Carbon Leakage

Carbon leakage occurs when climate policy in one jurisdiction reduces emissions there but, as a consequence, causes emissions to increase elsewhere, partly offsetting the global benefit. It is therefore a cross-border displacement of emissions, rather than simply a decline in production or emissions within the regulating jurisdiction.

How carbon leakage occurs

Leakage principally arises through changes in production, trade and energy markets.

• Under the competitiveness channel, carbon costs can disadvantage emissions-intensive, trade-exposed industries, causing imports, foreign production or investment to increase in jurisdictions with weaker constraints.
• Under the energy-market channel, lower fossil-fuel demand in regulated economies may reduce international fuel prices and encourage greater consumption elsewhere.
• A relocation of production counts as leakage only when it is caused by the climate policy relative to a plausible counterfactual without that policy.

Why it matters and how it is assessed

Carbon leakage can weaken the environmental effectiveness and domestic political acceptability of climate policy, although it does not necessarily eliminate the policy's net emissions reduction.

• The leakage rate compares the policy-induced increase in emissions outside the regulated area with the emissions reduction achieved inside it.
• Measurement is difficult because it requires estimating embedded emissions, international market responses and what emissions would otherwise have occurred.
• Leakage concerns are greatest for emissions-intensive industries that face substantial international competition.

Policy responses and international concerns

Governments may use free allowance allocation, targeted support or output-based measures to reduce relocation pressures, but such measures can dilute carbon-price incentives. A carbon border adjustment seeks to place an equivalent carbon cost on covered imports according to their embedded emissions.

• International coordination on carbon pricing, common standards, sectoral arrangements, technology and climate finance can address the regulatory differences that generate leakage.
• Border measures require credible emissions measurement and careful design to avoid arbitrary discrimination or disguised trade restrictions, consistent with Article 3.5 of the UNFCCC.
• Developing countries also assess such measures through equity and common but differentiated responsibilities and respective capabilities, recognised in Article 3.1 of the UNFCCC.