What is it about?
This paper evaluates the effectiveness of the current policy adopted by the EU Emissions Trading System (EU ETS), to address the potential competitiveness effects of climate policy -- an approach called “ex-ante free allocation” whereby sectors that are considered vulnerable to these effects receive emission allowances for free. It therefore assesses the details of policy design to address these issues. Specifically it asks whether the “activity level threshold rules” (introduced in 2013 to limit the provision of excess free allocation to installations operating well below full capacity due for example to low demand) have been successful or not.
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Why is it important?
The paper makes an important and innovative contribution to the knowledge base on designing provisions to address competitiveness concerns under emissions trading schemes, by providing new and robust evidence that the current EU ETS rules create severe incentive distortions that are inconsistent with the overall goal of the policy. Specifically, it finds evidence in the cement sector that firms respond by ‘gaming’ (strategically adjusting) output levels to obtain more free allocation. This led to excess production of cement-clinker, and increased the pollution-intensity of cement production in affected countries. This is a significant finding because it is exactly the contrary of the purpose of the EU ETS which is to reduce emissions. By quantifying the magnitude of these effects and comparing them to alternative policy scenarios, the analysis shows that moving away from the current free allocation methodology to an alternative, output-based approach will improve the efficiency of the scheme.
Perspectives
The close examination of the arbitrary threshold rule is interesting, because its introduction provides a natural experiment to evaluate the consequences of companies’ responses to such design. The findings thus contribute to the wider policy evaluation literature by supporting the evidence of strong responses to thresholds in the policy design (e.g. Sallee and Slemrod 2012).
Dr Misato Sato
London School of Economics and Political Science
Read the Original
This page is a summary of: EU ETS, Free Allocations, and Activity Level Thresholds: The Devil Lies in the Details, Journal of the Association of Environmental and Resource Economists, September 2015, University of Chicago Press,
DOI: 10.1086/682343.
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