compared to the original CDM project the negative leakage effects amount to merely 25%. Thus, we end up with a positive leakage effect of (50-25) % = 25% in this case.

Although equation (III.2.10) in general terms indicates that positive leakage is more likely than negative leakage, one cannot rule out the possibility of negative leakage. This follows from the argument in the previous paragraph: If the positive leakage effects in the local market are small (either due to high supply elasticity or low demand elasticity), and the negative leakage effects in the global market are big, we may end up with a negative overall leakage rate.<sup>22</sup> In the table below we show the leakage rate based on equation (III.2.10) for a CDM project for either the local or the global fossil fuel. As before, in the base case we assume equal elasticities. We also assume equal market sizes and market shares in the base case.<sup>23</sup> As seen from Table 2 below, in the base case the leakage rate is 30% when the CDM project reduces consumption of the local fuel, and 20% when it reduces consumption of the global fuel. Econometric studies on price elasticities vary a lot, and it is difficult to conclude which are higher, demand or supply elasticities. The same ambiguity applies to elasticities in Annex B vs. Non-Annex B, and to elasticities of different fossil fuels. Table 2 shows effects of alternative assumptions, and the degree of leakage rate is found to depend significantly on these assumptions. The same applies to assumptions about market sizes.

**Table 2. Leakage rate with one global and one local fossil fuel**

||_L_<br>_Q_|_G_<br>_Q_|
|---|---|---|
|**Base case**|**30%**|**20%**|
|Annex B elasticities=2*Non-Annex B elasticities|36%|14%|
|Demand elasticities= 2 *Supply elasticities|33%|22%|
|Supply elasticities=2*Demand elasticities|22%|15%|
|Elasticities in global market=2*Elasticities in local market|25%|13%|
|Global market size= 2 *Sumof local market sizes|25%|13%|
|Annex B demand=2*Non-Annex B demand|36%|11%|
|“Oil and coal”<sup>a</sup><br>|31%|11%|
|“Fossilandnon-fossil”<sup>b</sup>|-20%|20%|

a Oil is the global fuel and coal the local fuel. Market shares/sizes are 60/40 and 40/60 for respectively oil and coal demand in Annex B vs. Non-Annex B. Equal elasticities.

b Fossil is global and non-fossil is local with no market response in Non-Annex B.

Source: Own simulations.

In the second-to-last row of Table 2 we assume that oil is the global fuel and coal the local fuel, and have used approximate market shares/sizes from 2007.<sup>24</sup> A CDM project that reduces consumption of the local fuel, coal, here has a leakage rate of 31%. In the last row we have assumed that local demand in Non-Annex B is completely unresponsive to demand. This

> 22 This may be seen from equation (III.2.10) with either a sufficiently high supply elasticity of the local good ( _y_ 2 _L_ ) or sufficiently low demand elasticity of the local good ( _d_ 2 _L_ ). 23 That is, demand in the global market equals combined demand in the two local markets, which themselves are equal in size.

> 24 There is of course trading in coal between Annex B and Non-Annex B countries, but one cannot speak of one global coal market in the same way as for the oil market (mainly because of much higher transport costs relative to the value of the fuel). Still, this scenario should only be considered as illustrative.

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