The EU ETS: Economic and Environmental Effects of the Cap and Trade System

 The EU ETS: Economic and Environmental Effects of the Cap and Trade System
 
Abstract
            Many countries continue to implement emission trading schemes in an effort to limit both the release of harmful levels of carbon dioxide into the atmosphere and its subsequent absorption into the oceans causing acidification. This adoption trend would address market failure naturally in any economy that does not prevent harmful emissions. The European Union’s Emissions Trading Scheme (EU-ETS) is the largest greenhouse gas trading system to date. The objective of this study is to analyze the general economic effects of EU-ETS, particularly in two areas for evaluation: (1) environmental effectiveness measured through emissions reduction; (2) economic efficiency measured through price effects. A central conclusion is that the absence of elasticity in the structure of the EU ETS cap can undermine its value in providing incentives for a reduction in emissions if financial conditions continue to change drastically like during the last financial crisis that ravaged Europe. In this study, I will use the term “carbon credit” for short, but under the EU ETS system, the tax applies to either the carbon content of fossil fuels before combustion or the CO2 in gases after combustion. It also applies to other greenhouse gases, such as methane from landfills, animals and coal seams.

Introduction
When emission trading schemes (ETS) were first created, their purpose was to realize carbon emission reduction targets proposed in the 1997 Kyoto Protocol and to address climate issues raised during the 2015 Paris Climate Summit. The EU ETS operates on the cap and trade standard[1]. A cap is set on the entire amount of specific greenhouse gases, which can be released by installations covered by the system. Organizations obtain or purchase emission allowance within the cap, which they can trade with one another as required. However, they can purchase limited amounts of global credits from emission-saving schemes across the world. The objective of limitation on the total number of allowances available is to guarantee them a value[2]. A company ought to surrender adequate allowances annually so as to cover all its extensions; otherwise, heavy penalties are imposed. A company can keep spare allowances to cover its prospective requirements or else sell them to another company that is short of allowances it is decreasing its emissions. Trading offers flexibility, which ensures that emissions are cut where it is not expensive to do so. Investment in clean, low-carbon technologies is also promoted by a robust carbon price[3].

Currently, the EU ETS is in its third phase, considerably varying from the first and second phases. The major changes include:

     One EU-wide cap on emissions is applicable in place of the past system of national caps
     The default technique of allocating allowances is auctioning instead of free allocation, and harmonized allocation rules are applicable to the allowances still given away for free.
     It is comprised of more sectors and gases.
     About 300 million allowances are set aside in the New Entrants Reserves to fund the deployment of innovative renewable energy technologies and carbon capture and storage via the NER 300 program.
         The EU ETS system covers the following gases and sectors with the concentration on emissions, which can be measured, reported and confirmed with a high degree of precision:

    Carbon dioxide from power and heat generation; commercial aviation; and energy-intensive industry sectors like oil refineries, steelworks, and production of iron, lime, acids and bulk organic chemicals.
    Nitrous oxide from production of nitric, adipic and glyoxylic acids.
    Perfluorocarbons from aluminum production.
            Membership in the EU ETS is obligatory for companies in these sectors, but in some sectors, companies of a specific size are included. Certain small installations can be excluded in case governments put in place fiscal or other measures, which will cut their emissions by an equal amount. The EU ETS was applicable in the aviation sector to flights between airports situated in the European Economic Area EEA alone until 2016. The EU ETS has confirmed that placing a price on carbon and trading in it can work. Emissions from installations in the scheme are reducing as indented- by approximately 5% in contrast to the start of the third phase[4]. Emissions from covered sectors will be 21% lower in 2020 compared to 2005. They will be 43% lower in 2030 under the Commission’s proposal[5]. The EU ETS is the first and the largest global emissions trading system in the world, accounting for three-quarters of global carbon trading.  The EU ETS also encourages the growth of emissions trading in other nations and regions. The objective of EU is to connect the EU ETS with other compatible systems.  

History and evolution of the EU ETS Carbon System
The launch