Daniel H. Cole
This chapter surveys the origins of emissions trading in theory and early practice, from John Dales’ initial explication of the instrument through its first large scale experiment in the 1990 US Clean Air Act Amendments.
The idea of emissions trading reflects the fact that the costs of reducing emissions differ between regulated entities. Differences in marginal abatement costs will hence spur permit trading, leading to their equalization across market participants and aggregate cost efficiency in equilibrium. In view of the broad range of activities covered by the EU ETS, one can expect significant differences in emission reduction costs and hence strong incentives for trade. This chapter presents empirical evidence on trading in the EU ETS: EUA trade is analysed and discussed and the use of international credits for compliance under the EU ETS is addressed on country and sector level. In addition, trading flows on installation and company level are assessed. The empirical analysis of the EU ETS shows that the assumptions of the theory of emissions trading are not matched by the real-world setting. Allowance imports and exports showed only a very limited correlation with allowance surpluses and allowance deficits. This phenomenon cannot only be observed at country and sector level, where differences between installations and intra-firm transfers could have been a possible explanation for these discrepancies, but first analyses of trading in the EU ETS show that several companies have bought additional allowances on the market in Phase 1 despite being endowed with surplus allocation and the absence of banking between Phases 1 and 2. While the EU ETS is far from being a perfect market, empirical evidence shows an increase in trading activity since 2005 as agents became accustomed to the new market. A higher stringency of the cap in the EU ETS and the possibility of banking allowances might help stabilise carbon prices and hence mitigate inefficiencies.
If firms participating in an emissions trading scheme (ETS) perceive market power, the permit price and the distribution of abatement and production is a function of the initial permit allocation, which contrasts with the case of perfect competition. The underlying reason is that abatement does not happen where it is cheapest, but where it maximizes firm profits, which is generally not the same if firms act strategically. As a result, society pays more to reduce emissions to a given emissions cap than it would in the absence of ETS market manipulation. This chapter reviews the literature about market power in emission markets. The earlier theoretical work abstracts from an interaction between permit and product markets. This makes the problem tractable and leads to an intuitive result: Net permit sellers will use their market power to increase the permit price, whereas the opposite holds for net buyers. The more recent literature shows that if firms are able to pass on emission costs to product prices, even net permit buyers can have an incentive to increase the permit price, provided that they receive a sufficiently generous free allocation of permits. Another important result is that if firms are able to bank but not borrow permits, as is typically the case in real-world ETS, downward price manipulation is unlikely to be a concern. The empirical literature about this topic is much more scarce, however, because firm-specific data about abatement costs are not available. Instead, the empirical literature has focused on firms’ permit holdings over time and compared them to counterfactual scenarios where firms act competitively. Whereas the studies about the US Acid Rain Program find no evidence for the exercise of market power, analyses of the RECLAIM market and the EU ETS are consistent with strategic behavior by large firms.
Marjan Peeters and Huizhen Chen
This chapter aims to further the debate regarding the role of law for establishing an adequate enforcement strategy for an emissions trading scheme. We focus on sanction regimes within the EU ETS and the Chinese emissions trading pilot projects. Section 2 sets the scene by pointing at the need of an adequate enforcement approach and related legal scholarship. Section three presents the specific case of the EU ETS, established by Directive 2003/87/EC from 2003, while section 4 turns to the recently developed greenhouse gas emissions trading pilot projects in China. In particular, sections 3 and 4 focus on sanctions for excess emissions, discussing recent case law regarding penalties for emissions trading within the EU and specific enforcement approaches in the emerging emissions trading regimes in China. Section 5 concludes, highlighting that proper evaluation of compliance with emissions trading regimes is a challenge in itself, not only for governments, but also for academics who want to gain further insights into how emissions trading regimes work in the practice of different legal systems. In conclusion, access to information regarding compliance and enforcement with an emissions trading regime needs to be further explored, not only for China but also for the EU.
Karoline S. Rogge
The Paris Climate Agreement calls for decarbonization of the economy in the second half of this century. This requires a radical redirection and acceleration of technological change towards low- and particularly zero-carbon solutions. Global carbon pricing is seen as a key enabler for such decarbonization, with the European Union’s Emission Trading System (EU ETS) serving as an important pillar. This chapter reviews the evidence on the innovation impact of the EU ETS. The review shows a very limited effect of the scheme on technological innovation, but there are clear signs of it having stimulated organizational innovation, with the impact being more pronounced for the electricity sector than for industry. The initially high expectations of the EU ETS regarding technological innovation largely dissipated once the scheme’s lack of stringency became apparent and prices collapsed accordingly. Also, for many of the rather incremental innovations that have taken place, the EU ETS was shown to be only one contributing factor among others, with the broader policy mix and long-term targets playing a particularly pivotal role in stimulating innovation. In contrast, there is clear evidence that the EU ETS has been a key driver of various organizational innovations, including making climate change a top management issue. However, so far, these organizational innovations have only had limited effects on shifting corporate strategies towards low-carbon solutions because of low carbon prices, the relatively high share of free allocations in industry, and more pressing business concerns. Despite this, the scheme’s positive impact on organizational innovations should not be underestimated, as these constitute a necessary precondition for future technological innovations. The findings suggest that the Commission’s proposal for the fourth trading period of the EU ETS points in the right direction, but further efforts will be needed to significantly increase the scarcity of EU allowances and the share of auctioning in order to fully unleash the scheme’s transformative power. If the identified shortcomings are not addressed, the EU ETS cannot play its intended role in guiding the decarbonization of the European economy, for which innovations in low-carbon solutions are a fundamental requirement.
Katherine Nield and Ricardo Pereira
The broad involvement and diversity of products within the European Emissions Trading Scheme (EU ETS) has been important in driving liquidity and market efficiency and has itself fuelled further market growth. But as the EU carbon market has grown in size, value and complexity it has become an increasingly attractive playground for fraudsters. Fraud has materialised on this market in a variety of sophisticated forms, including Value Added Tax (VAT) carousel fraud and emissions allowance thefts. In recognition of specific vulnerabilities within the EU ETS trading system, significant changes to the way that emissions allowances are traded were introduced to the Registry Regulation in 2013, as well to the EU financial markets regulations in 2012–2014, in an attempt to strengthen the EU ETS against financial crimes. This chapter examines the major forms of fraud that have affected the EU ETS, and highlights specific characteristics of emissions allowances and the registries system through which they are traded that have made the EU ETS especially vulnerable to fraud. Moreover, it discusses the regulatory reforms that have been implemented at both EU and national levels to address these vulnerabilities.
Josephine van Zeben
Within economic theory, emission trading schemes have long been advocated for their relative simplicity and their allocative and dynamic efficiency. Despite these apparent strengths, regulators have only recently started to meaningfully incorporate emission trading into their toolbox. This chapter focuses on an implementation challenge that does not necessarily present itself as such: litigation. Experiences with the EU ETS have made the potential impact of litigation on ETS development an increasingly salient issue for regulators. Nonetheless, the implications of litigation for the design and functioning of an ETS are less clear than some of the other implementation challenges. This chapter provides an analytical overview of the types of litigation that ETS are exposed to and the ways in which these different categories of litigation can, and have, affect(ed) ETS design and development.