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The European Union’s CO₂ Emissions Trading Scheme (EU ETS) has shown that cap-and-trade systems can work in a highly decentralized multinational setting, but that experience has also revealed some issues in governance that threaten the feasibility of cap-and-trade in an international setting. These issues are captured in the conflicting demands for differentiation and harmonization. This chapter examines the experience of the EU ETS and of cap-and-trade systems in the USA in resolving this conflict with particular attention to the governance institutions and their potential applicability on a broader global scale.

EU member-states rely on both a collectively governed EU Emissions Trading Scheme (EU ETS) as well as a wide array of national instruments that operate in parallel with the EU ETS. Parallel instruments tend to undermine the strength of the ETS-based carbon price. In this chapter, we estimate when parallel instruments force the EU ETS into redundancy, permanently driving the carbon price down to €0. Probabilistic analysis shows that redundancy of the EU ETS is certain if the parallel instruments trigger more abatement than 45 MtCO₂/yr. If parallel instruments trigger more abatement than 20 MtCO₂/yr., redundancy of the EU ETS depends on the economic growth rate around Europe. The lower the economic growth rate the greater the likelihood of ETS redundancy. Note that the thresholds levels can be significantly below these estimates if either policymakers or firms lack full commitment to the EU ETS.

The European Union’s Emissions Trading System (EU ETS) is the most salient example of emissions trading being used as a climate policy instrument, which many would argue is the most promising form for an eventual global climate regime. These keynote remarks address what is known and not known about the functioning of this instrument in this pioneering, multinational cap-and-trade system. The discussion proceeds through topics that can be considered settled, those that remain to be addressed, and some that remain unsettled. The conclusion is that the EU ETS works in the sense of achieving its basic objective, but that understanding of how and why it works rests more on theory than on empirical verification. This essay can also be seen as presenting an agenda for research on the EU ETS.

This paper exploits a detailed and original database to analyse the welfare and efficiency implications of the move to benchmark-based free allocation rules in EU ETS Phase 3(2013-20). It is shown empirically that the new allocation rules will lead to a material improvement of the distributional welfare properties of free allocation, by reducing the scope for windfall profits in non-electricity sectors of the EU ETS. Evidence also suggests that new rules have the potential to improve the economic efficiency of the EU ETS by forcing a larger share of installations to purchase allowances at the margin. However, although harmonised benchmarks help to reduce the scope for competitive distortions arising from differing allocation levels to installations in the same sector, the use of ex-ante output levels to determine allocations still leaves considerable scope for internal market distortions, as illustrated using the example of the cement sector.

In this introductory chapter, we describe the goals of the workshop in Venice that has led to this collection of essays and give a brief overview over the individual chapters in this book. We divide them into four different thematic sections that focus, respectively, on the current state and the development of the EU ETS (Section I); aspects related to political economy in the sense that firms aim to influence climate regulation (Section II); interactions with parallel instruments of climate policy (Section III); and firm behavior in the emissions market (Section IV). We provide some general and mostly positive conclusions about the EU ETS as a policy experiment, but argue that in order for it to provide a significant contribution to combatting climate change, the future cap should be tightened.

This chapter details EU efforts in taking action against climate change and, in conjunction, maintaining more energy efficient solutions. Notably, the EU committed itself to taking action against anthropogenic climate change in the early 1990s and has before and since then played a leading role in the attempts to agree on and implement effective measures at the international level for curbing greenhouse gas emissions. The chapter explores climate change measures relating to the reducing of emissions of greenhouse gases in a cost-effective manner, most particularly in the EU’s 2003 emissions trading scheme (EU ETS), as well as measures falling beyond the scope of the EU ETS. This chapter also looks at the EU’s energy efficiency measures, especially in response to the EU’s ‘20-20-20 by 2020’ targets. In order to meet these goals, the chapter explores energy efficiency solutions, methods of carbon capture and storage (CCS), renewable energy resources, and ecolabelling.

This paper discusses the EU ETS as a dynamic system. I review changes to the rules of the market that have been proposed or implemented in reaction to observed market developments. I link such a changing regulatory environment to the literature on regulatory uncertainty. Investment decisions may be distorted due to uncertain market conditions. However, the relative impact on the different investment options, e.g., the choice of technologies, is ambiguous. I highlight this discussion based on a simple analytical model.

After RGGI’s implementation in 2008, a series of political set backs led some to declare cap and trade “dead.” This chapter rejects the asserted demise of cap and trade, arguing that the public benefit model for climate policies offers the best hope for political progress. The chapter reviews post-2008 climate policies, noting thatdespite a few prominent failures,cap and trade with auction has become the most common approach to addressing climate change. In addition, the chapter documents how three policies—the EU ETS, California’s cap and trade program, and RGGI—used the public benefit frame to resist political challenges and strengthen their emissions goals. The chapter then describes additional potential applications for the public benefit model, including carbon tax policies and the new Clean Power Plan regulations promulgated by the U.S. EPA in 2015. As uses of the public benefit frame expand, the chapter notes, a key question for the future will be what types of policy designs will be perceived as “fitting” with the norms that constitute the frame. Finally, the chapter discusses how normative framing could improve the ability to understand and predict other sudden policy changes beyond the topic of climate change.

This chapter provides a brief overview of the EU ETS. It outlines the design and scope of this market, presents data on aggregate allocation as well as emissions, and summarizes the development of allowance prices between 2005 and today.

This chapter describes the “old” model of cap-and-trade policy design that largely controlled emissions trading policy from its origins in the 1970s through the 1990s, under which emissions trading programs were adopted reluctantly, and “grandfathered” emissions allowances to current emitters at no cost. It also describes some important events starting in the 1990s that helped lay the groundwork for the sudden switch to auctions in RGGI, including: greater attention to allocation rules by political actors, new precedents such as spectrum rights auctions and severance taxes on some nature resources, new political and economic pressures from electricity deregulation, and the emergence of “public benefit” charges and programs to improve energy efficiency for consumers. In addition, this period saw the emergence of new polluter pays and public ownership normative frames in the context of emissions allowances. At the same time, the chapter documents how these initial changes were insufficient to successfully promote allowance auctions in the development of two prominent cap and trade programs: the initial phase of the EU ETS from 1998-2005, and the NOx Budget emissions trading program from 1994-2005.

Even for the largest economy in the world, ever-larger climate bailouts are not a responsible solution to confronting present and future climate impacts. Governments everywhere, including in the United States, will have to raise unprecedented amounts of money to cope with the impacts of climate change. This chapter examines how communities can raise the money needed, and how can they do so while keeping the financial strain as low as possible. It highlights some traditional solutions, such as taxes, borrowing, and buying reinsurance, alongside newer ideas, such as setting up special reserve funds, using value capture, raising funds from carbon taxes and cap-and-trade mechanisms, and issuing green and catastrophe bonds.