Carbon leakage occurs in any carbon pricing regime that is not global, which means all of them so far. That is inherently unfair to sectors that are subject to a carbon price but compete with those that are not. The European Green Deal aims to rectify the problem in the EU Emissions Trading Scheme (ETS) by moving beyond the current second (or third) best option, which allocates emissions quotas for free for industrial sectors, and putting a price on carbon at the EU border for selected but not yet named sectors.
Our model-based analysis concludes that expanding the EU ETS is a more effective policy option because it would reduce emissions, while a carbon border adjustment would not. We compared these two options for the power sectors in the West Balkan countries as well as Ukraine, Belarus, Moldova and Turkey, and assessed the emissions, cost and policy implications. The two policy options have markedly different impacts on carbon dioxide emissions.
Counterintuitively, our analysis shows that the border carbon adjustment increases overall carbon emissions. Emissions increase in the EU as additional coal-fired and gas-fired generation comes online to substitute for the fenced-off imported generation. This increase exceeds the emissions reductions in the exporting countries, where gas power plants reduce their production to make room for coal generation that is no longer imported to the EU.
A larger EU ETS, however, would reduce emissions by 52,000 kt in 2030 compared with business as usual, an amount slightly less than the annual emissions of Polish coal plants. Expanding the ETS reshuffles the merit order (i.e., the order in which power plants are called on to meet demand) by driving up the cost of dirty coal and lignite plants in the West Balkans, Turkey and Ukraine and crowding those plants out.