Critical review of recent report on cost pass-through and carbon leakage
In a report by CE Delft and Öko-institute (December 2015), significant cost pass-through rates were estimated for a number of sectors, including fertilisers. This was interpreted to suggest that the EU industry was not at risk of carbon leakage, as they could pass through increased ETS costs to consumers.
Combining our knowledge of econometric modelling and the economics of the fertiliser industry, we argued that the results in the report were counter-intuitive and contrary to basic economic understanding. We argue that the counter-intuitive results are driven both by errors in the econometric methodology as well as limited understanding of the economics of fertiliser industry
The main conclusions of our study are
- The estimated price elasticities from the econometric model and the resulting calculated pass through rates are inconsistent with the basic economics of the fertiliser industry, by suggesting that producers pass through ETS costs significantly, but do not pass through natural gas costs. Indeed the opposite should be true as the ETS cost only affects EU producers, while the natural gas price also to some extent affects non-EU producers.
- The estimated results are not robust to conservative sensitivity analyses. By making two plausible sensitivity analyses, the calculated cost pass through rate of urea ammonium nitrate, for example, goes from almost 400 per cent to above 1,000 per cent, highlighting the enormous uncertainty of the results.
- The authors seem to interpret their estimation results as long run relationships, while the econometric results imply that they are in fact to be interpreted as short run dynamics. This means that the estimations are capturing week-to-week variation instead of the relevant underlying adjustments in the price of fertilisers due to changing production costs
- The estimated cost pass through rates are inconsistent with basic economics such as the expected negative relationship between trade intensity of a given product and the cost pass-through rates. Moreover, the authors have not been able to reproduce some of the other expected relationships between cost pass-through and e.g. EU market shares, market concentration and transportation costs.
The study was commissioned by Fertilizers Europe Download