The 2018 Reform of EU ETS: Consequences for Project Appraisal

11 Pages Posted: 5 Jun 2020

Date Written: May 11, 2020

Abstract

The European Union's Emissions Trading System is the largest system in the world for trade in greenhouse gases. It used to be a cap-and-trade scheme with a fixed supply of permits. However, a recent reform of the system "punctures the waterbed" by making the supply of permits endogenous. The current paper discusses how to handle permits in economic evaluations. It considers both schemes with a fixed cap and schemes with an endogenous cap. The paper also derives a rule when the project causes an induced intertemporal change in the supply of permits under an endogenous cap. An induced reduction in emissions, what we term a "permit multiplier", is associated with benefits but comes at a cost as production is displaced when the number of available permits decreases. The permit multiplier implies that emissions within the EU ETS are valued differently from emissions occurring elsewhere even under an endogenous cap. A further novel result is that an endogenous cap could increase the social profitability of abatement efforts. By replacing purchases of permits, abatement could cause a reduction in the endogenous supply of permits and hence emissions.

Keywords: Cost-benefit analysis, permits, waterbed puncture, endogenous cap, ETS, climate gases, social cost of carbon

JEL Classification: H23, H43, Q51, Q54

Suggested Citation

Johansson, Per-Olov, The 2018 Reform of EU ETS: Consequences for Project Appraisal (May 11, 2020). Available at SSRN: https://ssrn.com/abstract=3598039 or http://dx.doi.org/10.2139/ssrn.3598039

Per-Olov Johansson (Contact Author)

Stockholm School of Economics ( email )

P.O. Box 6501
Stockholm
SWEDEN
+46 8 736 92 82 (Phone)
+46 8 30 21 15 (Fax)

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