Carbon leakage is a term used to describe the migration of emissions between jurisdictions, resulting in increased greenhouse gas emissions.
To explain carbon leakage further; if a business decides to shut down their production facility in Country A, which has strict regulations, and instead open a new site in Country B which has more lenient climate policy. This decision to move location could have been influenced due to the financial benefit in avoiding penalties such as a carbon tax which only apply in Country A.
Although Country A may see reduced emissions as the company leaves, those emissions have only been displaced and still contribute to global warming. Due to the lack of preventative measures in Country B the company would now be likely to emit more greenhouse gases than if they stayed in Country A. This overall net increase in global emissions is known as carbon leakage.
Guarding against the problem
While tight regulations on greenhouse gas emissions are well intended, these intentions can be compromised if the policy leads to carbon leakage. In recent years emissions in many areas (such as Europe and the United States) have fell, while emissions continue to rise in developing nations. Preventative measures may be taken to try and mitigate the appeal of moving production elsewhere – one example would be a tax on the import of goods from countries with lenient climate policy. However, this has the drawback of impacting competitiveness of international trading.
Risk of Carbon leakage in ETS
Many participants in the UK Emissions Trading Scheme receive free allowances which are designed to reduce risk of carbon leakage; however, this risk becomes greater as the amount of free allowances lessen and the cost of carbon increases. The problem is not rooted only in the cost of carbon within UK ETS, but the lack of consistent pricing across the world. Carbon leakage has become a problem as different countries and jurisdictions look to reduce contribution to climate change at varying rates. Ultimately, a consistency of targets to reduce emissions and similar penalties across the globe will negate any possibility of carbon leakage in future.
The UK Government has acknowledged the increased risk of carbon leakage as the UK transitions to net zero emissions and the need to guard against the UK’s decarbonisation policy being undermined.
Further to the Developing the UK Emissions Trading Scheme consultation released March 2022, the Treasury have recently announced plans to release a further consultation later this year specifically on domestic carbon leakage mitigations.
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Swan Energy has been involved with the UK ETS (formerly EU ETS) since its conception. Find out more about the UK ETS support and consultancy service we offer.