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Industry-Level Emission Trading in the EU

the number of economic sectors involved, a reasonable approach is to include only a small
number of sectors that contribute significantly to total emissions and exhibit larger
differences in marginal abatement costs.

In this paper, we have analyzed the economic implications of restricting emission trading
to the EU power sectors as compared to unrestricted trade as well as strictly domestic
action. We find that industry-level emission trading among EU power producers already
yields a large share of potential efficiency gains from full trade. However, this results only
holds if permits are auctioned to the electricity sector and not given away for free. In the
latter case, the gains from equalization of marginal abatement costs across power
producers get absorbed up from economy-wide efficiency losses due to the implicit
subsidies for the electricity sectors.

With respect to cost distribution, the transition from purely domestic action to a
comprehensive trading system does not provide a Pareto-improvement because countries
with low marginal abatement costs may lose initial cost advantages (terms-of-trade gains)
under the no-trade case that are not offset by additional income from permit sales. On the
other hand, comprehensive trade reduces the dispersion of welfare costs across EU
countries which may be interpreted as a shift towards more "equitable" burden sharing.
Restriction of permit trade which may be defeated on transaction costs grounds can run
cross equity considerations as it accentuates the relative gains for low tax countries even
more at the expense of other countries.

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