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Industry-Level Emission Trading in the EU

If the national governments give away permits to the power sector rather than selling them,
the aggregate EU efficiency gains fall close to zero as power producers use the additional
income to lower electricity prices and mitigate adverse adjustment effects of carbon
abatement on power production. Grandfathered permits, then, work as implicit output
subsidies which cause efficiency losses due to the implied distortions in the allocation of
production resources (see Bohringer, Ferris and Rutherford 1998). As can be seen from
Table 10, grandfathering further reduces negative effects on power production and even
implies significant positive output changes as compared to the baseline for various EU
countries. While grandfathering can not be defended on efficiency grounds, it significantly
reduces the dispersion of production changes in power industries across the EU countries.

Finally, note that there is an important interaction between the distribution of permit rents
and the permit price itself. Implicit subsidies to the power producers under ELE_GP lead
to lower relative prices for emission-intensive electricity generation which, in turn, creates
higher demands and higher permit prices (see Table 7 for the associated difference in
equalized marginal abatement costs between ELE_AP and ELE_GP).

4 Conclusions

In wake of the forthcoming Kyoto budget period 2008-2012, the EU is contemplating
commencement of an emission trading scheme within the Community by 2005. One major
question to be resolved is the sectoral scope of an intra-EU emission trading system.
Considering that transaction costs of an emission trading system may quickly increase with

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