What is carbon leakage?

Quick Answer: Carbon leakage occurs when climate policies in one country or region cause greenhouse gas emissions to shift to another with weaker regulations, rather than reducing global emissions overall. It is a recognised risk in carbon pricing and emissions trading schemes, where businesses relocate production or source from less-regulated suppliers to avoid carbon costs. Carbon leakage undermines the environmental effectiveness of climate policy by displacing emissions rather than eliminating them.

What is carbon leakage?

Carbon leakage is the increase in greenhouse gas emissions in one jurisdiction that results, directly or indirectly, from climate policy measures implemented in another. The term comes from the idea that emissions "leak" across borders when regulations create an uneven playing field between regions.

The most straightforward example: a manufacturer in a country with a carbon price finds it cheaper to import goods from a country without one, rather than reducing its own emissions. The global carbon total stays the same or increases, but the regulated country appears to have cut its footprint. The emissions have moved, not disappeared.

This is distinct from a genuine reduction in emissions. Carbon leakage produces statistical progress in one place while creating real-world harm elsewhere.

Why does carbon leakage happen?

Carbon leakage typically occurs through two mechanisms: competitiveness effects and fossil fuel market effects.

Competitiveness effects arise when carbon pricing raises production costs in regulated regions. Energy-intensive industries, including steel, cement, aluminium, and chemicals, become less competitive against imports from countries without equivalent carbon costs. Production shifts to those countries, and with it, the associated emissions.

Fossil fuel market effects work differently. When climate policy reduces demand for fossil fuels in one region, global prices for those fuels can fall. Lower prices increase consumption elsewhere, partially offsetting the original reduction. This channel is harder to observe directly but is significant in modelling long-term policy outcomes.

A third, less-discussed driver is supply chain restructuring. Companies that want to avoid carbon costs may not relocate their own operations but instead switch to suppliers in less-regulated markets. The emissions appear in the supply chain rather than in the company's direct operations, which makes them harder to track and attribute.

What is the carbon leakage rate, and how is it measured?

The carbon leakage rate is the percentage of domestic emissions reductions that are offset by emissions increases abroad. A leakage rate of 50% means that for every tonne of CO2 reduced domestically, half a tonne is added elsewhere. A rate above 100% would mean climate policy causes a net increase in global emissions, though this is considered unlikely in practice.

Estimates vary considerably depending on the sector, the policy design, and the modelling approach used. The European Commission has historically used leakage rates of between 5% and 30% for different industrial sectors when assessing EU Emissions Trading System (EU ETS) risk. Some academic models produce higher estimates for specific sectors under specific conditions.

Measuring leakage accurately is difficult because it requires separating the effect of climate policy from other factors that influence trade and investment decisions, including energy costs, labour costs, exchange rates, and broader economic conditions.

How do policymakers respond to carbon leakage risk?

Several policy mechanisms exist to reduce the risk of carbon leakage, with varying degrees of effectiveness.

Free allocation of carbon allowances is the most widely used approach. Under the EU ETS, industries deemed at high risk of carbon leakage receive a portion of their emission allowances for free, rather than having to buy them at auction. This reduces the cost burden and makes relocation less attractive. The trade-off is that it weakens the price signal that is supposed to drive emissions reduction.

Carbon border adjustment mechanisms (CBAMs) are a more direct response. The EU's Carbon Border Adjustment Mechanism, which began its transitional phase in October 2023, applies a carbon price to imports of certain goods, including steel, cement, aluminium, fertilisers, electricity, and hydrogen, based on the embedded emissions in those products. The logic is straightforward: if a domestic producer pays for carbon, an importer should too. This levels the playing field without exempting domestic industry from the carbon price.

Sector-specific agreements and international coordination represent a longer-term solution. If more countries adopt comparable carbon pricing, the incentive to relocate production diminishes. Progress here has been slow, but the expansion of carbon markets globally, including in China, South Korea, and Canada, reduces the scale of the leakage risk over time.

Why does carbon leakage matter for companies measuring their footprint?

For companies carrying out carbon accounting, carbon leakage is relevant in two ways.

First, it affects how you interpret your own Scope 3 emissions. If your suppliers are based in countries with weaker climate regulations, part of your supply chain footprint may reflect production that shifted there specifically to avoid carbon costs elsewhere. This does not change how you measure or report those emissions, but it does affect how you interpret the real-world impact of your supply chain choices.

Second, carbon leakage is one reason why regulators and frameworks increasingly require full-scope reporting across Scopes 1, 2, and 3, rather than just direct emissions. A company that only reports Scope 1 and 2 can appear to reduce its footprint by outsourcing high-emission activities, which is a form of leakage at the company level. The GHG Protocol's Scope 3 standard exists, in part, to make this kind of displacement visible.

Seedling builds Scope 3 measurement into its standard process, which means companies get a complete picture of their emissions rather than one that only captures what happens on-site. That matters when stakeholders, customers, or regulators want to know whether reported reductions reflect genuine progress or a shift in where emissions occur.

What is the difference between carbon leakage and greenwashing?

Carbon leakage and greenwashing are related but distinct concepts. Carbon leakage is primarily a policy problem: it describes what happens when climate regulations in one place displace emissions to another. It can occur even when companies and governments are acting in good faith within the rules they operate under.

Greenwashing involves misrepresenting the environmental credentials of a product, company, or policy, whether deliberately or through poor methodology. A company that claims to have reduced its carbon footprint by switching to a supplier with lower reported emissions, without verifying those figures or accounting for the full supply chain, may be greenwashing even if no formal carbon price is involved.

The practical overlap is this: incomplete carbon accounting creates the conditions for both. When companies only measure part of their footprint, genuine emissions reductions become indistinguishable from displacement. Rigorous, full-scope measurement is the baseline requirement for telling the difference.

As carbon border adjustments become more common and supply chain due diligence requirements tighten, companies that understand where their emissions actually occur, rather than where they appear on paper, will be better positioned to respond to regulatory and commercial pressure.