Carbon leakage scrutiny in ETS and non-ETS industrial sectors in China

Carbon leakage is one of the most critical environmental issues considered in China during the process of enacting mitigation policies. This study analyzes potential carbon leakage risk within and outside an emissions trading scheme (ETS). Results show that within ETS, six and eight four-digit subsectors are considered at risk of carbon leakage under a regulated and liberalized electricity market, respectively. Accordingly, the appropriate proportion of free allowances required for compensation varies between 15.8% and 17.0%. For non-ETS subsectors, four scenarios are designed for in-depth analysis. The results show that carbon leakage occurs in most scenarios. With carbon tax and a regulated market, the risk that carbon leakage will most likely occur in non-ETS sectors in China are insignificant if the average auctioning factor of ETS is lower than 60%. This result suggests that carbon leakage in non-ETS sectors is an insignificant concern in the near term. However, it can be serious if the auctioning factor increases or if the electricity market is liberalized in the future. Meanwhile, the sensitivity analysis implies that ETS expansion will help prevent non-ETS sectors from carbon leakage risk and will make the implementation of the auction mechanism for allocating initial allowances attractive and acceptable. Therefore, this study highlights that the design of carbon tax and its complementary measures should be regarded seriously to assure synergy, particularly with the process of the electricity market.