Through a brief look at the science and economics of climate, the authors show that if climate change turns out to be a serious threat, an effective response will require a substantial and very long-term global effort. Today's focus on near-term emissions reductions will be counter-productive if it delays development of the institutions and policy architectures that would be necessary to mount and sustain such an effort over much of the next century. The authors discuss three legacies that our generation could leave that would make this struggle to devise a global response easier: (1) an international climate agreement that could, if necessary, reduce greenhouse gas emissions substantially, at least cost, while being responsive both to changes in our scientific understanding and to evolving political and economic conditions, (2) enhanced technical options that could, if necessary, ease the task of maintaining economic growth while controlling greenhouse gas emissions, and (3) an international system that could, if necessary, transfer substantial sums to developing countries to assist their participation in an emissions control effort. Building these legacies is a huge challenge, but this task merits at least the same sense of urgency that has motivated pre-Kyoto negotiations about short-term CO2 emissions reductions.

Provisions to endow new entrants with free allowances and to require closed facilities to forfeit allowance endowments are ubiquitous in the EU Emissions Trading Scheme, but a new design feature in cap-and-trade systems. This essay seeks to explore, within a comparative statics framework, the effect of these provisions on agent behavior in output and emissions markets assuming profit maximization. The main conclusion is that the principal effect is on capacity. The effect of the resulting over-capacity on output markets is to reduce output price and to increase output. The effect on emissions markets is more ambiguous in that it depends on the emission characteristics of the new capacity, existing capacity, and the capacity not retired, and the distribution of the excess capacity among these categories.
Copyright IAEE

There are many obstacles to the development of an international CO2 emissions trading system, but the biggest is a feature that is often assumed: the existence of a single national system. Once a national system is in place, an international system will develop naturally more as a matter of self-interested trade than as international agreement. Meeting the Kyoto targets will create a scarcity; and the scarcity requires that use and the associated rent be allocated somehow. This allocation--deciding who gets what--is a familiar problem and the largest impediment to the creation of a national system, and thus of an international regime of CO2 emissions trading. The paper reviews the various instruments by which such the Kyoto target might be met from the standpoint of the allocation of the scarce use and the associated rent. In particular, the paper emphasizes that existing users will largely continue to use the scarce resource and that they now actively exercise the incipient right to the proposed scarcity. Creation of the scarcity and the allocation of rights raise fundamental issues of equity that lie pre-eminently in the political realm. The author observes that the creation of the scarcity and the allocation of rights are fused and that agreement on one will occur only as there is agreement on the other. Nevertheless, such problems have been solved before --for land and for SO2 permits--although in both cases the conditions were easier than what is now proposed for CO2.An international CO2 trading system will develop from a national allowance system for the same reasons that trading can be expected to occur domestically. However, the unavoidable requirement of certification and verification will impede access to non-Annex B sources of emission reduction, and at the same time encourage countries with such sources to accept Annex B limits. The negotiation of such limits raises the same problems of allocation as faced at the national level, only on a global scale; and there is even less agreement here. Nevertheless, the discussion on global allocation will not begin in earnest until a national system creates the trade opportunities that will make an Annex B limit worth pursuing. The development of an international system for CO2 emissions trading should not be expected to be either quick or easy, but to occur only by accretion and mostly as a matter of self-interested trade.

Copyright American Council for Capital Formation Center for Policy

This paper provides an initial analysis of the European Union Emissions Trading Scheme (EU ETS) based on the installation-level data for verified emissions and allowance allocations in the first trading year. Those data, released on May 15, 2006, and subsequent updates revealed that CO2 emissions were about 4% lower than the allocated allowances. The main objective of the paper is to shed light on the extent to which over-allocation and abatement have taken place in 2005. We propose a measure by which over-allocation can be judged and provide estimates of abatement based on emissions data and indicators of economic activity as well as trends in energy and carbon intensity. Finally, we discuss the insights and implications that emerge from this tentative assessment.