Asymmetric environmental regulation, interfuel substitution and carbon leakage

This paper examines how plants adjust their production in response to asymmetric carbon pricing. When plants compete across areas, asymmetric regulation can lead to carbon leakage, shifting emissions from regulated to unregulated areas. I build a production model with multiple fuel inputs, imperfect competition, and region-specific carbon taxes. Using publicly available Canadian plant-level data on a wide range of air pollutants, I invert the chemical reactions from combustion to back out plants’ fuel usage. I then estimate the model by exploiting variation in the British Columbia (B.C.) and Quebec carbon taxes, which were implemented in 2008 and 2007, respectively. Findings indicate substantial emissions reductions in British Columbia, with 95 % confidence intervals ranging from 7 % to 48 %, and no reduction in Quebec. Contrary to theoretical predictions of carbon leakage, the analysis reveals no statistically significant shift in production toward unregulated provinces. A detailed decomposition reveals that the absence of leakage was primarily due to the regulated plants’ ability to absorb the tax by switching from oil to natural gas and by reallocating output from dirtier to cleaner plants within British Columbia.