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Economic Perspectives on Potential Future Developments of the EU Emissions Trading Scheme: Multilateral Linkages, Price Floors, and Use of Auction Revenues

Paper Session

Sunday, Jan. 6, 2019 8:00 AM - 10:00 AM

Atlanta Marriott Marquis, International 3
Hosted By: American Economic Association
  • Chair: Claire Gavard, Centre for European Economic Research (ZEW)

Unilateral Action under an Emissions Cap

Michael Pahle
,
Potsdam Institute for Climate Impact Research (PIK)
Dallas Burtraw
,
Resources for the Future (RFF)
Oliver Tietjen
,
Potsdam Institute for Climate Impact Research (PIK)
Christian Flachsland
,
Mercator Research Institute on Global Commons and Climate Change (MCC)
Ottmar Edenhofer
,
Potsdam Institute for Climate Impact Research (PIK)

Abstract

Cap-and-trade programs with multiple jurisdictions such as the EU Emission Trading Scheme (EU ETS) must accommodate varying ambition among participants. Jurisdictions that value mitigation highly often consider additional unilateral action, which has two consequences: First, if the cap is binding, more mitigation in one jurisdiction enables less in other jurisdictions (waterbed effect). Second, it will reduce the price of allowances leading to even higher motivation for unilateral action, i.e. it creates a negative feedback. Both effects endanger cap and trade as a mechanism for cooperation, putting its durability at stake. Given that ambitious EU member states increasingly rely on unilateral measures in presence of a low EU ETS allowance price, there is reason to believe that the EU ETS may be nearing such a state.
We investigate a price floor for allowances (an auction reserve price) in the face of unanticipated changes in allowance demand that affects the allowance price. Using a numerical electricity market model (LIMES-EU), we investigate how a price floor affects auction revenues, and consumer and producer surplus among member states. We consider unilateral state specific minimum prices and multilateral coalitions within the EU ETS in which a subset of states enacts a minimum auction price. Finally, we consider multiple price steps that constitute a price responsive supply curve. We examine efficiency in a complex policy setting to ask if a price floor could increase the cost-effectiveness of national policy mixes, and consider distributional impacts, such as potential gains for “inactive” member states. Finally, we investigate if there is a combination of price floors and implicit or explicit transfer schemes that constitute a Pareto improvement. Tentative findings illustrate that unilateral action initiates an implicit transfer among member states and at least over some range of measures, the cost effectiveness of the climate policy portfolios can be improved.

Emissions Reserve Price Options for EU Member States

Carolyn Fischer
,
Vrije University Amsterdam
Christoph Böhringer
,
University of Oldenburg

Abstract

Several EU member states (MS) are exploring options for setting minimum carbon prices nationally. We evaluate different possibilities and their consequences on national and ETS-wide carbon prices, compliance costs, the revenues from emission allowances, emissions, and overall cost-effectiveness. We explore analytically and then numerically three policy options, referred to as “TAX”, “KILL” and “BILL”. First, a “TAX” policy would implement a national minimum price by adding a tax equal to the difference between the prevailing ETS price and the targeted minimum price. Second, a national auction reserve price would “KILL” allowances by withholding them from auction, raising the ETS price to the national reserve price. Third, a final option would be to require local overcompliance: participating MS would “BILL” their covered entities for extra allowances per ton of emissions (i.e., resident covered entities would have to surrender pF/pA allowances for their emissions at the ratio of the desired national floor price over the ETS market price); this policy increases demand for allowances, and thus pushes up the ETS price. Among the options, for a given domestic minimum price, TAX raises the most revenues for the coalition (assuming they are not large net exporters of allowances), at the expense of the rest, since the resulting “waterbed effect” lowers system-wide allowance prices rather than emissions. KILL lowers emissions the most, without sacrificing overall cost-effectiveness, and if a coalition of MS has sufficient shares of the supply while demand for allowances is sufficiently steep the price increase can offset the revenue cost of lost sales for the coalition. BILL requires less sacrifice of revenues by the coalition than KILL, for somewhat less cost-effectiveness. We use an empirically parameterized numerical model based on MS-specific abatement costs and allowance allocations to quantify the distributional and efficiency implications for different MS coalitions and minimum price targets across the different policy options.

Linking Permit Markets Multilaterally

Baran Doda
,
London School of Economics (LSE)
Simon Quemin
,
Paris-Dauphine University
Luca Taschini
,
London School of Economics (LSE)

Abstract

We develop a general model to analyze multilateral linkages between permit markets and characterize the determinants, magnitude and distribution of efficiency gains in an arbitrary linkage group. We decompose these gains into gains in the group's internal bilateral linkages and quantify those that are attributable to effort and risk sharing. We also characterize individual preferences over possible groups and analyze the relationship between autarky and linking prices. In a quantitative illustration we calibrate the model’s autarky equilibrium to match the implications of the Paris Agreement pledges for the power sectors of five jurisdictions which use or have considered both emissions trading and linking. We show that linking can generate gains of up to 3.26 billion 2005US$ per year relative to autarky, split roughly equally between effort and risk sharing. These gains are reduced by about 20% in the presence of banking and borrowing.

Using Emissions Trading Schemes to Reduce Heterogeneous Distortionary Taxes: the case of Recycling Carbon Auction Revenues to support Renewable Energy

Claire Gavard
,
Centre for European Economic Research (ZEW)
Sebastian Voigt
,
Centre for European Economic Research
Aurelien Genty
,
European Commission

Abstract

While emissions trading schemes are developed by nations to mitigate their greenhouse gas emissions, behavioural studies have shown that the political and public acceptability of these market-based instruments depends on the way the associated revenues are used. One option the general public approves of is to use them to support renewable energy. If this consists in reducing a pre-existing electricity levy that heterogeneously applies to the various sectors of the economy, the reduction of this distortionary tax thanks to the carbon revenues results in general equilibrium effects that may have unequal sectoral impacts. This is what we examine in the case of the European Union. With a modelling approach including a detailed disaggregation of European sectors, we find that using auction revenues from the Emissions Trading Scheme (ETS) to support electricity generation from renewable sources results in a 2% rise in electricity demand in the whole economy due to the reduced electricity levy that electricity consumers have to pay to support renewable energy. This results in a 1.8% ETS carbon price increase. The carbon constraint for the non-ETS sectors is 5.9% looser as a consequence of the larger electricity use by these sectors. While the energy intensive sectors generally benefit from electricity levy exemptions, we observe that, due to the energy and ETS price increase, the combination of these exemptions and of the use of carbon auction revenues to support renewable energy makes the ETS sectors worse off than if carbon revenues are transferred to households. In aggregate, the recycling option analysed here results in a GDP gain due to its impacts on the non-ETS sectors, the reduction of the electricity levy and associated distortionary effects.
Discussant(s)
Carolyn Fischer
,
Vrije University Amsterdam
Luca Taschini
,
London School of Economics (LSE)
Claire Gavard
,
Centre for European Economic Research (ZEW)
Dallas Burtraw
,
Resources for the Future (RFF)
JEL Classifications
  • Q5 - Environmental Economics
  • H2 - Taxation, Subsidies, and Revenue