Unilateral Action under an Emissions Cap
AbstractCap-and-trade programs with multiple jurisdictions such as the EU Emission Trading Scheme (EU ETS) must accommodate varying ambition among participants. Jurisdictions that value mitigation highly often consider additional unilateral action, which has two consequences: First, if the cap is binding, more mitigation in one jurisdiction enables less in other jurisdictions (waterbed effect). Second, it will reduce the price of allowances leading to even higher motivation for unilateral action, i.e. it creates a negative feedback. Both effects endanger cap and trade as a mechanism for cooperation, putting its durability at stake. Given that ambitious EU member states increasingly rely on unilateral measures in presence of a low EU ETS allowance price, there is reason to believe that the EU ETS may be nearing such a state.
We investigate a price floor for allowances (an auction reserve price) in the face of unanticipated changes in allowance demand that affects the allowance price. Using a numerical electricity market model (LIMES-EU), we investigate how a price floor affects auction revenues, and consumer and producer surplus among member states. We consider unilateral state specific minimum prices and multilateral coalitions within the EU ETS in which a subset of states enacts a minimum auction price. Finally, we consider multiple price steps that constitute a price responsive supply curve. We examine efficiency in a complex policy setting to ask if a price floor could increase the cost-effectiveness of national policy mixes, and consider distributional impacts, such as potential gains for “inactive” member states. Finally, we investigate if there is a combination of price floors and implicit or explicit transfer schemes that constitute a Pareto improvement. Tentative findings illustrate that unilateral action initiates an implicit transfer among member states and at least over some range of measures, the cost effectiveness of the climate policy portfolios can be improved.