuilding

  • f rubber tyres

Manufacture of other rubber products Manufacture of plastic plates, sheets, tubes and profiles Manufacture of other plastic products Manufacture of plastic packing goods 'Manufacture of builders w are of plastic

Total Sectoral GVA in 2004 £7,842 million Manufacturing of rubber tyres and tubes (SIC 25.11); GVA £562 million (2004) Retreading and rebuilding of rubber tyres (SIC 25.12); GVA £29 million (2004)

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4 digit Glass and Ceramics Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/MWh

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 0% 20% 40% 60% 80% 100% Non- EU Trade Intensity Potential maximum and net gross value added at stake (MVAS/ NVAS)

M anufacture of flat glass Shaping and processing of flat glass M anufacture of hollow glass M anufacture of glass fibres M anufacture and processing of other glass, including technical glassware M anufacture of ceramic household and

  • rnamental articles

M anufacture of ceramic sanitary fixtures M anufacture of other ceramic products M anufacture of refractory ceramic products M anufacture of ceramic tiles and flags M anufacture of bricks, tiles and construction products, in baked clay M anufacture of other technical ceramic products

Total sector GVA in 2004 £2,451 million Manufacture of hollow glass (SIC 26.13); GVA £329 million (2002 data) Manufacture of flat glass (SIC 26.11); GVA £159 million (2002 data)

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4 digit Non-Ferrous Metals Assumptions: CO2 price=€20/tCO2; Pass through in electricity = €10/MWh

0% 2% 4% 6% 8% 10% 0% 20% 40% 60% 80% 100% Non-EU Trade Intensity Potential value at stake (GVAS / MVAS under 0 to 100% free allocation

Precious metals production Aluminium production Lead, zinc and tin production Copper production Other non0ferrous metal production Total Sector GVA in 2004 £1,309 million Aluminium production (SIC 27.42); GVA £444 million (2004) Copper production (SIC 27.44); GVA £131 million (2004)

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Presentation of results from Climate Strategies study

The Differentiation and Dynamics of EU ETS Competitiveness impacts

Convened by:

Supporting m aterial: UK-EU com parators

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0% 5% 10% 15% 20% 25% EU 27 United Kingdom Belgium Bulgaria Czech Republic Denmark Germany Estonia Ireland Spain France Italy Cyprus Latvia Hungary Netherlands Austria Poland Portugal Romania Sector share of national GVA Metal Basic Metal Cement Plastic Chemicals Refining Publishing Paper Wood Textile Tobacco Food

Figure 30 Share of sectors analysed in this chapter of the GDP of EU countries

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Trade intensity of top 2 3 sectors w ith Non-EU and EU countries in UK and Germ any

0% 20% 40% 60% 80% 100% 120% 140% 160% 180% 200% Casting services of iron Throwing, preparation & texture of silk,filament yarn Copper production Other textile weaving Flat glass Veneer sheets, plywood, laminboard, particle & fibre board Retreaded pneumatic tyres, of rubber New rubber tyres Hollow glass Textile finishing services Household & toilet paper & paper products Refined petroleum products Nonwovens & articles made from nonwovens, except apparel Industrial gases Coke oven products Malt Pulp, paper & paperboard Other basic inorganic chemicals Aluminium & aluminium products Fertilizers & nitrogen compounds Basic iron & steel & ferro-alloys Cement Lime UK non-EU UK EU G non-EU G EU

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Ratio of energy expenditure relative to gross value added in Germ any and UK

0% 10% 20% 30% 40% 50% 60% 70% L i m e C e m e n t B a s i c i r

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Energy Expenditure / GVA UK UK (using German energy shares) Germany

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Value at stake for Germ any and UK

0% 5% 10% 15% 20% 25% 30% 35% 40% Casting services of iron Throwing, preparation & texture of silk,filament yarn Copper production Other textile weaving Flat glass Veneer sheets, plywood, laminboard, particle & fibre board Retreaded pneumatic tyres, of rubber New rubber tyres Hollow glass Textile finishing services Household & toilet paper & paper products Refined petroleum products Nonwovens & articles made from nonwovens, except apparel Industrial gases Coke oven products Malt Pulp, paper & paperboard Other basic inorganic chemicals Aluminium & aluminium products Fertilizers & nitrogen compounds Basic iron & steel & ferro-alloys Cement Lime UK indirect UK direct G indirect G direct

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Share of gross value added in the turnover for Germ an sectors

0% 10% 20% 30% 40% 50% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Lime Cement Basic iron & steel & ferro-alloys Fertilizers & nitrogen compounds Aluminium & aluminium products Other basic inorganic chemicals Pulp, paper & paperboard Malt Coke oven products Industrial gases Nonwovens & articles made from nonwovens, except apparel 0% 10% 20% 30% 40% 50% 1995 1997 1999 2001 2003 2005 Refined petroleum products Household & toilet paper & paper products Textile finishing services Hollow glass New rubber tyres Retreaded pneumatic tyres, of rubber Veneer sheets, plywood, laminboard, particle & fibre board Flat glass Other textile weaving Copper production Throwing, preparation & texture of silk,filament yarn Casting services of iron

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Share of investm ents in the turnover for Germ an sectors

0% 2% 4% 6% 8% 10% 12% 14% 16% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Lime Cement Basic iron & steel & ferro-alloys Fertilizers & nitrogen compounds Aluminium & aluminium products Other basic inorganic chemicals Pulp, paper & paperboard Malt Coke oven products Industrial gases Nonwovens & articles made from nonwovens, except apparel 0% 5% 10% 15% 20% 25% 30% 1995 1997 1999 2001 2003 2005 Refined petroleum products Household & toilet paper & paper products Textile finishing services Hollow glass New rubber tyres Retreaded pneumatic tyres, of rubber Veneer sheets, plywood, laminboard, particle & fibre board Flat glass Other textile weaving Copper production Throwing, preparation & texture of silk,filament yarn Casting services of iron

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Presentation of results from Climate Strategies study

The Differentiation and Dynamics of EU ETS Competitiveness impacts

Convened by:

Supporting m aterial: Evolution of recent trade patterns

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10 20 30 40 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 2 1 2 2 2 3 2 4 2 5 2 6 Mt of cement

A high domestic market share

  • A share of these imports is

controlled by EU firms.

  • We come back to the observed

rise later.

  • Even in 2006, Import ratio may

be considered as low given the important price differences across countries.

Climate Strategies – IDDRI Meeting 13th September 2007

Extra EU Intra EU Non EU Import ratio: 3% 8%

Source: Eurostat

EU cement & clinker imports

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5 10 15 20 25 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Mt of cement

SPAIN ITALY PORTUGAL HUNGARY BULGARY FRANCE OTHERS

5 10 15 20 25 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Mt of cement

SPAIN ITALY PORTUGAL HUNGARY BULGARY FRANCE OTHERS

Is the picture changing? « The rise in non EU imports »

Climate Strategies – IDDRI Meeting 13th September 2007

The rise in Spanish and Italian imports is mainly explained by local factors, not by a reduction of trade barriers:

  • a high consumption growth, +130% and +60% respectively, unlikely to persist
  • ver a long time;
  • a lack of new investment: transitory boom expected, bad forecasts

Source: Eurostat

Destination of non EU Imports

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Is the picture changing? « The recent surge in Chinese imports »

Climate Strategies – IDDRI Meeting 13th September 2007

2 4 6 8 10 12 14 16 18 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Mt of cement VENEZUELA RUSSIA INDIA THAILAND EGYPT TURKEY CHINE CROATIA OTHERS 2 4 6 8 10 12 14 16 18 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Mt of cement VENEZUELA RUSSIA INDIA THAILAND EGYPT TURKEY CHINE CROATIA OTHERS

Source: Eurostat

Chinese imports do not add themselves to the other sources of imports. Chinese cement is mainly substituting for Turkish and Egyptian cement. Non EU imports keep increasing at the same pace, driven by continued Spanish and Italian consumption growth.

Origin of non EU Imports

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Presentation of results from Climate Strategies study

The Differentiation and Dynamics of EU ETS Competitiveness impacts

Convened by:

Supporting m aterial: Structure and trade trends in the EU Steel sector

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Part 1

1 – General trends in the absence of the EU ETS

B – The EU Steel sector

Climate Strategies – IDDRI Meeting 13th September 2007

Long products ~ Electric Arc Furnace EAF Flat products ~ Basic Oxygen Furnace BOF ~50% ~50%

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Despite important operating cost differences across countries, EU market share is high

Climate Strategies – IDDRI Meeting 13th September 2007

10 20 30 40 1999 2000 2001 2002 2003 2004 2005 2006 Mt

Flat products: Long products: Import ratio Import ratio 14% 24% 10% 14% EU Imports from outside the EU

Source: Eurostat

Moreover, the EU net exports (exports – imports) are positive.

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High international pressure on EU prices?

Climate Strategies – IDDRI Meeting 13th September 2007

100 200 300 400 500 600 700 800 janv-00 janv-01 janv-02 janv-03 janv-04 janv-05 janv-06 janv-07 USD/T EU CHINA CIS LAM TURKEY

Export prices for Hot Rolled Coil

Source: Datastream

EU prices are mainly determined by the prices abroad? If this were true: the EU price menus the price abroad should be roughly constant

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Moderate international pressure on EU prices

Climate Strategies – IDDRI Meeting 13th September 2007

  • 150
  • 100
  • 50

50 100 150 200 janv-00 janv-01 janv-02 janv-03 janv-04 janv-05 janv-06 janv-07 USD/T EU-CHINA EU-CIS EU-LAM EU-TURKEY

EU export price menus RoW export prices for HRC

Source: Datastream

An econometric study on the EU Basic Metals sector, led by Gerald and Scott (2007), concludes that: The international price has a strong influence on the EU

  • price. The influence of the

domestic cost is similarly strong.

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A world market fragmented? Confirmation by trade data

Climate Strategies – IDDRI Meeting 13th September 2007

The world market appears fragmented into regional markets partially interconnected through price.

20 40 60 80 100 120 140 160 180 EUROPE EUROPE AMERICA AMERICA ASIA ASIA Export to Import from Export to Import from Export to Import from MT Others ASIA AMERICA EUROPE

Steel trade across Regions

Source: IISI (2007)

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Trade barriers

Climate Strategies – IDDRI Meeting 13th September 2007

International Pressure on EU market

Difference in operating costs between the EU and the RoW

Transport Consumption / Capacity Import restriction Cost of instability Product differentiation Service differentiation

Trade Barriers

Import and export tariffs, standards Proximity with consumers, different stages of tech developments… Just in time delivery, technical assistance… Balance on the markets abroad (& domestic)

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Future Challenges

Climate Strategies – IDDRI Meeting 13th September 2007

  • 1. Does the 2006 surge in imports signal the start of a continuous decline of

trade barriers? Further analysis would be required as part of this rise may be attributed to:

  • The apparition of (transitory) excess capacities abroad, notably in China.
  • The EU rise in consumption (+10% between 2005 and 2006), especially in Italy.
  • 2. Internationalisation of firms: better ability of taking advantage of cost

differences Relocation?

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Relocation

Climate Strategies – IDDRI Meeting 13th September 2007

Nowadays most of steel plants are built to supply the local markets. The sustainability of this situation is not guaranteed for BOF semis: high cost differences across countries, relatively low product differentiation. What scale of relocation for BF semis? Controversial. Relocation barriers:

  • Social viscosity, sunk costs and current boom slow down process;
  • Semis are differentiated products;
  • Countries are reluctant to host export plants;
  • The production chain is made sensitive to risks.
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Part 2

2 – Impact of the EU ETS

A – Impact on production costs

Climate Strategies – IDDRI Meeting 13th September 2007

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Part 2

Climate Strategies – IDDRI Meeting 13th September 2007

What is the pass through ability of the EU cement and steel sectors?

2 – Impact of the EU ETS

B – Insights from economics literature on the pass through

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The determinants of pass through

Climate Strategies – IDDRI Meeting 13th September 2007

EU production level EU capacity Marginal production cost Demand to EU producers Cost increase Price increase EU production level EU capacity Marginal production cost Demand to EU producers Cost increase Price increase

Pass through under perfect competition

The steeper the EU marginal cost curve, the lower the pass through The steeper the demand to EU producers, the higher the pass through. Trade barriers make this curve steep. Effect of market power

  • EU market power reduces the pass through? True under some particular

assumptions on the demand curve (not too convex).

  • RoW market power increases the EU pass through: exporters have interest

in not flooding the EU market to benefit from higher margins.

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Exogeneous & endogeneous pass through in applied models

Climate Strategies – IDDRI Meeting 13th September 2007

Study Sector PT Main assum ptions Szabo et al. (2006) – IPTS Hidalgo et al. (2003) – IPTS Cement Steel 100% 100% ? ? Smale et al. (2006) Cement Steel ~ 80% 65% Market power linear demand Demailly and Quirion (2006) Cement ~ 75% Market power linear demand, capacity constraint, transport costs. McKinsey and Ecofys (2006) Cement BOF Steel EAF Steel 0-15% 6% 66% ? ? ? Mathiesen and Maestad (2004) BOF Steel EAF Steel 60% 80% Capacity constraint, transport costs and product differentiation Reinaud (2004) Cement Steel 0 - 100% 0 - 100% ? NB: Average cost pricing ? NB: Average cost pricing Manne and Mathiesen (1994) Aluminium 40% Singificant despite perfect substitution and because

  • f capacity constraint abroad
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Empirical literature (1)

Climate Strategies – IDDRI Meeting 13th September 2007

Walker (2006) assesses the pass through of the EU ETS opportunity cost during 2005: it varies between 10 and 40%. However, difficult to disentangle between;

  • The role of the international pressure and
  • What reduces the opportunity cost (updating, notion of opportunity cost)

Gerald and Scott (2007) Non-Metallic Minerals: The World price is "nowhere significant in explaining movements in the [EU] prices”. Conversely, EU "domestic costs significantly determine a substantial portion of these (…) prices". Basic Metals sector. The world price has a strong and significant influence on EU prices. The influence of domestic costs is similar. The European price is a more important determinant: “This indicates that environmental tax (…) applied across the EU would limit the effect on competitiveness”.

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Empirical literature (2)

Climate Strategies – IDDRI Meeting 13th September 2007

Literature on Exchange Rate Pass Through This estimates the pass through of exporters into their prices for foreign consumers, following a shock on exchange rates. This shock is asymmetric and incurred by few producers, as exporters generally have low market shares on foreign markets. However, values for relative pass through are not negligible: For cement: 20% in Gaulier et al. (2006), 40% in Knetter (1993) For steel: 40% in Gaulier et al. (2006), 50% in Athukorala and Menon (1994) The literature gives support to the assumption of significant pass through in both sectors: high pass through in the cement sector, intermediate for the steel sector.

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Part 2

Climate Strategies – IDDRI Meeting 13th September 2007

What would be the impact on the two dimensions of competitiveness?

2 – Impact of the EU ETS

C – Short run impacts: Insights from a simple modelling framework

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Modelling assumptions

Climate Strategies – IDDRI Meeting 13th September 2007

  • Time Horizon: 2015
  • Geographical aggregation : EU 27
  • Products: BOF steel products are aggregated. Cement products are aggregated.
  • Electricty cost increase: 80% pass-through in the electricity sector
  • Abatement cost: Marginal Abatement Cost Curve from PRIMES
  • Demand drop: depends on the demand elasticity (ε)
  • Price increase: depends on the Pass Through
  • Market share loss: depends on a trade elasticity (σ), called the Armington

elasticity. KEY PARAMETERS FOR COMPETITIVENESS

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The Armington specification

Climate Strategies – IDDRI Meeting 13th September 2007

20 40 60 80 100 120 140 160 0,50 0,75 1,00 1,25 1,50 1,75 2,00 EU Price / RoW Price Mt of BOF steel

EU Demand to EU Producers EU Demand to RoW Producers σ =5 σ =0.5 σ =2.75 σ =2.75 σ =5 σ =0.5

20 40 60 80 100 120 140 160 0,50 0,75 1,00 1,25 1,50 1,75 2,00 EU Price / RoW Price Mt of BOF steel

EU Demand to EU Producers EU Demand to RoW Producers σ =5 σ =0.5 σ =2.75 σ =2.75 σ =5 σ =0.5

50 100 150 200 250 300 0,50 0,75 1,00 1,25 1,50 1,75 2,00 EU Price / RoW Price Mt of cement

EU Demand to EU Producers EU Demand to RoW Producers σ =2.8 σ =1.6 σ =1.6 σ =0.4 σ =2.8 σ =0.4

50 100 150 200 250 300 0,50 0,75 1,00 1,25 1,50 1,75 2,00 EU Price / RoW Price Mt of cement

EU Demand to EU Producers EU Demand to RoW Producers σ =2.8 σ =1.6 σ =1.6 σ =0.4 σ =2.8 σ =0.4

50 100 150 200 250 300 0,50 0,75 1,00 1,25 1,50 1,75 2,00 EU Price / RoW Price Mt of cement

EU Demand to EU Producers EU Demand to RoW Producers σ =2.8 σ =1.6 σ =1.6 σ =0.4 σ =2.8 σ =0.4

Armington specification based on the assumption that products are differentiated according to their place of production debatable for cement. However, in practice, the value of the Armington elasticity reflects all the trade barriers between different countries. It is econometrically tested.

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Scenarios

Climate Strategies – IDDRI Meeting 13th September 2007

Three scenarios for the international pressure :

  • Zero pass through scenario.
  • Complete pass through scenario. The value of the Armington elasticity is

the highest found in the literature. They are built to lead to the highest profit margin or market share losses

  • Central or Half pass through scenario: The value of the Armington elasticity

is the mean of the range of estimates we found in the literature. We assume that the RoW price remains constant The three previous scenarios are crossed with the three scenarios on the allocation methodologies and with the three CO2 prices.

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Impact on the import ratio

Climate Strategies – IDDRI Meeting 13th September 2007

CO2 price (€/t) 15 30 45 Non EU Import ratio (%) Zero PT Scenario Half PT Scenario Complete PT Scenario 15 30 45 15 30 45

Auction or Free Eco Free Ind

10 15 20 27 BAU=8 25 CO2 price (€/t) 15 30 45 Non EU Import ratio (%) Zero PT Scenario Half PT Scenario Complete PT Scenario 15 30 45 15 30 45

Auction or Free Eco Free Ind Auction or Free Eco Free Ind

10 15 20 27 BAU=8 25 CO2 price (€/t) 15 30 45 25 30 BOF products – Non EU Import ratio (%) BAU=20 Zero PT Scenario Half PT Scenario Complete PT Scenario 15 30 45 15 30 45

Auction or Free Eco Free Ind

All steel products – Non EU Import ratio (%) BAU=17 20 23 CO2 price (€/t) 15 30 45 25 30 BOF products – Non EU Import ratio (%) BAU=20 Zero PT Scenario Half PT Scenario Complete PT Scenario 15 30 45 15 30 45

Auction or Free Eco Free Ind Auction or Free Eco Free Ind

All steel products – Non EU Import ratio (%) BAU=17 20 23

  • High impacts if one assumes a high CO2 price, a high pass through, a high

Armington elasticity, Free Eco or AU and that the RoW price remains constant.

  • If not, and especially if one assumes that Free Ind dominates, the impact remains

modest. CEMENT BOF STEEL

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Impact on the EBIT Margin

Climate Strategies – IDDRI Meeting 13th September 2007

CO2 price (€/t) 15 30 45

  • 20

20 40 80 EBIT Margin (%)

  • 40

Zero PT Scenario Half PT Scenario Complete PT Scenario 15 30 45 15 30 45 60 BAU

Free Eco Free Ind Auction

CO2 price (€/t) 15 30 45

  • 20

20 40 80 EBIT Margin (%)

  • 40

Zero PT Scenario Half PT Scenario Complete PT Scenario 15 30 45 15 30 45 60 BAU

Free Eco Free Ind Auction

² CO2 price (€/t) 15 30 45 20 BOF products – EBIT Margin (%) Zero PT Scenario Half PT Scenario Complete PT Scenario 15 30 45 15 30 45 30 10 BAU

Free Eco Free Ind Auction

All steel products – EBIT Margin (%) 12 18 6 24 ² CO2 price (€/t) 15 30 45 20 BOF products – EBIT Margin (%) Zero PT Scenario Half PT Scenario Complete PT Scenario 15 30 45 15 30 45 30 10 BAU

Free Eco Free Ind Auction

All steel products – EBIT Margin (%) 12 18 6 24

  • The impact is huge and positive with a significant pass through if Free Eco

dominates; huge and negative under massive auctioning if pass through is not high.

  • Under Free Ind, the impacts remain modest. It is not true anymore for the cement

sector if we assume low pass through. CEMENT BOF STEEL

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Part 2

Climate Strategies – IDDRI Meeting 13th September 2007

2 – Impact of the EU ETS

D – Long run impacts

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Long Run: the relocation issue

Climate Strategies – IDDRI Meeting 13th September 2007

Relocation is a concern given the importance of transnational firms. However, two elements soften this fear.

  • Closure Rule and the New Entrant Reserve: the emission cost is limited to the

value of the allowances that have to be bought (if any).

  • Importance of investment costs vs uncertainty on the benefice of relocating

because of the EU ETS: Uncertainties on the allocation methodology, the CO2 price, hence on the cost impact of ETS. The ETS might collapse or some sectors opt out. The asymmetry of the constraint may be reduced by the spread of the carbon constraint worldwide, the implementation of Border Tax Adjustments

  • r Carbon Export taxes in non EU countries.
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Part 2

Climate Strategies – IDDRI Meeting 13th September 2007

2 – Impact of the EU ETS

E – Tipping points?

Is there a CO2 price above which imports or relocation become massive, the pass through ability drops to zero, EU firms stop producing…

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Tipping points

Climate Strategies – IDDRI Meeting 13th September 2007

The impact of the ETS on production costs depends on the plant considered (technology, energy mix, product…) The trade barriers smooth the competitiveness impacts. For example:

  • Product and service differentiation. The aggregation of personal

preferences tends to make the switch from local products to imports smooth.

  • Transportation costs depend on the geographical location of the exporters’

plant and of the targeted EU consumer. Balance between capacity and consumption in the RoW. The size of this barrier depends on the exporting country considered, and varies a lot through time. Market power of exporters tends to smooth the impacts (no interest in flooding the market). This suggests that tipping points can only be identified if we make very simplifying assumptions.

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Conclusions General trends in the absence of EU ETS

Climate Strategies – IDDRI Meeting 13th September 2007

Currently, the international pressure on the EU cement sector is generally low and moderate on the steel sector. In both sectors, we have identified the trade and outsourcing barriers which explain this situation. “The picture is changing”. This statement requires further support. Given the importance of transnational firms in these sectors, one may fear a partial relocation of the EU production

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Conclusion Impact of the EU ETS on costs

Climate Strategies – IDDRI Meeting 13th September 2007

If one assumes full auctioning of allowances or pure grandfathering, the impact

  • f the EU ETS on productions costs is high for BOF steel and very high for

cement. However, this highly depends on the allocation methodology and the behaviour of manufacturers vis-à-vis the opportunity cost of free allowances. From the economics literature there are grounds for expecting a high pass through ability in the cement sector, an intermediate in the steel sector.

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Conclusion Competitiveness impacts

Climate Strategies – IDDRI Meeting 13th September 2007

We use a simple short term model based on econometric estimates of the trade sensitivity. Short term market share or profit margin losses may be very high under unlikely sets of assumptions. In the long run, one may fear a significant relocation. However: the current methodology of allocation reduces the emission cost for investment decisions. to relocate because of the EU ETS is hazardous given the high uncertainty on the future cost impact of the ETS and the permanence of its asymmetry. Preferably, these conclusions should be “disaggregated”.

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References

Climate Strategies – IDDRI Meeting 13th September 2007

  • Demailly, D., Quirion, P., 2006. CO2 abatement, competitiveness and leakage in the European cement industry under the EU ETS:

grandfathering versus output-based allocation. Climate Policy 6, 93-113.

  • Gerald, J.F., Scott, S., 2007. The market structure and sector vulnerability. Working paper for the COMETR Research Project.

http://www2.dmu.dk/cometr/

  • IISI [International Iron and Steel Institute], 2007. World Steel in Figures. http://www.worldsteel.org
  • Kettner C., Köppl A., Schleicher S., Thenius G., 2007. Stringency and Distribution in the EU Emissions Trading Scheme – The 2005 Evidence.

WIFO, Vienna, February

  • Manne, A.S., Mathiesen, L., 1994. The Impact of Unilateral OECD Carbon Taxes on the Location of Aluminium Smelting. International Journal of

Global Energy Issues, 6, 52-61.

  • McKinsey & Ecofys, 2006. EU ETS review. Report on International Competitiveness. European Commission, DG environment.
  • Reinaud, J., 2004. Industrial Competitiveness under the European Union Emission Trading Scheme, IEA Information Paper.
  • Smale, R., Hartley, M., Hepburn, C., Ward, J., Grubb, M., 2006. The impact of CO2 emissions trading on firm profits and market prices. Climate

Policy 6(1), 31–48.

  • Szabo, L., Hidalgo, I., Ciscar, J.C, Soria, A., 2006. CO2 emission trading within the UE and Annex B countries: the cement industry case. Energy

Policy , 34(1), pp. 72-87

  • Walker N., 2006. Concrete Evidence? An Empirical Approach to Quantify the Impact of EU Emissions Trading on Cement Industry
  • Competitiveness. School of Geography, Planning and Environmental Policy, University College Dublin. Working Paper.
  • Watson, C., Newman, J., Upton, R.H.T., Hackmann, P., 2005. Can Transnational Agreements Help Reduce GHG Emissions? Round Table on

Sustainable Development, OECD, Paris.