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EU ETS, Free Allocations, and Activity Level Thresholds: The Devil Lies in the Details

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  • Frédéric Branger
  • Jean-Pierre Ponssard
  • Oliver Sartor
  • Misato Sato

Abstract

It is well known that discontinuous jumps or thresholds in tax or subsidies are socially inefficient, because they create incentives to make strategic behavioral changes that lead to substantial increases in private benefits. This paper investigates these distortions in the context of the EU Emissions Trading Scheme, where activity level thresholds (ALTs) were introduced in Phase 3 to reduce the overallocation of free allowances to low-activity installations. Using installation-level data, we find evidence that cement producers indeed respond to such thresholds when confronted with low demand, by strategically adjusting output to obtain more free allocation. We estimate that in 2012, ALTs induced excess cement clinker production of 6.4 Mt (5% of total EU output), and in affected regions this further distorted trade patterns and reversed carbon intensity improvements. As intended, ALTs reduced free allocation by 4%; however, a linear scheme (output-based allocation) would have achieved a 32% reduction.

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  • Frédéric Branger & Jean-Pierre Ponssard & Oliver Sartor & Misato Sato, 2015. "EU ETS, Free Allocations, and Activity Level Thresholds: The Devil Lies in the Details," Journal of the Association of Environmental and Resource Economists, University of Chicago Press, vol. 2(3), pages 401-437.
  • Handle: RePEc:ucp:jaerec:doi:10.1086/682343
    DOI: 10.1086/682343
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    Cited by:

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    3. Philippe Quirion, 2022. "Output-based allocation and output-based rebates: a survey," Chapters, in: Handbook on Trade Policy and Climate Change, chapter 7, pages 94-107, Edward Elgar Publishing.
    4. Garnadt, Niklas & Grimm, Veronika & Reuter, Wolf Heinrich, 2020. "Carbon adjustment mechanisms: Empirics, design and caveats," Working Papers 11/2020, German Council of Economic Experts / Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung.
    5. Jakob, Michael, 2021. "Climate policy and international trade – A critical appraisal of the literature," Energy Policy, Elsevier, vol. 156(C).
    6. Simona Bigerna & Maria Chiara D’Errico & Paolo Polinori, 2022. "Sustainable Power Generation in Europe: A Panel Data Analysis of the Effects of Market and Environmental Regulations," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 83(2), pages 445-479, October.
    7. Neuhoff, K. & Ritz, R., 2019. "Carbon cost pass-through in industrial sectors," Cambridge Working Papers in Economics 1988, Faculty of Economics, University of Cambridge.
    8. Meunier, Guy & Montero, Juan-Pablo & Ponssard, Jean-Pierre, 2018. "Output-based allocations in pollution markets with uncertainty and self-selection," Journal of Environmental Economics and Management, Elsevier, vol. 92(C), pages 832-851.
    9. Maria-Eugenia Sanin & Sylvain Sourisseau, 2019. "Pervasive EUAs free allocation: the case of the steel industry," Documents de recherche 19-06, Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne.
    10. Woerdman Edwin & Nentjes Andries, 2019. "Emissions Trading Hybrids: The Case of the EU ETS," Review of Law & Economics, De Gruyter, vol. 15(1), pages 1-32, March.
    11. Verde, Stefano F. & Graf, Christoph & Jong, Thijs, 2019. "Installation entries and exits in the EU ETS: patterns and the delay effect of closure provisions," Energy Economics, Elsevier, vol. 78(C), pages 508-524.
    12. Stede, Jan & Pauliuk, Stefan & Hardadi, Gilang & Neuhoff, Karsten, 2021. "Carbon pricing of basic materials: Incentives and risks for the value chain and consumers," Ecological Economics, Elsevier, vol. 189(C).
    13. Misato Sato, Karsten Neuhoff, Vera Zipperer, 2017. "Benchmarks for emissions trading – general principles for emissions scope," GRI Working Papers 321, Grantham Research Institute on Climate Change and the Environment.
    14. Meunier, Guy & Montero, Juan-Pablo & Ponssard, Jean-Pierre, 2017. "Using output-based allocations to manage volatility and leakage in pollution markets," Energy Economics, Elsevier, vol. 68(S1), pages 57-65.
    15. Stede, Jan & Pauliuk, Stefan & Hardadi, Gilang & Neuhoff, Karsten, 2021. "Carbon pricing of basic materials: Incentives and risks for the value chain and consumers," Ecological Economics, Elsevier, vol. 189(C).
    16. Lange, Ian & Maniloff, Peter, 2021. "Updating allowance allocations in cap-and-trade: Evidence from the NOx Budget Program," Journal of Environmental Economics and Management, Elsevier, vol. 105(C).
    17. Stefano F. Verde & Christoph Graf & Thijs Jong and Claudio Marcantonini, 2016. "Installation entries and exits in the EU ETS industrial sector," RSCAS Working Papers 2016/19, European University Institute.
    18. Dorman,Peter, 2022. "Alligators in the Arctic and How to Avoid Them," Cambridge Books, Cambridge University Press, number 9781316516270.
    19. Cludius, Johanna & de Bruyn, Sander & Schumacher, Katja & Vergeer, Robert, 2020. "Ex-post investigation of cost pass-through in the EU ETS - an analysis for six industry sectors," Energy Economics, Elsevier, vol. 91(C).
    20. Sean Healy & Katja Schumacher & Wolfgang Eichhammer, 2018. "Analysis of Carbon Leakage under Phase III of the EU Emissions Trading System: Trading Patterns in the Cement and Aluminium Sectors," Energies, MDPI, vol. 11(5), pages 1-25, May.

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    More about this item

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • L23 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Organization of Production
    • L61 - Industrial Organization - - Industry Studies: Manufacturing - - - Metals and Metal Products; Cement; Glass; Ceramics

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