Climate Policy

The Effects on Developing Countries of the Kyoto Protocol and CO2 Emissions Trading

This paper examines the effect of the Kyoto Protocol on developing economies using marginal abatement curves generated by MIT's Emissions Prediction and Policy Assessment model (EPPA). In particular, the paper addresses how developing countries are affected by the scope of CO2 emissions trading, by various limitations that Annex I countries might place on emissions trading, by the nature of the Clean Development Mechanism, and by changes in the international trade flows in conventional goods and services. In general, it is found that developing countries benefit from emissions trading, both from the new export opportunities and by the lesser distortion of Annex I economies. This effect is particularly pronounced for energy exporting countries since Annex I countries are able to substitute cheaper reductions of coal emissions in developing countries for more expensive reductions of oil emissions within Annex I. The paper also highlights the implications of the apparent inelastic demand for tradable permits from non-Annex I countries and the conflict between revenue maximization and other goals assigned to the Clean Development Mechanism.

The efficiency and robustness of allowance banking in the U.S. Acid Rain Program

The Efficiency and Robustness of Allowance Banking in the U.S. Acid Rain Program A. Denny Ellerman* and Juan-Pablo Montero** This paper provides an empirical evaluation of the efficiency of allowance banking in the nationwide market for sulfur dioxide (SO2) emission allowances that was created by the U.S. Acid Rain Program. We develop a model of efficient banking, select appropriate parameter values, and evaluate the efficiency of observed temporal pattern of abatement based on aggregate data from the first eight years of the Acid Rain Program. Contrary to the general opinion that banking in this program has been excessive, we find that it has been reasonably efficient. We also identify the erroneous assumptions underlying the earlier view and the conditions required for efficient banking to exist independently of changes in the counterfactual, an attribute we call robustness. These results show that firms use banking provisions in a rational and predictable way and that, at least in the US Acid Rain Program, there is no support for the often expressed concern that banked permits will be used all at once to create emissions spikes.
Copyright IAEE

The Efficiency and Robustness of Allowance Banking in the U.S. Acid Rain Program

This paper provides an empirical evaluation of the efficiency of allowance banking (i.e., abating more in early periods in order to abate less in later periods) in the nationwide market for sulfur dioxide (SO2) emission allowances that was created by the U.S. Acid Rain Program. We develop a model of efficient banking, select appropriate parameter values, and evaluate the efficiency of observed temporal pattern of abatement based on aggregate data from the first eight years of the Acid Rain Program. Contrary to the general opinion that banking in this program has been excessive, we find that it has been reasonably efficient. We also show that this optimal banking program is robust to the errors in expectation that characterized the early years of this program; however, this property is due to design features that are unique to the U.S. Acid Rain Program.

The Elusive Transformation: Science, Technology and the Evolution of International Politics

This book delves into the roles of science and technology across the entire range of relations among nations, including security and economic issues, environmental questions, international economic competitiveness, the spread of weapons technology, the demise of communism, the new content of dependency relations, and the demanding new problems of national and international governance. It shows how the structure and operation of the scientific and technological enterprises have interacted with international affairs to lead to the dramatic evolution of world politics experienced in this century, particularly after World War II.

© Princeton University Press

The EU's Emissions Trading Scheme: A Prototype Global System?

The European Union's Emission Trading Scheme (EU ETS) is the world's first multinational cap-and-trade system for greenhouse gases. As an agreement between sovereign nations with diverse historical, institutional, and economic circumstances, it can be seen as a prototype for an eventual global climate regime. Interestingly, the problems that are often seen as dooming a global trading system — international financial flows and institutional readiness — haven't appeared in the EU ETS, at least not yet. The more serious problems that emerge from the brief experience of the EU ETS are those of (1) developing a central coordinating organization, (2) devising side benefits to encourage participation, and (3) dealing with the interrelated issues of harmonization, differentiation, and stringency. The pre-existing organizational structure and membership benefits of the European Union provided convenient and almost accidental solutions to the need for a central institution and side benefits, but these solutions will not work on a global scale and there are no obvious substitutes. Furthermore, the EU ETS is only beginning to test the practicality of harmonizing allocations within the trading system, differentiating responsibilities among participants, and increasing the stringency of emissions caps. The trial period of the EU ETS punted on these problems, as was appropriate for a trial period, but they are now being addressed seriously. From a global perspective, the answers that are being worked out in Europe will say a great deal about what will be feasible on a broader, global scale.

The European Carbon Market in Action: Lessons from the First Trading Period Interim Report

The European Union Emissions Trading Scheme (EU ETS) is the largest greenhouse gas market ever established. The European Union is leading the world's first effort to mobilize market forces to tackle climate change. A precise analysis of the EU ETS's performance is essential to its success, as well as to that of future trading programs. The research program "The European Carbon Market in Action: Lessons from the First Trading Period," aims to provide such an analysis. It was launched at the end of 2006 by an international team led by Frank Convery, Christian De Perthuis and Denny Ellerman. This interim report presents the researchers' findings to date. It was prepared after the research program's second workshop, held in Washington DC in January 2008. The first workshop was held in Paris in April 2007. Two additional workshops will be held in Prague in June 2008 and in Paris in September 2008. The researchers' complete analysis will be published at the beginning of 2009.

[Report also available in: French]

The European Union Emissions Trading Scheme: Origins, Allocation, and 2005 Results

The European Union Emissions Trading Scheme (EU ETS) is the world's first large experiment with an emissions trading system for carbon dioxide (CO2) and it is likely to be copied by others if there is to be a global regime for limiting greenhouse gas emissions. After providing a brief discussion of the origins of the EU ETS, its relation to the Kyoto Protocol, and its precedents in Europe and the U.S., this paper focuses on allowance allocation—the process of deciding who will receive the newly limited rights to emit CO2. We describe how allowances were allocated in the EU ETS, with particular emphasis on the issues and problems encountered, including the lack of readily available installation-level data, the participants in the process, the use of projections, the choices of Member States with respect to auctioning, benchmarking, and new entrant provisions, and the difficult issue of deciding to whom the expected shortage was to be allocated. Finally, we discuss the recently available data on 2005 emissions and what they indicate concerning over-allocation, trading patterns, and abatement. We conclude with some observations about the broader implications of the EU ETS, what seems to be unique about CO2, and the fact that non-economic considerations inform the allocation of allowances.

©2007 Association of Environmental and Resource Economists

The European Union's CO2 Cap-and-Trade System in Perspective

The performance of the European Union’s Emissions Trading System (EU ETS) to date cannot be evaluated without recognizing that the first three years from 2005 through 2007 constituted a "trial" period and understanding what this trial period was supposed to accomplish. Its primary goal was to develop the infrastructure and to provide the experience that would enable the successful use of a cap-and-trade system to limit European GHG emissions during a second trading period, 2008-12, corresponding to the first commitment period of the Kyoto Protocol. The trial period was a rehearsal for the later more serious engagement and it was never intended to achieve significant reductions in CO2 emissions in only three years. In light of the speed with which the program was developed, the many sovereign countries involved, the need to develop the necessary data, information dissemination, compliance and market institutions, and the lack of extensive experience with emissions trading in Europe, we think that the system has performed surprisingly well.

Although there have been plenty of rough edges, a transparent and widely accepted price for tradable CO2emission allowances emerged by January 1, 2005, a functioning market for allowances has developed quickly and effortlessly without any prodding by the Commission or member state governments, the cap-and-trade infrastructure of market institutions, registries, monitoring, reporting and verification is in place, and a significant segment of European industry is incorporating the price of CO2 emissions into their daily production decisions. The development of the EU ETS and the experience with the trial period provides a number of useful lessons for the U.S. and other countries.

  • Suppliers quickly factor the price of emissions allowances into their pricing and output behavior.
  • Liquid bilateral markets and public allowance exchanges emerge rapidly and the "law of one price" for allowances with the same attributes prevails.
  • The development of efficient allowance markets is facilitated by the frequent dissemination of information about emissions and allowance utilization.
  • Allowance price volatility can be dampened by including allowance banking and borrowing and by allocating allowances for longer trading periods.
  • The redistributive aspects of the allocation process can be handled without distorting abatement efficiency or competition despite the significant political maneuvering over allowance allocations. However, allocations that are tied to future emissions through investment and closure decisions can distort behavior.
  • The interaction between allowance allocation, allowance markets, and the unsettled state of electricity sector liberalization and regulation must be confronted as part of program design to avoid mistakes and unintended consequences. This will be especially important in the U.S. where 50 percent of the electricity is generated with coal.

The EU ETS provides a useful perspective on the problems to be faced in constructing a global GHG emission trading system. In imagining a multinational system, it seems clear that participating nations will retain significant discretion in deciding tradable national emission caps albeit with some negotiation; separate national registries will be maintained with some arrangement for international transfers; and monitoring, reporting and verification procedures will be administered nationally although necessarily subject to some common standard. All of these issues have had to be addressed in the trial period and they continue to present challenges to European policy makers.

The deeper significance of the trial period of the EU ETS may be its explicit status as a work in progress. As such, it is emblematic of all climate change programs, which will surely be changed over the long horizon during which they will remain effective. The trial period demonstrates that everything does not need to be perfect at the beginning. In fact, it provides a reminder that the best can be the enemy of the good. This admonition is especially applicable in an imperfect world where the income and wealth effects of proposed actions are significant and sovereign nations of widely varying economic circumstance and institutional development are involved. The initial challenge is simply to establish a system that will demonstrate the societal decision that GHG emissions shall have a price and to provide the signal of what constitutes appropriate short-term and long-term measures to limit GHG emissions. In this, the EU has done more with the ETS, despite all its faults, than any other nation or set of nations.

The EU's Emissions Trading Scheme: A Prototype Global System?

The European Union's Emission Trading Scheme (EU ETS) is the world's first multinational cap-and-trade system for greenhouse gases. As an agreement between sovereign nations with diverse historical, institutional, and economic circumstances, it can be seen as a prototype for an eventual global climate regime. Interestingly, the problems that are often seen as dooming a global trading system — international financial flows and institutional readiness — haven't appeared in the EU ETS, at least not yet. The more serious problems that emerge from the brief experience of the EU ETS are those of (1) developing a central coordinating organization, (2) devising side benefits to encourage participation, and (3) dealing with the interrelated issues of harmonization, differentiation, and stringency. The pre-existing organizational structure and membership benefits of the European Union provided convenient and almost accidental solutions to the need for a central institution and side benefits, but these solutions will not work on a global scale and there are no obvious substitutes. Furthermore, the EU ETS is only beginning to test the practicality of harmonizing allocations within the trading system, differentiating responsibilities among participants, and increasing the stringency of emissions caps. The trial period of the EU ETS punted on these problems, as was appropriate for a trial period, but they are now being addressed seriously. From a global perspective, the answers that are being worked out in Europe will say a great deal about what will be feasible on a broader, global scale.

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