An Empirical Approach to Quantify the Impact of EU Emissions Trading on Cement Industry Competitiveness

A number of previous studies have considered the effect of the EU Emissions Trading Scheme (EU ETS) on the competitiveness of energy-intensive industrial sectors. These studies typically make theoretical predictions about product pricing, and of the profitability of European firms whose CO 2 emissions are capped, or firms which are intensive electricity users. This paper adds to the literature by empirically testing specific predictions which have been made about one sector covered by EU ETS, namely the manufacture of Portland Cement. The paper considers a variety of models that have been used to predict the economic effects of EU ETS. It then describes various oligopoly competition models in which firms are assumed to be short-term profit-maximisers, which can be used to make predictions about the expected impact of marginal costs on product prices. It examines in detail the specific predictions made one such model about the impact of EU ETS on UK product prices. It also reviews the methodology and results of a recent empirical study in the European electricity sector which appears to support these predictions. Finally, it analyses and interprets cement cost and price data, from a variety of sources, for seven European countries covering the period 1995–2005, and part of 2006. This includes the first year of operation of the Pilot EU Emissions Trading Scheme, when (for the first time) European cement producers faced a quantifiable opportunity cost for CO 2 emissions. The results confirm that average cement prices (with the exception of one country for which there is evidence of a collapse in collusive behaviour) were stable and remained well above the marginal production cost. However, although the average price levels were broadly consistent with competition models based on Cournot theory, the observed pass-through of incremental CO 2 costs into cement prices during 2005 was substantially lower than predicted by such models. It was also lower than the rate of CO 2 cost pass-through empirically measured in the European electricity sector during the same period. The implication is that cement producers (in contrast to fossil fuel electricity generators in the power sector) did not earn significant windfall profits from EU ETS during 2005. Two possible interpretations of this observation are: • that cement producers might be constrained from raising product prices by the threat of competition from outside the EU, and hence a longer term loss of market share and profits, with the possibility of a …