Carbon Leakage: The Impact of Asymmetric Emission Regulation on Technology and Capacity Investments

33 Pages Posted: 29 Nov 2015 Last revised: 20 Jul 2018

See all articles by Kristel Hoen

Kristel Hoen

Quintiq

Ximin (Natalie) Huang

University of Minnesota

Tarkan Tan

Eindhoven University of Technology (TUE) - School of Industrial Engineering

L. Beril Toktay

Georgia Institute of Technology - Sustainability

Date Written: January 17, 2018

Abstract

In the absence of global emission regulation, production cost di erences between regions are typically accentuated due to different emission charges, which may induce producers to shift production to an unregulated (or more loosely regulated) region and result in \carbon leakage." This is an imminent concern for emerging economies that plan for launching emission legislation. We investigate the problem from the perspective of an energy-intensive good producer subject to geographically asymmetric emission legislation and uncertainty in future emission cost. The producer has two ex-ante investment opportunities to mitigate its emission cost: investing in clean production technology in the regulated region and building production capacity in the unregulated region. It determines its production quantities in the two regions ex-post, after emission price uncertainty is resolved. In order to circumvent carbon leakage, regulators might impose policies that burden offshore production or subsidize local production. We study some plausible anti-leakage policies including Border Tax (BT), Output-based Allocation (OB), and Non-tradable Grandfathering (GF). We compare the influences of the anti-leakage policies on producer decisions in both an analytical model and a numerical study based on the cement industry. We show that when offshore production is feasible (i.e., a carbon leakage threat exists), a moderate rather than a high emission price with low volatility helps encourage more technology improvement and suppress o shore production. The BT and the OB policies are both effective in reducing carbon leakage. The e ect of the GF policy significantly depends on the choice of the specific policy parameter, which, if set improperly, may lead to even more severe carbon leakage than in the absence of an anti-leakage policy.

Keywords: Carbon leakage, Anti-leakage policies, Technology choice, Production capacity choice

Suggested Citation

Hoen, Kristel and Huang, Ximin (Natalie) and Tan, Tarkan and Toktay, L. Beril, Carbon Leakage: The Impact of Asymmetric Emission Regulation on Technology and Capacity Investments (January 17, 2018). Georgia Tech Scheller College of Business Research Paper No. 31. Available at SSRN: https://ssrn.com/abstract=2696173 or http://dx.doi.org/10.2139/ssrn.2696173

Kristel Hoen

Quintiq ( email )

Netherlands

Ximin (Natalie) Huang (Contact Author)

University of Minnesota ( email )

19th Avenue South
Minneapolis, MN 55455
United States

Tarkan Tan

Eindhoven University of Technology (TUE) - School of Industrial Engineering ( email )

PO Box 513
Eindhoven, 5600 MB
Netherlands

L. Beril Toktay

Georgia Institute of Technology - Sustainability ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

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