Compensation for indirect carbon costs. Impacts on electricity efficiency, production and emissions

The EU Emissions Trading System (EU ETS) leads to higher electricity prices and thus higher costs for electricity-intensive industries in the EU, reducing their competitiveness compared to those in non EU countries. This disparity may result in carbon leakage, where production shifts abroad, potentially increasing global emissions. To mitigate this, the EU introduced a compensation scheme in 2012, allowing member states to compensate affected industries for the higher electricity prices. This paper explores analytically and numerically the effects of this compensation scheme on production, electricity efficiency, and emissions. We find that while the EU ETS price signal reduces production and increases electricity efficiency, the compensation scheme can counteract these effects by boosting production and potentially reducing electricity efficiency. Additionally, conditional decarbonization or energy efficiency efforts may lead to socially inefficient investments and could have undesired impacts on electricity efficiency. These findings highlight the complex trade-offs in designing effective climate policies that balance environmental goals with industrial competitiveness.