J. Abrell, S. Rausch, and H. Yonezawa (2019). Higher Price, Lower Costs? Minimum Prices in the EU Emissions Trading Scheme. The Scandinavian Journal of Economics, 121(2), 446-481. Working paper version is available here.
J. Abrell and S. Rausch (2017). Combining Price and Quantity Controls Under Partitioned Environmental Regulation, Journal of Public Economics, 145, 226-242. Online appendix, including computer codes, is available here.
A recent study theoretically and empirically studies the conditions under which the introduction of a carbon price floor can improve the efficiency of the EU Emissions Trading System (ETS). While emissions trading systems have become centerpieces of market-based environmental regulation in many countries they have been shown to suffer from two major issues. First, they typically cover only a subset of emissions, thereby undermining the static cost-effectiveness of pollution control as marginal abatement costs (MACs) are not equalized across all sources. Second, exogenous shocks (economic recessions, fuel prices, and technology shocks) and overlapping environmental policies can lead to unforeseen impacts on the ETS permit price. Importantly, this might reduce the investment incentives for low-cost pollution-extensive “clean” future technologies with negative effects for dynamic cost-effectiveness. The first (and still by far the biggest) international system for trading greenhouse gas emission (GHG) allowances, the EU ETS also faces these issues: the EU’s climate policy is highly partitioned with only about one-half of the EU’s emissions covered by the EU ETS; and the price for EU emissions allowances is conceived to be too low.
The study examined whether and by how much the abatement costs of achieving a given environmental target under partitioned climate regulation that is partly based on an international ETS can be reduced by introducing a minimum price for ETS permits. We have theoretically characterized the conditions under which a price floor for ETS permits brings about welfare gains by reducing the differences in MAC across the partitions of environmental regulation. Using a country-level simulation model of the EU economy, we find that low to moderate ETS price floors on the order of 50-70 Euro per ton of CO2 can reduce the welfare costs of achieving EU climate policy targets by 20-30 percent relative to the current policy. Welfare gains are driven by a decrease in the difference in MACs between firms in the ETS and non-ETS partition and a reduction in negative tax-interaction effects as abatement is shifted away from non-ETS sectors that are subject to high pre-existing fuel taxes (in particular, the transportation sector). Importantly, we find that the cost of reducing CO2 emissions with an effective minimum price policy is close to, and can even be lower than, what would be realized under uniform carbon pricing (i.e., in the absence of partitioned environmental regulation). The efficiency argument for a minimum price in the EU ETS is strengthened by our finding that the likely distributional impacts among the EU member states do not adversely affect regional equity: most EU member states are better off with the gains of winning countries vastly exceeding the losses of losing countries.
A second paper analyzes hybrid emissions trading systems (ETS) under partitioned environmental regulation when firms' abatement costs and future emissions are uncertain. We show that hybrid policies that introduce bounds on the price or the quantity of abatement provide a way to hedge against differences in marginal abatement costs across partitions. Price bounds are more efficient than abatement bounds as they also use information on firms' abatement technologies while abatement bounds can only address emission uncertainty. Using a numerical stochastic optimization model with equilibrium constraints for the European carbon market, we find that introducing hybrid policies in EU ETS reduces expected excess abatement costs of achieving targeted emission reductions under EU climate policy by up to 89%. We also find that under partitioned regulation there is a high likelihood for hybrid policies to yield sizeable ex-post cost reductions.