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Oregon Sectoral Competitiveness Under Carbon Pricing Oregon Sectoral Competitiveness under Carbon Pricing Prepared for the Oregon Carbon Policy Office Final Report December 2018 Oregon Sectoral Competitiveness under Carbon Pricing 2 Contents Executive Summary ................................................................................ 3 1 Introduction .................................................................................. 15 2 Cap-and-Trade Context .................................................................. 17 3 Carbon Leakage Theory and Evidence ............................................. 21 4 Methodology and Results .............................................................. 31 5 Policy Options and Benchmarking .................................................. 63 6 Conclusions and Recommendations ............................................... 81 References............................................................................................ 85 Appendix 1 – Data Approximation Process ............................................ 92 Appendix 2 – Academic Evidence on Carbon Leakage ............................. 94 Appendix 3 – Sector Analyses ................................................................ 96 Cement ................................................................................................. 97 Chemicals ............................................................................................ 104 Food Manufacturing ........................................................................... 110 Glass ................................................................................................... 118 Iron and Steel, and Foundries ............................................................. 125 Lime and Gypsum ............................................................................... 134 Non-metallic Mineral Mining and Quarrying ..................................... 138 Other Non-metallic Mineral Products................................................. 142 Plastics ................................................................................................ 147 Pulp, Paper, and Paperboard .............................................................. 154 Semiconductors .................................................................................. 162 Wood Products and Sawmills ............................................................. 169 Oregon Sectoral Competitiveness under Carbon Pricing 3 Executive Summary Oregon has a competitive manufacturing and industrial sector, as evidenced from robust employment growth recently. The state is highly diversified with both high-tech and natural resource manufacturing in its top value-adding sectors. Oregon currently has its lowest unemployment rate in decades, in part due to manufacturing employment growth over 2010–17 that was more than double the national average. However, many industrial activities generate greenhouse gas (GHG) emissions and current trajectories suggest that Oregon will not achieve its reduction targets without additional effort. In 2016, Oregon emitted 61.9 million metric tons of carbon dioxide equivalent (MtCO2e ), 20% of which came from industrial activity. The state’s 2007 House Bill 3543 established targets for it to achieve emissions levels 10% below 1990 levels by 2020, and to achieve emissions levels 75% below 1990 levels by 2050. However, these targets will likely be missed if emissions continue at the current trajectory. As a result, the state is considering a cap-and-trade program as part of a strategy to drive cost-effective emissions reductions. In the industrial sector, the proposed cap-and-trade would impose a price on direct emissions from entities with emissions greater than or equal to 25,000 tCO2e per year. This mechanism would directly regulate about 30 manufacturing and mining sector facilities in Oregon whose emissions exceeded this threshold in at least one year over 2014–17. A cap-and-trade drives economic decarbonization by providing price incentives for both producers and consumers to undertake less emissions-intensive activities. It also provides regulated entities the flexibility of a market-based mechanism to determine how to reduce emissions. Moreover, carbon pricing can stimulate innovation and low-carbon investment. However, if the cap-and-trade is not designed to maintain industrial competitiveness, it can also lead to the risk of carbon leakage in covered emissions-intensive and trade-exposed (EITE) sectors. While carbon pricing is spreading globally, differences remain in carbon price levels, both within the US and with international competitors. This leads to divergences in compliance costs for the same industry in different locations, increasing production costs of companies in regulated jurisdictions in the short term. Sectors with high emissions and with few emissions reduction opportunities, and which compete strongly with facilities in non-regulated jurisdictions may, as a result, be at risk of reduced competitiveness. Carbon leakage occurs when this leads to production or investment shifting from jurisdictions with carbon pricing to more emissions-intensive jurisdictions, raising net global emissions. While the evidence is mixed, the risk of associated negative environmental, economic, and socio-political outcomes makes preventing carbon leakage central to any cap-and-trade mechanism design. While ex ante analyses predict carbon leakage impacts in EITE sectors, ex post evaluations have not yet found evidence it has occurred. This is because of low carbon prices and also, importantly, because carbon policy is designed to prevent carbon leakage. In addition, environmental compliance costs tend to be a minor component of production and investment decisions. However, when implementing a carbon price, policymakers have been careful to ensure carbon leakage risk is addressed given it implies an increase in global emissions, in addition to economic activity and employment shifting to external jurisdictions. Oregon Sectoral Competitiveness under Carbon Pricing 4 There are two central elements – carbon cost exposure and cost pass-through capacity – that influence whether an industrial sector is EITE, and thus at risk of carbon leakage. Carbon cost exposure examines the impact that carbon pricing has on a facility or sector. Cost pass-through capacity determines whether the facility or sector can pass through carbon costs to their consumers without significant loss of market share. The EITE identification methodology in this report follows a dual quantitative–qualitative approach to offer a holistic understanding of these two elements. Quantitative analysis provides initial insight into sectors’ carbon cost exposure. Qualitative analysis offers deeper insights on cost pass-through capacity by evaluating competitive dynamics, profitability and emissions reduction opportunities. The low number of facilities in Oregon means that the qualitative analysis is more important to offer a final assessment of leakage risk. Table 1. All potentially covered sectors in Oregon are at risk, or likely at risk, of carbon leakage Number of potentially Carbon leakage risk NAICS 4 code Sector description covered facilities assessment 3221 Pulp, Paper, and Paperboard 5 At risk 3273 Cement and Concrete 1 At risk 3344 Semiconductors 6 At risk 3212 Wood Products 2 At risk 3114 Food Manufacturing 5 At risk 3251 Chemicals 2 Likely at risk 3311 Iron and Steel 2 At risk 3211 Sawmills and Wood Preservation 1 At risk 3261 Plastics 2 Likely at risk 3315 Foundries 1 At risk 3274 Lime and Gypsum 1 Likely at risk 3279 Other Non-metallic Mineral Products 1 At risk 3272 Glass 1 At risk 2123 Non-metallic Mineral Mining and Quarrying 1 At risk Note: NAICS, North American Industrial Classification System Source: Vivid Economics The assessment for Oregon shows that all potentially covered manufacturing and mining sectors are either at risk, or likely at risk, of carbon leakage if the cap-and-trade is not designed to safeguard competitiveness. Table 1 illustrates the high-level findings from the overall leakage risk assessment for all potentially covered Oregon sectors. The distinction between the results of the assessment is: ⎯ At risk: while there are competing factors increasing and decreasing risk, the sector is at risk of carbon leakage on the balance of evidence; ⎯ Likely at risk: while there are competing factors increasing and decreasing risk, the sector is likely at risk of carbon leakage on the balance of evidence. However, a lack of evidence on cost pass-through capacity from one or more sectoral stakeholders prevents a more definitive conclusion. A cap-and-trade program in Oregon should nevertheless cover all EITE sectors, and a program designed to prevent carbon leakage is likely to successfully reduce emissions while also safeguarding competitiveness. Although the analysis finds that all potentially covered manufacturing and mining sectors are EITE, these Oregon Sectoral Competitiveness under Carbon Pricing 5 sectors still have some opportunities to reduce emissions, suggesting a carbon price will drive decarbonization at the margin. Furthermore, as more jurisdictions across the US and the world begin pricing carbon in their industrial sectors, long-run leakage risk to these jurisdictions will decline. In the short term, however, leakage risk will remain, and as such the cap-and-trade should be designed to safeguard industrial competitiveness. Economic theory and evidence from other jurisdictions strongly suggests that the twin objectives
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