Congress is considering legislation to reduce emissions of greenhouse gases that may, depending on the specifics of the final legislation, affect the competitiveness of energy- or greenhouse gas-intensive industries. Competitiveness can be a rather abstract term for which any precise meaning can be elusive. Competitiveness is a continuing phenomenon, with companies becoming more or less competitive according to a host of factors, including productivity, market demand, resource costs, labor costs, exchange rates, and the like. As stated by the Australian Government in its Green Paper on carbon reduction schemes: Changes in the cost structures of entities and industries are not unusual and occur continuously in a market-based economy; nor is it unusual for Government policy to change cost structures. For example, the adoption of high quality occupational health and safety standards have affected the profitability of Australia's labour-intensive traded industries, making it more difficult for them to compete with foreign producers that are subject to lower standards. Assistance is not usually provided to offset the impact of domestic policies on traded industries, as those policies reflect the priorities and values of the Government and community more generally. Most industries face a competitive market (sometimes international in scope) both in terms of producers of the same products and producers of substitute products. Also, in some cases, an industry may face a fairly elastic demand for its product. Thus, most industries are price sensitive, and therefore any increase in manufacturing costs—as by a carbon emission reduction requirement—hurts the competitiveness of a firm. This complex situation is further complicated for energy-intensive industries as competitors within the same industry may experience different energy price increases (particularly for electric power), depending on their individual energy needs and power arrangements. For example, an aluminum plant receiving power from a hydro-electric facility may not be affected the same way as a similar plant whose power contract is with a coal-fired power supplier. The addition of a carbon control regime to this competitive dynamic has raised concerns that, in the absence of similar policies among competing nations, if the United States adopts a carbon control policy, energy- or greenhouse gas-intensive, trade-exposed industries that must control their emissions or that find their feedstock or energy bills rising because of costs passed-through by suppliers may be less competitive and may lose global market share (and jobs) to competitors in countries lacking comparable carbon policies. In addition, this potential shift in production could result in some of the U.S. carbon reductions being undercut by increased production in less regulated countries; this is commonly known as "carbon leakage." Greenhouse gas reduction legislation introduced over the last two Congresses has included provisions to address carbon leakage and to mitigate the effect of carbon policies on U.S. competitiveness. In general, two strategies have been proposed: (1) providing assistance to greenhouse gas-intensive, trade-exposed industries; and (2) imposing tariffs on certain greenhouse gas-intensive goods imported into the country from countries not implementing comparable carbon policies. Such tariffs are frequently referred to as border measures. H.R. 2454 , as passed by the House, contains both of these strategies. This report examines the dynamics of this issue in three parts. First, the European Union (EU) has been implementing a cap-and-trade program for four years, and has finalized a third reduction phase that will run from 2013 through 2020. This report reviews and analyzes the experience of the EU in addressing its concerns about energy-intensive, trade-exposed industries, and the lessons those efforts may have for the United States. Second, the House-passed American Clean Energy and Security Act of 2009 ( H.R. 2454 ) contains both a free allocation scheme and a border measure among its provisions to address the concerns of energy-intensive, trade-exposed industries. This report reviews and analyzes these provisions. Third, these same provisions could come under scrutiny under various U.S. trade agreements, particularly within the World Trade Organization (WTO). Concerns have been expressed that the border measure contained in H.R. 2454 would be suspect under various provisos of the WTO. This report analyzes the potential WTO implications of any attempt to implement a subsidy or a border measure under H.R. 2454 . The EU's Emissions Trading System (ETS) covers more than 10,000 energy-intensive facilities across the 27 EU Member countries, including oil refineries, powerplants over 20 megawatts (MW) in capacity, coke ovens, and iron and steel plants, along with cement, glass, lime, brick, ceramics, and pulp and paper installations. In addition, aviation is currently being phased into the ETS. These covered entities emit about 40%-45% of the EU's total greenhouse gas emissions, and almost two-thirds of them are combustion installations. The trading program does not cover either carbon dioxide (CO 2 ) emissions from the transportation sector (except aviation), which account for about 25% of the EU's total greenhouse gas emissions, or emissions of non-CO 2 greenhouse gases, which account for about 20% of the EU's total greenhouse gas emissions. A Phase 1 trading period ran between January 1, 2005, and December 31, 2007. A Phase 2 trading period began January 1, 2008, covering the period of the Kyoto Protocol, and a Phase 3 has been finalized to begin in 2013. Under the Kyoto Protocol, the then-existing 15 nations of the EU agreed to reduce their aggregate annual average emissions for 2008-2012 by 8% from the Protocol's baseline level (mostly 1990 levels) under a collective arrangement called a "bubble." In light of the Kyoto Protocol targets, the EU adopted a directive establishing the EU-ETS that entered into force October 13, 2003. One objective of the second phase of the ETS is to achieve 3.3 percentage points of the 8.0% reduction required by the EU-15 under the Protocol. The importance of emissions trading was elevated by the accession of 12 additional central and eastern European countries to EU membership from May 2004 through January 2007. For the new EU-27, the overall ETS emissions cap is set at 2.08 billion metric tons of carbon dioxide (CO 2 ) annually for the Kyoto compliance period (2008-2012). The second phase Kyoto compliance stage of the ETS is built on the experience the EU gained from its preliminary Phase 1. The European Commission (EC) believes that the Phase 1 "learning by doing" exercise prepared the community for the difficult task of achieving the reduction requirements of the Kyoto Protocol. Several positive results from the Phase 1 experience assisted the ETS in making the Phase 2 process run smoothly, at least so far. First, Phase 1 established much of the critical infrastructure necessary for a functional emission market, including emissions monitoring, registries, and inventories. Much of the publicized difficulties the ETS experienced early in the first phase can be traced to inadequate emissions data infrastructure. Phase 1 significantly improved those critical elements in preparation for Phase 2 implementation. Second, the ETS helped jump-start the project-based mechanisms—Clean Development Mechanism (CDM) and Joint Implementation (JI)—created under the Kyoto Protocol. As stated by Ellerman and Buchner: The access to external credits provided by the Linking Directive has had an invigorating effect on the CDM and more generally on CO 2 reduction projects in developing countries, especially in China and India, the two major countries that will eventually have to become part of a global climate regime if there is to be one. Third, according to the EC, a key result of Phase 1 was its effect on corporate behavior. An EC survey of stakeholders indicated that many participants are incorporating the value of allowances in making decisions, particularly in the electric utility sector, where 70% of firms stated they were pricing the value of allowances into their daily operations, and 87% into future marginal pricing decisions. All industries stated that it was a factor in long-term decision-making. Figure 1 below indicates the cost sensitivity of various manufacturing activities in the United Kingdom as determined by Climate Strategies. Cost sensitivity is measured as the percentage of the activity's current gross value added at stake from a 20 euro per metric ton carbon price. As indicated by the bold , several of these industries are covered by the ETS, including lime, cement, basic iron and steel, refined petroleum products, pulp, paper and paperboard, hollow glass, and flat glass. The figure also indicates the direct and indirect cost components of implementing a carbon pricing policy. The cost impact of a 20 euro carbon price from a manufacturing process from direct emissions is indicated by the light blue versus the cost impact of indirect emissions resulting from higher electricity prices, which is indicated by the dark blue. As shown, the balance of direct and indirect costs differs substantially among the various sectors. After nine eastern European Member States threatened to veto an initial proposal to auction 100% of all allowances, the leaders of the European Union (EU) agreed to provide for some free allocation of allowances during Phase 3 that will begin in 2013. In making changes for Phase 3, the European Commission has identified three CO 2 emitting sectors for inclusion under the ETS: petrochemicals, ammonia, and aluminum. The ETS would also expand beyond CO 2 to include nitrous oxide (N 2 O) emissions from nitric, adipic, and glyoxalic acid production, and perfluorocarbon (PFC) emissions from the aluminum sector. These industries would be added to those currently covered: oil refineries, powerplants over 20 MW in capacity, coke ovens, and iron and steel plants, along with cement, glass, lime, brick, ceramics, and pulp and paper installations (aviation is currently being incorporated into the system). Most covered industries, except for electric powerplants, will be eligible for some free allocation of allowances to cover direct emissions under the Phase 3 agreement. For electric powerplants, most will receive no free allocation of allowances during Phase 3.