How to dismember a potent instrument – the intractability of the emission trade proposal of the European Commission

Panel: Panel 5. Market-based instruments

Authors:
Juha Honkatukia, Goverment Institute of Economic Research VATT
Heikki Kemppi, Goverment Institute of Economic Research VATT
Adriaan Perrels, Goverment Institute of Economic Research VATT

Abstract

The initiative of the European Commission to start up an emission trade system is fraught with difficulties. In order to be viable it should provide value added to justify the extra efforts it requires.

A review of the draft-directive unveils many critical issues, that undermine the value added. Many proposed measures and conditions increase the cost of participation, and reduce the emission trade market volume, thereby affecting both level and volatility of the permit price. Furthermore, the proposed organisation of the system is unbalanced as it simultaneously leans on (1) a devolution of policy planning tasks, (2) a centralisation of decision rights and, (3) an asymmetry in information levels and deployable specialist knowledge. As a consequence the directive proposals would complicate but not prevent gaming during the establishment and approval phase of the trade system.

The paper discusses (1) the burden sharing between trading and non-trading segments in the member countries, with special reference to Finland (2) the possible responses of companies to increased transaction cost and uncertainty, and (3) the consequences of the permit trade requirements for the earlier devised domestic climate policy and as a consequence for energy efficiency policies. The paper is based on a study conducted for the Ministry for the Environment, involving both an in-depth review of the directive and AGE-E3 model based calculations. The paper focuses on the analytical-qualitative clarification of effects. Some model results are added to underline the practical relevance of the identified risks and obstacles .