An economist tracks down carbon leakage

Construction workers' clothes hang by a thermal power plant near New Delhi, India - AP

Few people can be unaware of the arguments for an international agreement on carbon emissions, while even fewer may grasp the complexities this would entail. But that is why officials representing scores of developed and developing nations will huddle in Copenhagen for the next two weeks, attempting to hammer out the foundations of such an accord.

Given the general state of confusion over the role that markets could play in encouraging a global shift to cleaner energy, they face understandable difficulties. But economists are happy to help out in such situations.

To assist the policy makers, Robert Ritz of the Oxford Institute for Energy Studies in the UK has recently put forward an

analysis

of the tricky issue of "carbon leakage", which for the uninitiated is what happens when industries export their emissions to take advantage of uneven environmental regulation.

It is a huge problem that in the worst case could cause global carbon emissions to rise as a consequence of the laws that well-intentioned governments enact to control them. So addressing it is vital.

The institute's analysis is by no means light reading, as it bristles with mathematical formulas. Like all attempts to model the real world with equations, it also makes simplifying assumptions that may or may not be valid. Nonetheless, the approach yields important qualitative insights.

First is the unsettling conclusion that substantial carbon leakage can result from even a small part of an industry escaping regulation.

For the glass-half-full types, however, comes the important corollary that "even relatively small environmental efficiency improvements by regulated firms can reduce leakage rates significantly".

To understand this better, we can look at a real-world example.

In California, the oil firm

BP

produces coke as a byproduct of oil refining. As an efficient business operator, it sells the coke to anyone who wants to burn it as fuel, but as California has strict emissions regulations, most of the buyers are offshore (carbon leakage). Earlier this year, however, BP teamed up with the mining company

Rio Tinto

and the utility

Southern California Edison

in a

project

to transform the coke into hydrogen and carbon dioxide, use the hydrogen for power generation and capture and store the carbon dioxide.

The project is supported by state and federal funding. If it works out (an environmental efficiency improvement), BP will export less coke.

The example is instructive because it illustrates how actions by one or a few jurisdictions can counteract the carbon leakage caused by uneven international regulation.

The Oxford study suggests that unilateral carbon regulation may have a wide range of outcomes, but in many relevant situations could have beneficial effects that are only partially offset by increased emissions from unregulated firms: "Global carbon emissions can indeed be expected to decrease as a consequence of unilateral regulation."

The study also contends that carbon leakage will be higher when outside firms are relatively dirtier and inside firms have fewer profitable opportunities to switch to cleaner production technologies. This again suggests that, in the absence of an international agreement, governments could effectively use incentives programmes to progress towards environmental goals.

The need for government incentives would disappear if the world adopted uniform environmental regulation to produce a level playing field. But in the context of developed and developing nations bickering over the financial responsibility for addressing climate change, this may be too panglossian a dream.