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Carbon pricing in practice: a review of existing emissions trading systems

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Easwaran Narassimhan ORCID Icon,Kelly S. Gallagher ORCID Icon,Stefan Koester ORCID Icon &Julio Rivera Alejo

Received 08 Sep 2017, Accepted 17 Apr 2018, Published online: 06 May 2018
In this article

ABSTRACT

This article analyses the implementation of emissions trading systems (ETSs) in eight jurisdictions: the EU, Switzerland, the Regional Greenhouse Gas Initiative (RGGI) and California in the US, Québec in Canada, New Zealand, the Republic of Korea and pilot schemes in China. The article clarifies what is working, what isn’t and why, when it comes to the practice of implementing an ETS. The eight ETSs are evaluated against five main criteria: environmental effectiveness, economic efficiency, market management, revenue management and stakeholder engagement. Within each of these categories, ETS attributes − including abatement cost, stringency of the cap, improved allocation practices over time and the trajectory of price stability − are assessed for each system. Institutional learning, administrative prudence, appropriate carbon revenue management and stakeholder engagement are identified as key ingredients for successful ETS regimes. Recent implementation of ETSs in regions including California, Québec and South Korea indicates significant institutional learning from prior systems, especially the EU ETS, with these regions implementing more robust administrative and regulatory structures suitable for handling unique national and sub-national opportunities and constraints. The analysis also shows that there is potential for a ‘double dividend’ in emissions reductions even with a modest carbon price, provided the cap tightens over time and a portion of the auctioned revenues are reinvested in other emissions-reduction activities. Knowledge gaps exist in understanding the interaction of pricing instruments with other climate policy instruments and how governments manage these policies to achieve optimum emissions reductions with lower administrative costs.
Key policy insights
  • Countries are learning from each other on ETS implementation.
  • Administrative and regulatory structures of ETS jurisdictions appear to evolve and become more robust in every ETS analysed.
  • A ‘double dividend’ for emissions reductions may also exist in cases where mitigation occurs as a result of the ETS policy and when auction revenues are reinvested in other emissions-reduction activities.
KEYWORDS: Administrative capacity, allowances, auctioning, cap-and-trade, emissions cap, institutional learning, liquidity, leakage, linkage, revenue, stakeholder engagement

1. Introduction

The 2015 Paris Agreement has prompted governments to consider stronger policies to achieve decarbonization. Arguably, the most economically efficient way to reduce GHG emissions is through the use of carbon pricing policy instruments (Aldy, 2015Aldy, J. E. (2015). Pricing climate risk mitigation. Nature Climate Change, 5(5), 396–398. doi: 10.1038/nclimate2540[Crossref], [Web of Science ®], [Google Scholar]; Edenhofer et al., 2015Edenhofer, O., Jakob, M., Creutzig, F., Flachsland, C., Fuss, S., Kowarsch, M., … Steckel, J. C. (2015). Closing the emission price gap. Global Environmental Change, 31, 132–143. doi: 10.1016/j.gloenvcha.2015.01.003[Crossref], [Web of Science ®], [Google Scholar]; Metcalf & Weisbach, 2009Metcalf, G. E., & Weisbach, D.(2009). The design of a carbon tax. Harvard Environmental Law Review, 33, 499–556.[Web of Science ®], [Google Scholar]; Schmalensee & Stavins, 2015Schmalensee, R., & Stavins, R.(2015). Lessons learned from three decades of experience with cap-and-trade (No. w21742). Cambridge, MA: National Bureau of Economic Research. doi: 10.3386/w21742[Crossref], [Google Scholar]). Carbon pricing mechanisms fall into three main categories: cap-and-trade (i.e. emissions trading systems (ETS)), carbon taxation or hybrid mechanisms that combine elements of both.
This article focuses exclusively on ETSs and how they work in practice. An ETS establishes a cap either on total emissions or on emissions intensity, as measured by emissions per unit of gross domestic product (GDP). An ETS may include emissions from all GHGs or just some, such as CO2. Governments then provide allowances in the primary market,11. Primary market refers to the allowance allocation and distribution stage of an ETS, in which governments distribute emission allowances for free based on assessed firm-level quotas, through auctioning, or a combination of both.View all notestypically for free or through an auction, equal to the level of the cap (Aldy & Stavins, 2012Aldy, J. E., & Stavins, R. N. (2012). The promise and problems of pricing carbon: Theory and experience. The Journal of Environment & Development, 21(2), 152–180. doi: 10.1177/1070496512442508[Crossref], [Google Scholar]). A hybrid approach of partial auctioning and free allocation of some emission allowances is common in ETS markets. Firms may then trade allowances during a specified compliance period, after which they are surrendered to the government. Firms with lower abatement costs are expected to sell their allowances to firms with higher abatement costs in the secondary market,22. The secondary market is the ETS jurisdiction’s trading market where participating firms are allowed to buy and sell the allowances they received initially in the primary market.View all notes and overall, emissions reductions are theoretically achieved at least cost.
Each ETS evaluated here has strengths and weaknesses. This article evaluates the implementation of the ETSs of the EU, Switzerland, the Regional Greenhouse Gas Initiative (RGGI) and California in the US, Québec province in Canada, New Zealand, the Republic of Korea and China’s seven city and provincial pilots – Beijing, Shanghai, Tianjin, Chongqing, Shenzhen, Guangdong and Hubei (see Appendix 2 for a brief summary of these eight ETSs). These cases were selected to cover ETSs at the supranational, national and sub-national levels. They represent diverse geographies and a range of inception dates, allowing us to identify best practices, linkage opportunities and learning within and across systems, and knowledge spillovers, if any, from older to newer systems.
The ETSs are evaluated against five main criteria: environmental effectiveness, economic efficiency, market management, revenue management and stakeholder engagement. Within each of these categories, ETS attributes including abatement cost, stringency of the cap, improved allocation practices over time and the trajectory of price stability are assessed for each system. Past scholarly literature on ETSs typically assessed the environmental and economic effectiveness of one particular jurisdiction or comparatively for sub-regions within a higher jurisdiction (Haites et al., 2018Haites, E., Maosheng, D., Gallagher, K. S., Mascher, S., Narassimhan, E., Richards, K. R., & Wakabayashi, M.(2018, January). Experience with carbon taxes and greenhouse gas emissions trading systems. Retrieved from SSRN:https://ssrn.com/abstract=3119241. doi: 10.2139/ssrn.3119241[Crossref], [Google Scholar]; see Appendix 1 of the supplementary section for a list of key existing studies). This article, however, evaluates ETS implementation across different levels of jurisdiction and geographies, and over time. Other performance attributes besides environmental and economic effectiveness are assessed as discussed in Section 2.
The article is organized as follows: Section 2 introduces the methodological framework employed to evaluate the performance of the eight ETSs. Section 3 compares the implementation of the ETSs using the methodological framework. Sections 4 and 5 provide key findings, identify knowledge gaps in existing literature and recommend key areas for future research.

2. Methods

Key design considerations for an ETS include determining which GHGs and which sectors will be regulated under the cap; at what point of regulation emissions will be regulated (upstream or downstream); the stringency of the cap (or the total allowable emissions); costs of abatement, compliance and ETS administration; method of allowance allocation and distribution; monitoring, reporting and verification (MRV) of emissions and allowances; and impacts on international competitiveness (PMR and ICAP, 2016PMR & ICAP. (2016). Emissions trading in practice: A handbook on design and implementation. Washington, DC: Partnership on Market Readiness (PMR), International Carbon Action Partnership (ICAP), and World Bank. [Google Scholar]; Schmalensee & Stavins, 2017Schmalensee, R., & Stavins, R. N.(2017). The design of environmental markets: What have we learned from experience with cap and trade? Oxford Review of Economic Policy, 33(4), 572–588. doi: 10.1093/oxrep/grx040[Crossref], [Web of Science ®], [Google Scholar]). Additional considerations include policies that provide system flexibility such as banking credits for future compliance and borrowing credits from future compliance periods, creation of an allowance reserve to stabilize secondary market prices and ensure liquidity, creation of new trading registries to monitor and track carbon allowance markets, accounting for carbon offsets, international linkage, revenue management and stakeholder engagement (PMR and ICAP, 2016PMR & ICAP. (2016). Emissions trading in practice: A handbook on design and implementation. Washington, DC: Partnership on Market Readiness (PMR), International Carbon Action Partnership (ICAP), and World Bank. [Google Scholar]; Schmalensee & Stavins, 2017Schmalensee, R., & Stavins, R. N.(2017). The design of environmental markets: What have we learned from experience with cap and trade? Oxford Review of Economic Policy, 33(4), 572–588. doi: 10.1093/oxrep/grx040[Crossref], [Web of Science ®], [Google Scholar]).
Based on these attributes, we created a qualitative evaluation framework to assess the relative performance of the eight ETSs against five main criteria: environmental effectiveness, economic efficiency, market management, revenue management and stakeholder engagement, and 18 sub-attributes (see Table 1). Based on a detailed review of the existing literature, we appraise the performance of the ETSs for each criterion and characterize each attribute as functioning at a low, medium or high level (Anger, Asane-Otoo, Böhringer, & Oberndorfer, 2016Anger, N., Asane-Otoo, E., Böhringer, C., & Oberndorfer, U.(2016). Public interest versus interest groups: A political economy analysis of allowance allocation under the EU emissions trading scheme. International Environmental Agreements: Politics, Law and Economics, 16(5), 621–638. doi: 10.1007/s10784-015-9285-6[Crossref], [Web of Science ®], [Google Scholar]; Álvarez & André, 2015Álvarez, F., & André, F. J. (2015). Auctioning versus grandfathering in cap-and-trade systems with market power and incomplete information. Environmental and Resource Economics, 62(4), 873–906. doi: 10.1007/s10640-014-9839-z[Crossref], [Web of Science ®], [Google Scholar]; Burtraw & McCormack, 2017Burtraw, D., & McCormack, K.(2017). Consignment auctions of free emissions allowances. Energy Policy, 107, 337–344. doi: 10.1016/j.enpol.2017.04.041[Crossref], [Web of Science ®], [Google Scholar]; Haites, 2016Haites, E. (2016). Experience with linking greenhouse gas emissions trading systems. Wiley Interdisciplinary Reviews: Energy and Environment, 5(3), 246–260. doi: 10.1002/wene.191[Crossref], [Web of Science ®], [Google Scholar]; Holt & Shobe, 2015Holt, C. A., & Shobe, W. (2015). Price and quantity ‘collars’ for stabilizing emissions allowance prices: An experimental analysis of the EU ETS market stability reserve. [Google Scholar]; Ji, Zhang, & Yang, 2017Ji, J., Zhang, Z., & Yang, L. (2017). Comparisons of initial carbon allowance allocation rules in an O2O retail supply chain with the cap-and-trade regulation. International Journal of Production Economics, 187, 68–84. doi: 10.1016/j.ijpe.2017.02.011[Crossref], [Web of Science ®], [Google Scholar]; Schmalensee & Stavins, 2015Schmalensee, R., & Stavins, R.(2015). Lessons learned from three decades of experience with cap-and-trade (No. w21742). Cambridge, MA: National Bureau of Economic Research. doi: 10.3386/w21742[Crossref], [Google Scholar]; and studies listed in Appendix 1 of the supplementary section).

Table 1. Assessment framework for comparing ETS regimes.

3. Comparative assessment of ETS regimes

3.1. Environmental effectiveness

The environmental effectiveness of each ETS is assessed based on the number of key emitting sectors covered in the jurisdiction’s overall climate policy, the quantity of emissions included under a cap relative to the jurisdiction’s ETS-covered emissions, the tightening of the cap over time and emissions reduction achieved (Haites et al., 2018Haites, E., Maosheng, D., Gallagher, K. S., Mascher, S., Narassimhan, E., Richards, K. R., & Wakabayashi, M.(2018, January). Experience with carbon taxes and greenhouse gas emissions trading systems. Retrieved from SSRN:https://ssrn.com/abstract=3119241. doi: 10.2139/ssrn.3119241[Crossref], [Google Scholar]). The coverage of key emitting sectors is assessed based on whether the ETS covers the major emitting sectors and a majority of the GHGs, or at least covers sectors that are not otherwise covered by alternative carbon mitigation policies. The proportion of total covered emissions capped under the ETS and the rate at which the cap is tightened over time is used to assess the stringency of the programme. A cap nearly equal to the covered sector’s business as usual (BAU) emission levels without a tightening schedule for future years would mean that the system is not inducing emissions reductions beyond reductions in the emissions intensity of its economy. Table 2 provides a summary of the environmental benchmarks compared across the ETS cases.

Table 2. Environmental effectiveness of ETS regimes.

3.1.1. Coverage of key emitting sectors

All the ETSs fall short of a 100% economy-wide cap either because the entire economy is not capped or only some GHGs are regulated. California and Québec, whose ETSs are bilaterally linked, regulate the most with their second compliance period covering 85% of GHG emissions (including the energy-intensive transport sector). The RGGI system regulates only CO2 in the electricity sectors of the nine participating states, namely, Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island and Vermont. Regulated CO2 emissions total to 20% of its sub-jurisdiction’s total GHG emissions (Ramseur, 2017Ramseur, J. L. (2017). The regional greenhouse gas initiative: Lessons learned and issues for congress (No. R41836). Washington, DC: Congressional Research Service. [Google Scholar]), leaving emissions-intensive sectors such as transportation unregulated. New Zealand, Korea and China’s pilot programmes fall short of achieving full coverage using their ETS or other climate policies. Although the New Zealand (NZ) ETS requires all sectors to report emissions, purchase and surrender New Zealand Units (NZU), it exempts biological emissions from agriculture (Ministry for the Environment, 2016aMinistry for the Environment. (2016a). The New Zealand emissions trading scheme evaluation 2016(Evaluation report no. ME 1129). Wellington: Ministry for the Environment. [Google Scholar]). The New Zealand economy is driven by primary production and biological gases (i.e. methane and nitrous oxide) account for 54% of New Zealand’s GHG emissions (Parliamentary Commissioner for the Environment, 2016Parliamentary Commissioner for the Environment. (2016). Climate change and agriculture: Understanding the biological greenhouse gases. Wellington: Parliamentary Commissioner for the Environment. [Google Scholar]), effectively reducing the overall GHG coverage by half. The EU ETS covers about 45% of the jurisdiction’s GHG emissions with some national-level carbon taxes such as in Norway, Sweden and Ireland, covering remaining GHG emissions in their respective jurisdictions.

3.1.2. Emissions cap and stringency

Emissions caps can be set as an absolute cap in tons of GHGs or as a cap on GHG intensity, denoted in terms of GHG per unit of GDP. The level of the cap can be decided using a ‘top-down’ approach of imposing estimated emission reductions or through a ‘bottom-up’ approach of participating entities or regions reporting projected emissions reductions for a compliance period (Ellerman, Buchner, & Carraro, 2007Ellerman, A. D., Buchner, B. K., & Carraro, C. (2007). Allocation in the European emissions trading scheme: Rights, rents and fairness. Cambridge: Cambridge University Press.[Crossref], [Google Scholar]). In order to establish an appropriate top-down emissions cap, regulators need reliable estimates on current and likely future emissions (Munnings, Morgenstern, Wang, & Liu, 2016Munnings, C., Morgenstern, R. D., Wang, Z., & Liu, X. (2016). Assessing the design of three carbon trading pilot programs in China. Energy Policy, 96, 688–699. doi: 10.1016/j.enpol.2016.06.015[Crossref], [Web of Science ®], [Google Scholar]). Similarly, for a bottom-up cap to be effective, regulators must have reliable information regarding current firm-level emissions and the emissions-reduction potential of the participating firms or regions. Either way, an information asymmetry exists because firms hold the information needed by regulators. This challenge can be addressed by establishing an emissions inventory system with mandatory reporting prior to the initiation of the programme or by using the ETS market itself to discover the real price of abatement. The first report on verified emissions published by the European Commission at the aggregated EU-wide level had a dramatic impact on the carbon price, which fell by almost 50% in a few days as surrendered allowances in the first phase indicated that the nationally aggregated emissions cap had resulted in an overestimation of 125 million allowances (Chevallier, 2011Chevallier, J. (2011). Carbon price drivers: An updated literature review. [Google Scholar]). Since there was no provision to bank allowances between phase one and later phases, the prices collapsed further. Since phase two, the EU has allowed banking between phases. In phase three, the system has transitioned to a jurisdiction-wide cap that decreases 1.74% per year (Ellerman & Buchner, 2008Ellerman, A. D., & Buchner, B. K.(2008). Over-allocation or abatement? A preliminary analysis of the EU ETS based on the 2005–06 emissions data. Environmental and Resource Economics, 41, 267–287. doi: 10.1007/s10640-008-9191-2[Crossref], [Web of Science ®], [Google Scholar]; Meadows, 2017Meadows, D. (2017). Update on the EU ETS and EU climate policy. Luxembourg: European Commission. [Google Scholar]; Schmalensee & Stavins, 2015Schmalensee, R., & Stavins, R.(2015). Lessons learned from three decades of experience with cap-and-trade (No. w21742). Cambridge, MA: National Bureau of Economic Research. doi: 10.3386/w21742[Crossref], [Google Scholar]). The EU ETS also implemented an EU Transaction Log (EUTL) to track the trading of allowances within each member country (Frunza, 2013Frunza, M. (2013). Fraud and carbon markets: The carbon connection. Abingdon: Routledge. [Google Scholar]).
Switzerland calculated the emissions-abatement potential of each participating firm individually before allocating allowances and allowed firms to voluntarily opt in to the ETS programme (CDC et al., 2015bCDC, EDF, & IETA. (2015b). Switzerland: An emissions trading case study. Brussels: CDC Climate Research, Environmental Defense Fund (EDF) and IETA. [Google Scholar]). To align with the EU ETS, Switzerland made its emissions cap mandatory for all of its participants in the second compliance period with a 1.74% decrease per year.
RGGI, California and Québec set top-down emissions caps based on projected emission levels calculated using estimates of future economic growth. RGGI and California also factored in the effect of complementary policies on total emissions. In spite of careful projections, the emissions cap of 188 million tons that RGGI set in 2005 ended up being too high, as actual emissions were 124 million tons when the programme launched in 2009. This overallocation in the case of RGGI did not represent a substantial problem for the market due to the creation of a price floor which kept allowance prices from falling to near zero. Excess allowances, roughly 23%, were permanently removed from the market after the first compliance period (RGGI, 2017bRGGI Inc. (2017b). Distribution of first control period CO2 allowances. Retrieved fromhttps://www.rggi.org/sites/default/files/Uploads/Allowance-Tracking/FCP_Allowance-Distribution.pdf [Google Scholar], 2017eRGGI Inc. (2017e). Distribution of second control period CO2 allowances. Retrieved fromhttps://www.rggi.org/sites/default/files/Uploads/Allowance-Tracking/SCP_Allowance-Distribution.pdf [Google Scholar]). Lower electricity demand resulting from energy-efficiency improvements, an economic downturn, fuel switching from coal to natural gas and additions of nuclear, wind and solar generation all contributed to the overallocation of allowances (Jones, Atten, & Bangston, 2017Jones, B. M., Atten, C. V., & Bangston, K. (2017). A pioneering approach to carbon markets: How the northeast states redefined cap and trade for the benefit of consumers. Concord, MA: MJ Bradley. [Google Scholar]; RGGI, 2010RGGI Inc. (2010). Relative effects of various factors on RGGI electricity sector CO2 emissions: 2009 compared to 2005. New York: New York Energy Research and Development Authority. [Google Scholar]). RGGI authorities corrected course and set a 44% lower cap in the next compliance period with an annual reduction of 2.5% until 2020 (Ramseur, 2017Ramseur, J. L. (2017). The regional greenhouse gas initiative: Lessons learned and issues for congress (No. R41836). Washington, DC: Congressional Research Service. [Google Scholar]). While the EU ETS and RGGI initially suffered from miscalculated top-down emission caps, the credibility of Korea’s ETS cap has also been questioned for its heavy reliance on a bottom-up approach using reporting from manufacturers to derive an abatement target, while discounting the concerns of environmental organizations and civil society (Kim, 2015Kim, M. (2015). A study on the impact analysis of introducing emission trading system on CBP market and policy implications. The Transactions of the Korean Institute of Electrical Engineers, 64(5), 667–679. doi: 10.5370/KIEE.2015.64.5.667[Crossref], [Google Scholar]).
The NZ ETS originally operated without a nationwide cap in order to accommodate carbon sequestration from its forestry sector and unlimited international offsets from the Kyoto Protocol’s clean development mechanism (CDM). With the allowance supply restricted to domestic NZU units, the system is moving towards an effective fixed cap that equals the annual free allocations and forest carbon removal allowances issued (ICAP, 2017cICAP. (2017c). New Zealand emissions trading scheme (NZ ETS). Berlin: International Carbon Action Partnership. [Google Scholar]). Finally, the Chinese ETS pilots vary significantly in the way they set their emissions targets with Guangdong choosing an absolute cap, Shanghai allocating allowances without announcing an emissions cap, and Shenzhen issuing both intensity and absolute caps for the 2013–2015 period. It is unclear whether Guangdong, Shanghai and Shenzhen did economic assessments to estimate their current and future CO2emissions (Munnings et al., 2016Munnings, C., Morgenstern, R. D., Wang, Z., & Liu, X. (2016). Assessing the design of three carbon trading pilot programs in China. Energy Policy, 96, 688–699. doi: 10.1016/j.enpol.2016.06.015[Crossref], [Web of Science ®], [Google Scholar]). Reflecting the variation in economic conditions between the Chinese cities, Guangdong increased its emissions cap to allow for increased industrial production, Hubei decreased its cap to reflect new economic growth patterns, Chongqing reduced its cap by 4.13% a year, and Beijing, Shanghai, Tianjin and Shenzhen kept their caps unchanged between 2013 and 2015 (Xiong, Shen, Qi, Price, & Ye, 2017Xiong, L., Shen, B., Qi, S., Price, L., & Ye, B. (2017). The allowance mechanism of China’s carbon trading pilots: A comparative analysis with schemes in EU and California. Applied Energy, 185, 1849–1859. doi: 10.1016/j.apenergy.2016.01.064[Crossref], [Web of Science ®], [Google Scholar]).

3.1.3. Emissions reductions achieved

Emissions reductions achieved by an ETS can be measured by the change in actual emissions covered by the ETS (Haites et al., 2018Haites, E., Maosheng, D., Gallagher, K. S., Mascher, S., Narassimhan, E., Richards, K. R., & Wakabayashi, M.(2018, January). Experience with carbon taxes and greenhouse gas emissions trading systems. Retrieved from SSRN:https://ssrn.com/abstract=3119241. doi: 10.2139/ssrn.3119241[Crossref], [Google Scholar]), but it is difficult to directly attribute these results to the ETS in jurisdictions with other complementary emissions-reduction policies. The endogenous and simultaneous nature of interaction between complementary policies such as feed-in tariffs or energy efficiency performance standards, and the ETS, makes it difficult to estimate the net impact of an ETS on overall emissions reduction (Hood, 2013Hood, C. (2013). Managing interactions between carbon pricing and existing energy policies (Report). Paris: IEA Insights Publication. [Google Scholar]). With this caveat, we provide existing estimates of emissions reduced across the ETS programmes.
For the EU, studies estimate that a 2.5–5% total emissions reduction (about 150–300 MMTCO2e) was achieved during phase one and a 6.3% reduction (i.e. 260 MMTCO2e) between 2008 and 2009 in phase two of the EU ETS against baseline emissions (Brown, Hanafi, & Petsonk, 2012Brown, L. M., Hanafi, A., & Petsonk, A. (2012). The EU emissions trading system: Results and lessons learned. Washington, DC: Environmental Defense Fund. [Google Scholar]; Hu, Crijns-Graus, Lam, & Gilbert, 2015Hu, J., Crijns-Graus, W., Lam, L., & Gilbert, A. (2015). Ex-ante evaluation of EU ETS during 2013–2030: EU-internal abatement. Energy Policy, 77, 152–163. doi: 10.1016/j.enpol.2014.11.023[Crossref], [Web of Science ®], [Google Scholar]). Another study estimates that an average annual emissions reduction in the range of 40 to 80 MMTCO2eper year, (i.e. 2 to 4% of total capped emissions) is attributable to the EU ETS in phases one and two (Laing, Sato, Grubb, & Comberti, 2014Laing, T., Sato, M., Grubb, M., & Comberti, C. (2014). The effects and side-effects of the EU emissions trading scheme. Wiley Interdisciplinary Reviews: Climate Change, 5(4), 509–519. doi:10.1002/wcc.283doi: 10.1002/wrna.1227[Crossref], [Web of Science ®], [Google Scholar]). Bel and Joseph (2015Bel, G., & Joseph, S. (2015). Emission abatement: Untangling the impacts of the EU ETS and the economic crisis. Energy Economics, 49, 531–539. doi: 10.1016/j.eneco.2015.03.014[Crossref], [Web of Science ®], [Google Scholar]), however, estimate that most emissions reductions are likely to be linked to the 2008 economic crisis so the impact of the EU ETS is just 11.5% to 13.8% of the total GHG emissions reduced during phases one and two (Bel & Joseph, 2015Bel, G., & Joseph, S. (2015). Emission abatement: Untangling the impacts of the EU ETS and the economic crisis. Energy Economics, 49, 531–539. doi: 10.1016/j.eneco.2015.03.014[Crossref], [Web of Science ®], [Google Scholar]). In phase three, verified GHG emissions from fixed installations covered by the ETS decreased 2.9% from 2015 to 2016 while the EU’s total GHG emissions fell by 0.7% in the same period (European Commission, 2017bEuropean Commission. (2017b). Report from the commission to the European parliament and the council: Two years after Paris – progress towards meeting the EU’s climate commitments. Luxembourg: Publications Office of the European Union. (EC). [Google Scholar]). With new measures to reduce the allowance surplus in phase three, the EU ETS is anticipated to induce greater emission reductions after 2025 (Hu et al., 2015Hu, J., Crijns-Graus, W., Lam, L., & Gilbert, A. (2015). Ex-ante evaluation of EU ETS during 2013–2030: EU-internal abatement. Energy Policy, 77, 152–163. doi: 10.1016/j.enpol.2014.11.023[Crossref], [Web of Science ®], [Google Scholar]). For Switzerland, there is no literature analysing the impact of the Swiss ETS programme on the country’s overall emissions mitigation trajectory (FOEN, 2016aFOEN. (2016a). Evaluation of incentive effect of emissions trading scheme (Federal audit). Bern: Federal Office for the Environment FOEN. [Google Scholar]). Similar to Switzerland, there are no studies estimating the emissions reduced by the Chinese ETS pilots since their implementation in 2013.
In the RGGI jurisdiction, economy-wide CO2 emissions dropped 35% between 2009 and 2014 compared with a 12% drop in non-RGGI states during the same period (CERES, 2015CERES. (2015). The regional greenhouse gas initiative: A fact sheet. Retrieved fromhttps://www.ceres.org/sites/default/files/Fact20Sheets20or20misc20files/RGGI20Fact20Sheet.pdf [Google Scholar]). CO2 emissions in the electricity sector (the sector regulated by RGGI) dropped 52.3% between 2009 and 2012 (Murray & Maniloff, 2015Murray, B. C., & Maniloff, P. T.(2015). Why have greenhouse emissions in RGGI states declined? An econometric attribution to economic, energy market, and policy factors. Energy Economics, 51, 581–589. doi: 10.1016/j.eneco.2015.07.013[Crossref], [Web of Science ®], [Google Scholar]). Although these emissions reductions cannot be solely attributed to RGGI due to the presence of other policies and factors such as the renewable portfolio standard (RPS), economic recession and lower natural gas prices, total emissions in the jurisdiction’s electricity sector in this period could have been 24% higher in the absence of the programme (Murray & Maniloff, 2015Murray, B. C., & Maniloff, P. T.(2015). Why have greenhouse emissions in RGGI states declined? An econometric attribution to economic, energy market, and policy factors. Energy Economics, 51, 581–589. doi: 10.1016/j.eneco.2015.07.013[Crossref], [Web of Science ®], [Google Scholar]).
The California Air Resources Board (CARB) estimates that California is on track to reduce its emissions to 1990 levels by 2020. Emissions of regulated entities were estimated to be 9% below the 2014 annual cap of 160 MMTCO2e at the end of the first compliance period (Camuzeaux, 2015Camuzeaux, J. (2015, November). Cap and trade under AB 32 – Now it’s an “official success”. Retrieved fromhttp://blogs.edf.org/climatetalks/2015/11/05/cap-and-trade-under-ab-32-now-its-an-official-success/ [Google Scholar]). It is too early to know how much the Québec system has reduced its emissions, but in 2013, a 7.5% reduction from 2005 levels was calculated for the province, although not directly attributable to the ETS (Government of Canada, 2016Government of Canada. (2016). Canada’s second biennial report on climate change. Gatineau: Environment and Climate Change Canada. [Google Scholar]).
In New Zealand, Bertram and Terry (2010Bertram, G., & Terry, S. (2010). The carbon challenge. Wellington: Bridget Williams Books. [Google Scholar]) conclude that domestic emissions were reduced by only 23 MMTCO2e in 2008 and 19 MMTCO2e in 2009. Free allowances to emissions intensive and trade exposed (EITE) firms, the absence of a nationwide emissions cap and an international offset cap until 2015 allowed many ETS participants to meet their obligations without real reductions in firm-level emissions (Bullock, 2012Bullock, D. (2012). Emissions trading in New Zealand: Development, challenges and design. Environmental Politics, 21(4), 657–675. doi: 10.1080/09644016.2012.688359[Taylor & Francis Online], [Web of Science ®], [Google Scholar]). Similarly, in Korea, a lack of liquidity and the political nature of allowance allocations reduced confidence in the system (Kim, 2015Kim, M. (2015). A study on the impact analysis of introducing emission trading system on CBP market and policy implications. The Transactions of the Korean Institute of Electrical Engineers, 64(5), 667–679. doi: 10.5370/KIEE.2015.64.5.667[Crossref], [Google Scholar]; PMR & ICAP, 2016PMR & ICAP. (2016). Emissions trading in practice: A handbook on design and implementation. Washington, DC: Partnership on Market Readiness (PMR), International Carbon Action Partnership (ICAP), and World Bank. [Google Scholar]). Market liquidity has remained stagnant, resulting in negligible amount of emissions being traded in the early phase (Suk, Lee, & Jeong, 2017Suk, S., Lee, S., & Jeong, Y. S. (2017). The Korean emissions trading scheme: Business perspectives on the early years of operations. Climate Policy, 1–14. doi: 10.1080/14693062.2017.1346499[Taylor & Francis Online], [Google Scholar]).

3.2. Economic efficiency

The economic efficiency of an ETS is assessed based on the marginal cost of abatement and cost of compliance (i.e. MRV costs) for firms regulated under an ETS, and the government’s cost of administering the ETS (PMR & ICAP, 2016PMR & ICAP. (2016). Emissions trading in practice: A handbook on design and implementation. Washington, DC: Partnership on Market Readiness (PMR), International Carbon Action Partnership (ICAP), and World Bank. [Google Scholar]). In general, it was difficult to find compliance and administrative costs in the literature, and this is one knowledge gap that should be addressed through future research.
The marginal costs of abatement provided in Table 3 do not always help us assess the cost effectiveness of a system because sectors that are difficult to regulate are often exempted from the ETS. For instance, the RGGI has one of the lowest marginal abatement costs ($4.50 in 2016) but the system does not regulate the jurisdiction’s energy intensive transport sector. California has a higher marginal abatement cost ($12.83 in 2016) but covers more than three fourths of the economy’s emissions including electricity, transport and industrial sectors.

Table 3. Economic efficiency of ETS regimes.

The methodological framework assesses an ETS with low permit prices, a low cost of compliance and low administration costs as the best performing system (see Table 1). However, the framework is limited in its assessment of efficiency when considering the alternative non-market-based policies that currently or in the future may cover the emissions not covered by an ETS. Covering economy-wide emissions under a market-based policy like ETS is likely to be more cost effective than non-ETS sectors regulated by non-market based environmental policies (Schmalensee & Stavins, 2017Schmalensee, R., & Stavins, R. N.(2017). The design of environmental markets: What have we learned from experience with cap and trade? Oxford Review of Economic Policy, 33(4), 572–588. doi: 10.1093/oxrep/grx040[Crossref], [Web of Science ®], [Google Scholar]).

3.3. Market management

In the primary market, the performance of allowance allocation can be assessed by examining the current method of allocations, the change in allocation methodology over time and the percentage of allowances auctioned (see Table 4). When compared to auctioning, free allocations affect the efficiency of allowance trading with poor price discovery in the market, and lack of transparency in transferring allowance value to firms can affect the fairness of the ETS (Burtraw & McCormack, 2017Burtraw, D., & McCormack, K.(2017). Consignment auctions of free emissions allowances. Energy Policy, 107, 337–344. doi: 10.1016/j.enpol.2017.04.041[Crossref], [Web of Science ®], [Google Scholar]) to both ETS and non-ETS participants (Anger et al., 2016Anger, N., Asane-Otoo, E., Böhringer, C., & Oberndorfer, U.(2016). Public interest versus interest groups: A political economy analysis of allowance allocation under the EU emissions trading scheme. International Environmental Agreements: Politics, Law and Economics, 16(5), 621–638. doi: 10.1007/s10784-015-9285-6[Crossref], [Web of Science ®], [Google Scholar]). Grandfathering (i.e. allocating permits based on historical emissions), fixed-sector benchmarking (i.e. based on a product or sector’s historical or current emissions) and output-based allocation (i.e. based on a firm’s current output) are the most common approaches for free allocation (PMR & ICAP, 2016PMR & ICAP. (2016). Emissions trading in practice: A handbook on design and implementation. Washington, DC: Partnership on Market Readiness (PMR), International Carbon Action Partnership (ICAP), and World Bank. [Google Scholar]). Within free allocations, fixed-sector benchmarking and output-based allocation can be relatively more effective in inducing low carbon production compared to grandfathering (Cong & Wei, 2010Cong, R. G., & Wei, Y. M. (2010). Potential impact of (CET) carbon emissions trading on China’s power sector: A perspective from different allowance allocation options. Energy, 35(9), 3921–3931. doi: 10.1016/j.energy.2010.06.013[Crossref], [Web of Science ®], [Google Scholar]; Zhang, Wang, & Tan, 2015Zhang, Y. J., Wang, A. D., & Tan, W.(2015). The impact of China's carbon allowance allocation rules on the product prices and emission reduction behaviors of ETS-covered enterprises. Energy Policy, 86, 176–185. doi: 10.1016/j.enpol.2015.07.004[Crossref], [Web of Science ®], [Google Scholar]; Zetterberg, 2014Zetterberg, L. (2014). Benchmarking in the European Union emissions trading system: abatement incentives. Energy Economics, 43, 218–224. doi:10.1016/j.eneco.2014.03.002[Crossref], [Web of Science ®], [Google Scholar]), particularly in emissions-intensive firms (Ji et al., 2017Ji, J., Zhang, Z., & Yang, L. (2017). Comparisons of initial carbon allowance allocation rules in an O2O retail supply chain with the cap-and-trade regulation. International Journal of Production Economics, 187, 68–84. doi: 10.1016/j.ijpe.2017.02.011[Crossref], [Web of Science ®], [Google Scholar]). Hence, a system with 100% free allocations based on grandfathering of historical emissions is classified as low-performing, while a system with complete auctioning or partial free allocations benchmarked on a firm’s emissions inventory is classified as high performing (see Table 1).

Table 4. Market management in ETS regimes.

Similarly, indicators such as price stability, existence of an allowance reserve, price ceiling or price floor, banking and borrowing, percentage of offset credits allowed and the volume of trading in the market (i.e. liquidity) illuminate the tension between achieving long-term policy certainty while maintaining system flexibility to adjust to unforeseen circumstances. In this study, a system is assessed as low performing if there is no pre-determined annual emissions cap for future years and no price containment measures, but the system would qualify as high performing if there is a set annual cap that decreases at a pre-determined rate every year, along with both price containment and emissions containment features, with a price collar rather than a quantity collar (Holt & Shobe, 2015Holt, C. A., & Shobe, W. (2015). Price and quantity ‘collars’ for stabilizing emissions allowance prices: An experimental analysis of the EU ETS market stability reserve. [Google Scholar]). Banking of allowances to future periods is often used as a tool that provides temporal flexibility and results in cost efficiency over time (PMR & ICAP, 2016PMR & ICAP. (2016). Emissions trading in practice: A handbook on design and implementation. Washington, DC: Partnership on Market Readiness (PMR), International Carbon Action Partnership (ICAP), and World Bank. [Google Scholar]). Hence, we use banking of allowances as a criterion to assess a system as better performing. Borrowing of allowances can happen either within years in a multi-year compliance period or between different compliance periods. Finally, linkage with other external markets could be compared across ETSs based on whether the market is unilaterally linked to international offsets (with or without limits on the amount of offset credits that may be purchased by a firm) or bilaterally linked with another jurisdiction, with or without mutual recognition of a compliance mechanism (Haites, 2016Haites, E. (2016). Experience with linking greenhouse gas emissions trading systems. Wiley Interdisciplinary Reviews: Energy and Environment, 5(3), 246–260. doi: 10.1002/wene.191[Crossref], [Web of Science ®], [Google Scholar]).

3.3.1. Allowance allocation and distribution

Once an emissions cap is defined, policy makers must choose whether to auction or freely allocate allowances. The basis for free allowance calculations includes the use of historical emissions, historical emissions intensity, industrial benchmarks that differentiate allocations based on the nature of a product or the production process, early-action incentives that reward new entrants with credits for emissions-reducing activities prior to enrolment and rolling baseline years that allow firms to be benchmarked on their latest emissions data if their emissions increased significantly from the original benchmark (European Commission, 2011European Commission. (2011). Guidance on allocation methodologies (Guidance document). Brussels: European Commission. [Google Scholar]; Pang & Duan, 2016Pang, T., & Duan, M. (2016). Cap setting and allowance allocation in China's emissions trading pilot programmes: Special issues and innovative solutions. Climate Policy, 16(7), 815–835. doi: 10.1080/14693062.2015.1052956[Taylor & Francis Online], [Web of Science ®], [Google Scholar]; PMR & ICAP, 2016PMR & ICAP. (2016). Emissions trading in practice: A handbook on design and implementation. Washington, DC: Partnership on Market Readiness (PMR), International Carbon Action Partnership (ICAP), and World Bank. [Google Scholar]; Xiong et al., 2017Xiong, L., Shen, B., Qi, S., Price, L., & Ye, B. (2017). The allowance mechanism of China’s carbon trading pilots: A comparative analysis with schemes in EU and California. Applied Energy, 185, 1849–1859. doi: 10.1016/j.apenergy.2016.01.064[Crossref], [Web of Science ®], [Google Scholar]; Ye, Jiang, Miao, Li, & Peng, 2016Ye, B., Jiang, J., Miao, L., Li, J., & Peng, Y. (2016). Innovative carbon allowance allocation policy for the Shenzhen emission trading scheme in China. Sustainability, 8(1), 3. doi: 10.3390/su8010003[Crossref], [Web of Science ®], [Google Scholar]). Each ETS scheme uses a combination of these features when calculating their free allowance allocations to individual firms.
The EU ETS was initiated with a politically palatable, free, grandfathered allowance-allocation method, based on bottom-up reporting of historical emissions by firms in each member state in its first compliance period. In phase 2, the EU ETS mostly distributed free allowances based on a product’s benchmarked emissions and historical production levels along with 3% auctioning (European Commission, 2011European Commission. (2011). Guidance on allocation methodologies (Guidance document). Brussels: European Commission. [Google Scholar]; ICAP, 2017fICAP. (2017f). EU ETS. Berlin: International Carbon Action Partnership. [Google Scholar]). Since phase 3, the EU ETS has auctioned 40% of its allowances with 100% in electricity and 15% in the aviation sector, while allocating freely to the manufacturing sector. California initially calculated its allocations based on a benchmarked, three-year moving-average output for each industry. Electric utilities were given free allowances and required to consign the allowances to a state-run auction. The utilities were mandated to use the proceeds from the auction on investments in energy efficiency and renewable energy for the benefit of the rate payers. Electricity generating units had to purchase allowances from the state-run auctions. In the second trading period (2013–2020), California uses a mix of free allocations, auctioning and fixed price allowance sales for different sectors (see Table 4) (ICAP, 2017hICAP. (2017h). USA – California cap-and-trade program. Berlin: International Carbon Action Partnership. [Google Scholar]). Québec allocated allowances freely based on an entity’s historical emissions intensity from 2007–2010. However, during the second trading period, Québec harmonized its ETS with California, in preparation for linkage with the Californian system. The Swiss ETS has gone one step further in protecting its EITE sectors, by not only allocating most allowances for free, but also offering early-action credits and redistribution benefits from its CO2 levy revenue for ETS-participating firms that are exempt from the CO2 levy (FOEN, 2016aFOEN. (2016a). Evaluation of incentive effect of emissions trading scheme (Federal audit). Bern: Federal Office for the Environment FOEN. [Google Scholar]).
Along similar lines, the NZ ETS gave preferential treatment to its EITE sectors (i.e. agriculture and land use sectors) by assigning free allowances based on grandfathered historical emissions, fixed until 2018, with a linear phase-out of free allowances starting in 2019 and moving to full auctioning by 2030 (Bullock, 2012Bullock, D. (2012). Emissions trading in New Zealand: Development, challenges and design. Environmental Politics, 21(4), 657–675. doi: 10.1080/09644016.2012.688359[Taylor & Francis Online], [Web of Science ®], [Google Scholar]). With a change in government, New Zealand also introduced a ‘transition period’ where non-forestry sector participants were required to meet only half of their emission obligations (i.e. by surrendering one allowance for two units of emissions) with the price of NZUs capped at 25 NZ dollars (i.e. NZ $12.5 effective price per allowance) and the convertibility of NZUs to international offset units limited to prevent arbitrage when allowance prices are capped (Bertram & Terry, 2008Bertram, G., & Terry, S. (2008). The carbon challenge: Response, responsibility, and the emissions trading scheme. Wellington: Sustainability Council of New Zealand. [Google Scholar]; Bullock, 2012Bullock, D. (2012). Emissions trading in New Zealand: Development, challenges and design. Environmental Politics, 21(4), 657–675. doi: 10.1080/09644016.2012.688359[Taylor & Francis Online], [Web of Science ®], [Google Scholar]; ICAP, 2017cICAP. (2017c). New Zealand emissions trading scheme (NZ ETS). Berlin: International Carbon Action Partnership. [Google Scholar]). This essentially protected emitters from carrying the full cost of compliance. Eventually, the New Zealand government decided to phase out its one-for-two transitional measure by 2019 in order to meet its climate change targets and incentivize firm-level emissions reductions (Ministry for the Environment, 2016bMinistry for the Environment. (2016b). Phase out of the one-for-two transitional measure from the New Zealand emissions trading scheme(Factsheet no. INFO 760). Wellington, NZ: Ministry for the Environment. [Google Scholar]).
Korea’s ETS established its emissions target through consultation with its EITE industries. In 2015, at the beginning of the Korean ETS (KETS) programme, it allocated allowances freely and provided early action credits for new entrants (Song, Lim, & Yoo, 2015Song, T., Lim, K., & Yoo, S. (2015). Estimating the public’s value of implementing the CO2 emissions trading scheme in Korea. Energy Policy, 83, 82–86. doi: 10.1016/j.enpol.2015.04.007[Crossref], [Web of Science ®], [Google Scholar]). KETS allocated allowances at the firm level and calculated those allowances based on historical emissions at the sector/product level (Park & Hong, 2014Park, H., & Hong, W. K. (2014). Korea’s emission trading scheme and policy design issues to achieve market-efficiency and abatement targets. Energy Policy, 75, 73–83. doi: 10.1016/j.enpol.2014.05.001[Crossref], [Web of Science ®], [Google Scholar]). In the electricity sector, KETS created a mandatory upstream and downstream allowance obligation for power plants and electricity-consuming customers such as large commercial buildings (PMR & ICAP, 2016PMR & ICAP. (2016). Emissions trading in practice: A handbook on design and implementation. Washington, DC: Partnership on Market Readiness (PMR), International Carbon Action Partnership (ICAP), and World Bank. [Google Scholar]). Downstream obligations effectively create a price signal for indirect emitters because regulated electric utilities have limited ability to pass through compliance costs to consumers. KETS accounts for indirect downstream emissions by reflecting those allowances in a higher emissions cap (above the assigned cap of 1687 MMTCO2e in phase one), thereby preventing entities from being regulated twice for the same emissions (ICAP, 2016ICAP. (2016). Emissions trading worldwide (Status report). Berlin: International Carbon Action Partnership. [Google Scholar]).
Finally, the Chinese ETS pilots experimented the most when it comes to allowance allocation and distribution methods. The pilots chose to allocate based on the method that best suited the region’s economic structure. The Beijing and Tianjin pilots used a combination of historical emissions, historical carbon intensity and industrial benchmarks to allocate based on the region’s historical average carbon intensity multiplied by an intensity decline coefficient (Xiong et al., 2017Xiong, L., Shen, B., Qi, S., Price, L., & Ye, B. (2017). The allowance mechanism of China’s carbon trading pilots: A comparative analysis with schemes in EU and California. Applied Energy, 185, 1849–1859. doi: 10.1016/j.apenergy.2016.01.064[Crossref], [Web of Science ®], [Google Scholar]). Shanghai uses early action incentives to encourage early movers and employs a rolling baseline year so that enterprises can use the latest year’s emissions data as a benchmark to receive allowances if their emissions increased over 50% from 2009 to 2011 (Xiong et al., 2017Xiong, L., Shen, B., Qi, S., Price, L., & Ye, B. (2017). The allowance mechanism of China’s carbon trading pilots: A comparative analysis with schemes in EU and California. Applied Energy, 185, 1849–1859. doi: 10.1016/j.apenergy.2016.01.064[Crossref], [Web of Science ®], [Google Scholar]). The Guangdong and Hubei pilots follow the Shanghai formula without issuing early-action incentives, whereas Chongqing relies on self-declaration of emission reductions by entities. Shenzhen allocates 90% of allowances for free based on industrial benchmarks. For the manufacturing sector, Shenzhen follows a novel approach of post-allocation adjustment based on the difference between expected and actual firm-level emissions. Manufacturing firms are required to follow a strict MRV process and report their emissions output every year for adjustment (Ye et al., 2016Ye, B., Jiang, J., Miao, L., Li, J., & Peng, Y. (2016). Innovative carbon allowance allocation policy for the Shenzhen emission trading scheme in China. Sustainability, 8(1), 3. doi: 10.3390/su8010003[Crossref], [Web of Science ®], [Google Scholar]). Out of the seven pilots, Beijing, Shenzhen and Hubei follow California’s hybrid approach of distributing allowances freely, through auction and through fixed price sale. The Shanghai, Tianjin and Chongqing pilots distribute entirely for free, whereas Guangdong uses a combination of free distribution and auction (Xiong et al., 2017Xiong, L., Shen, B., Qi, S., Price, L., & Ye, B. (2017). The allowance mechanism of China’s carbon trading pilots: A comparative analysis with schemes in EU and California. Applied Energy, 185, 1849–1859. doi: 10.1016/j.apenergy.2016.01.064[Crossref], [Web of Science ®], [Google Scholar]).

3.3.2. Liquidity, price stability commitment and system flexibility

Liquidity and price volatility are two aspects of the secondary market that ETSs try to manage in order to ensure a stable long-term signal to complying firms. The Chinese pilots and Korea ETS suffer from a lack of trading in the market. Korea traded only 0.05% of freely allocated allowances in its first compliance period. The Korean government intervened by increasing borrowing from 10% to 20%, relaxing rules for entities to earn early action credits and auctioning 0.9 MMCO2e from its allowance reserve in June 2016 (World Bank, Ecofys, & Vivid Economics, 2016World Bank, Ecofys, & Vivid Economics. (2016). State and trends of carbon pricing 2016. Washington, DC: World Bank. [Google Scholar]). Yet there has been little to no activity in the marketplace since 2016 (ICAP, 2017bICAP. (2017b). Korea emissions trading scheme. Berlin: International Carbon Action Partnership. [Google Scholar]), perhaps because of overallocation, imperfect information for emitters or the presence of complementary policies (Munnings et al., 2016Munnings, C., Morgenstern, R. D., Wang, Z., & Liu, X. (2016). Assessing the design of three carbon trading pilot programs in China. Energy Policy, 96, 688–699. doi: 10.1016/j.enpol.2016.06.015[Crossref], [Web of Science ®], [Google Scholar]; Zhang, Zhang, Liu, & Bi, 2013Zhang, B., Zhang, H., Liu, B., & Bi, J.(2013). Policy interactions and underperforming emission trading markets in China. Environmental Science & Technology, 47(13), 7077–7084. doi: 10.1021/es401300v[Crossref], [PubMed], [Web of Science ®], [Google Scholar]). Surveying the firms participating in Korea ETS, Suk et al. (2017Suk, S., Lee, S., & Jeong, Y. S. (2017). The Korean emissions trading scheme: Business perspectives on the early years of operations. Climate Policy, 1–14. doi: 10.1080/14693062.2017.1346499[Taylor & Francis Online], [Google Scholar]) conclude that supply–demand imbalance, policy uncertainty and lack of preparedness of firms over carbon pricing as the key barriers to active trading in the secondary market (Suk et al., 2017Suk, S., Lee, S., & Jeong, Y. S. (2017). The Korean emissions trading scheme: Business perspectives on the early years of operations. Climate Policy, 1–14. doi: 10.1080/14693062.2017.1346499[Taylor & Francis Online], [Google Scholar]).
The EU ETS in phases one and two, RGGI, California in phase one and New Zealand experienced excess allowances in the secondary markets from overallocation. In phase three, the EU ETS has responded by creating a Market Stability Reserve (MSR) to begin operating in 2019, with the aim of aligning the demand and supply of allowances by placing up to 900 million surplus ‘backloaded’ allowances into the MSR to be released in the event of an allowance shortage (European Commission, 2017aEuropean Commission. (2017a). Report from the commission to the European parliament and the council: Report on the functioning of the European carbon market. Luxembourg: Publications Office of the European Union. (EC). Retrieved fromhttps://ec.europa.eu/commission/sites/beta-political/files/report-functioning-carbon-market_en.pdf [Google Scholar]; Hu et al., 2015Hu, J., Crijns-Graus, W., Lam, L., & Gilbert, A. (2015). Ex-ante evaluation of EU ETS during 2013–2030: EU-internal abatement. Energy Policy, 77, 152–163. doi: 10.1016/j.enpol.2014.11.023[Crossref], [Web of Science ®], [Google Scholar]). The EU MSR acts like a quantity collar rather than a price collar. The EU also intends to double the MSR’s capacity to absorb excess allowances in the market (Meadows, 2017Meadows, D. (2017). Update on the EU ETS and EU climate policy. Luxembourg: European Commission. [Google Scholar]). RGGI and California experienced excess market liquidity and price volatility in their initial compliance periods primarily due to miscalculation of future growth projections. Both established a reserve auction where allowances were sold at a reserve minimum price. RGGI cancelled about 23% of the allowances that went unsold (RGGI, 2017bRGGI Inc. (2017b). Distribution of first control period CO2 allowances. Retrieved fromhttps://www.rggi.org/sites/default/files/Uploads/Allowance-Tracking/FCP_Allowance-Distribution.pdf [Google Scholar], 2017eRGGI Inc. (2017e). Distribution of second control period CO2 allowances. Retrieved fromhttps://www.rggi.org/sites/default/files/Uploads/Allowance-Tracking/SCP_Allowance-Distribution.pdf [Google Scholar]) while California allowed the retired allowances to re-enter the market if auctions cleared above the reserve price for two consecutive schedules (ICAP, 2017hICAP. (2017h). USA – California cap-and-trade program. Berlin: International Carbon Action Partnership. [Google Scholar]). Korea appears to have learned from RGGI because it implemented a reserve auction. Korea allocated 9 million allowances for reserve auctions with about one third of those sold and the remaining retired (ICAP, 2017bICAP. (2017b). Korea emissions trading scheme. Berlin: International Carbon Action Partnership. [Google Scholar]). Unlike a quantity-based reserve, RGGI and California created a price containment reserve that will trigger additional auctions when permit prices hit a set price ceiling (see Table 4). The key difference, however, is that the RGGI price containment reserve has allowances outside the emissions cap while California’s reserve allowances come under the total emissions cap. In addition to a price containment reserve, RGGI will also have an emissions containment reserve starting in 2021 that will allow states to withhold allowances from the market when permit prices hit a price floor of $6 in 2021 with a 7% annual escalator (Resources for the future, 2017Resources for the Future. (2017). An emissions containment reserve for RGGI: How might it work?(Presentation). Washington, DC. Retrieved fromhttp://www.rff.org/files/document/file/170207_EmissionsContainmentReserveforRGGI.pdf [Google Scholar]).
New Zealand also experienced excess liquidity resulting from a glut of international offset credits in the trading market, which led to a collapse in the allowance price from $20 in May 2011 to $2 in May 2013 (Richter & Chambers, 2014Richter, J. L., & Chambers, L. (2014). Must uncertain times mean uncertain measures? Restoring What?, 57. [Google Scholar]). Unlike the other ETSs, until 2015, the NZ ETS did not have a limit on the number of international offset credits that could be purchased. In its second compliance period, NZ ETS brought the programme under a nationwide emissions cap and closed access to international offset credits (Diaz-Rainey & Tulloch, 2015Diaz-Rainey, I., & Tulloch, D. (2015). New Zealand’s emission trading scheme: A financial perspective. Accountancy and Finance Departmental Seminar Series. [Google Scholar]).
Finally, the Québec and Swiss ETS programmes suffered from a lack of liquidity, primarily due to the small size of their markets. Thanks to electricity sectors dominated by renewables, both programmes had fewer low cost opportunities to reduce emissions, leading to a high marginal abatement cost. Prior to linking the Québec system to California, allowance prices were between $37–43 per ton in 2013, three times the current price under a linked market (Purdon, Houle, & Lachapelle, 2014Purdon, M., Houle, D., & Lachapelle, E. (2014). Mapping the political economy of California and Quebec’s cap-and-trade systems. Ottawa: Sustainable Prosperity. [Google Scholar]). In the linked market, Québec currently maintains an allowance price containment reserve that aligns with California’s (Government of Québec, 2015Government of Québec. (2015). Québec’s cap-and-trade system for greenhouse gas emission allowance(Technical overview). Gatineau: Gouvernement du Québec. [Google Scholar]).

3.3.3. International linkage

Linkage between ETSs can be of three types: (1) a unilateral link where one ETS accepts the compliance instruments of another but not vice versa; (2) a bilateral link where each ETS accepts the compliance instruments of the other or have common compliance rules; (3) an indirect link where an ETS has a link to another ETS through a third market (Haites, 2016Haites, E. (2016). Experience with linking greenhouse gas emissions trading systems. Wiley Interdisciplinary Reviews: Energy and Environment, 5(3), 246–260. doi: 10.1002/wene.191[Crossref], [Web of Science ®], [Google Scholar]). Linked ETSs may benefit from improved cost effectiveness, better liquidity and price stability, lower emissions leakage and lower transaction costs (Haites, 2016Haites, E. (2016). Experience with linking greenhouse gas emissions trading systems. Wiley Interdisciplinary Reviews: Energy and Environment, 5(3), 246–260. doi: 10.1002/wene.191[Crossref], [Web of Science ®], [Google Scholar]; Metcalf & Weisbach, 2012Metcalf, G. E., & Weisbach, D.(2012). Linking policies when tastes differ: Global climate policy in a heterogeneous world. Review of Environmental Economics and Policy, 6(1), 110–129. doi: 10.1093/reep/rer021[Crossref], [Web of Science ®], [Google Scholar]). Linkages are likely when jurisdictions have similar environmental goals, economic conditions, a history of productive engagement on other issues and familiarity with each other’s regulatory and political systems (Ranson & Stavins, 2016Ranson, M., & Stavins, R. N. (2016). Linkage of greenhouse gas emissions trading systems: Learning from experience. Climate Policy, 16(3), 284–300. doi: 10.1080/14693062.2014.997658[Taylor & Francis Online], [Web of Science ®], [Google Scholar]).
California is notable for its international linkage with the Québec cap-and-trade programme beginning in 2014. The two systems were fairly easy to link owing to extensive and transparent communications between the two governments going as far back as 2008 (Benoit & Côté, 2015Benoit, J., & Côté, C. (2015). Essay by the Québec government on its cap-and-trade system and the western climate initiative regional carbon market: Origins, strengths and advantages. UCLA Journal of Environmental Law and Policy, 33, 42–60. [Google Scholar]). California and Québec created a common, electronic allowance registry to avoid gaming and potential double-counting. Strong verification and data accuracy safeguards were put in place to ensure the integrity of allowance credits, in addition to that of the offsets. To maintain price stability, the price floor was set at the highest minimum price of either region in US dollars. Linking with the California system allowed Québec’s cap-and-trade market to increase its liquidity through increased access to allowances. Ontario, which recently inaugurated its cap-and-trade programme, announced plans to link up with Québec and California in 2018, which will further increase the total number of tradable allowances and offsets (ICAP, 2017dICAP. (2017d). Ontario announces cap-and-trade program. Berlin: International Carbon Action Partnership. Retrieved fromhttps://icapcarbonaction.com/en/news-archive/280-ontario-announces-cap-and-trade-program [Google Scholar]).
On January 2016, the Swiss government agreed to link its ETS with the EU ETS market (The Federal Council, 2016The Federal Council. (2016, January). Negotiations on linking of EU and Swiss emissions trading schemes concluded. Retrieved fromhttps://www.admin.ch/gov/en/start/documentation/media-releases.msg-id-60425.html [Google Scholar]). The Swiss ETS aligned its compliance instruments during its second trading period with the EU ETS. As a small ETS market with only 5.3 MMTCO2eemissions cap, the Swiss ETS could potentially gain from linking with the EU ETS. Through linkage, the existing lack of market liquidity will ease. Further, carbon leakage and competitiveness concerns for Swiss companies can be reduced because 60% of its exports and 78% of imports occur within the EU region (Hawkins & Jegou, 2014Hawkins, S., & Jegou, I. (2014). Linking emissions trading schemes: Considerations and recommendations for a joint EU–Korean carbon market. International Centre for Trade and Sustainable Development. [Google Scholar]).
The KETS could potentially link to its regional neighbour, the Tokyo-Saitama ETS in Japan (Wakabayashi & Kimura, 2018Wakabayashi, M., & Kimura, O.(2018). The impact of the Tokyo metropolitan emissions trading scheme on reducing greenhouse gas emissions: Findings from a facility-based study. Climate Policy, 5, 1–16. doi: 10.1080/14693062.2018.1437018[Taylor & Francis Online], [Google Scholar]), or with the EU ETS. However, there is little indication of learning on the part of KETS from the Québec-California linkage when it comes to solving its liquidity issues.
Cutting off links to other markets can also be an option. Diaz-Rainey & Tulloch (2015Diaz-Rainey, I., & Tulloch, D. (2015). New Zealand’s emission trading scheme: A financial perspective. Accountancy and Finance Departmental Seminar Series. [Google Scholar]) argues that the case of the NZ ETS shows both the power and dangers of tacit linking to international carbon markets. As discussed in the previous section on carbon leakage, excess liquidity from international offsets forced the NZ ETS to delink itself from the CDM and international offset markets in 2015 and move towards a domestic market (Bullock, 2012Bullock, D. (2012). Emissions trading in New Zealand: Development, challenges and design. Environmental Politics, 21(4), 657–675. doi: 10.1080/09644016.2012.688359[Taylor & Francis Online], [Web of Science ®], [Google Scholar]). The EU ETS also delinked from the international CDM market in 2012. In May 2011, New Jersey announced that it would leave RGGI, but is now expected to re-join along with Virginia in the coming year (Profeta, 2017Profeta, T. (2017). Virginia, New Jersey could be the next states to link with RGGI. Durham: National Geographic – Changing Planet (blog). [Google Scholar]).

3.4. Revenue management

Tracking revenue generation and use in an ETS helps further corroborate the extent to which a system strives to balance the social, economic, environmental and political needs that arise out of implementing a carbon pricing policy. Table 5 shows the key metrics used to compare revenue management practices across the ETS cases. By rating ETSs across these revenue metrics, we intend to simply assess their performance individually for each revenue use category rather than making a collective judgment as to whether directing revenues towards one purpose is better or worse than the other.

Table 5. Revenue management in ETS regimes.

In 2015 alone, carbon pricing policies generated $26 billion in revenues worldwide (World Bank, 2016World Bank. (2016). What are the options for using carbon pricing revenues? (Executive briefing). Washington, DC: World Bank. [Google Scholar]). Revenues generated from auctioning allowances could be used in additional climate change mitigation, reducing ETS administrative costs, alleviating compliance cost burden for EITE firms, addressing distributional inequity by augmenting expenditure on public goods, reducing distortionary taxes, reducing budget deficits or to increase the flow of climate finance from developed to developing countries (Bowen, 2015Bowen, A. (2015). Carbon pricing: How best to use the revenue? (Policy brief). Grantham Research Institute and Global Green Growth Institute. [Google Scholar]; World Bank, 2016World Bank. (2016). What are the options for using carbon pricing revenues? (Executive briefing). Washington, DC: World Bank. [Google Scholar]).
The EU ETS generated about $17 billion in auctions between 2012 and 2016, with at least 50% of the revenue distributed for climate- and energy-related purposes and for retrofitting existing infrastructure (European Commission, 2017). Using revenue from allowance auctions, the EU plans to establish two new funds: an ‘Innovation’ fund to extend existing support for demonstration of innovative technologies, and a ‘Modernization’ fund to facilitate investments in modernizing the power sector and fostering energy efficiency (Meadows, 2017Meadows, D. (2017). Update on the EU ETS and EU climate policy. Luxembourg: European Commission. [Google Scholar]). Similarly, RGGI has generated about $2.7 billion in revenue, of which at least 25% must be used for ‘consumer benefit or strategic energy purpose’ by participating states (RGGI Inc., 2010RGGI Inc. (2010). Relative effects of various factors on RGGI electricity sector CO2 emissions: 2009 compared to 2005. New York: New York Energy Research and Development Authority. [Google Scholar]). In practice, RGGI states allocated 42% for energy efficiency programmes, 11% for bill assistance to low-income residents, 9% for GHG abatement, 8% for renewable energy development, 8% for state budget reductions, 4% for programme administration and 1% for RGGI management between 2009 and 2014 (Ramseur, 2017Ramseur, J. L. (2017). The regional greenhouse gas initiative: Lessons learned and issues for congress (No. R41836). Washington, DC: Congressional Research Service. [Google Scholar]). Allowance revenue has generated employment in the RGGI region, with estimates showing a net effect of 30,200 job-years between 2009 and 2025 (Hibbard, Okie, Tierney, & Darling, 2015Hibbard, P. J., Okie, A. M., Tierney, S. F., & Darling, P. G. (2015). The economic impacts of the regional greenhouse gas initiative on nine northeast and mid-Atlantic states. Boston, MA: Analysis Group. [Google Scholar]). Similar to the EU and RGGI, California raised $3.385 billion in revenue through 2017 and has invested revenue into high speed rail, low carbon transit, weatherproofing of low income homes and environmental conservation efforts (CCI, 2017CCI. (2017). Annual report to the legislature on California climate investments using cap-and-trade auction proceeds (Annual report). California: California Climate Investments (CCI). [Google Scholar]). Québec expects to raise $3.3 billion by 2020 towards the Québec Green Fund, a dedicated fund used to enhance the region’s emissions reductions (CDC et al., 2015aCDC, EDF, & IETA. (2015a). Québec: An emissions trading case study. Brussels: CDC Climate Research, Environmental Defense Fund (EDF), and IETA. [Google Scholar]). Overall, ETSs with a revenue generation instrument seem to redouble efforts on environmental effectiveness than directing revenues towards non-environmental purposes. As of 2014, about 70% of cap-and-trade revenues around the world earmarked revenues towards environmental purposes (Carl & Fedor, 2016Carl, J., & Fedor, D. (2016). Tracking global carbon revenues: A survey of carbon taxes versus cap-and-trade in the real world. Energy Policy, 96, 50–77. doi: 10.1016/j.enpol.2016.05.023[Crossref], [Web of Science ®], [Google Scholar]).

3.5. Stakeholder engagement

The level of stakeholder engagement can be assessed to some extent by tracking the number of meetings held per year or per period with stakeholders and the extent to which the general public is allowed to participate in the rule making or rule modification process. The frequency of stakeholder meetings may be judged as low to high based on whether these meetings were convened on demand from the stakeholders or pre-determined by the ETS-enforcing agency of the government. Similarly, the involvement of the public may be rated from low to high based on the existence of public participation either through public town hall meetings or opportunities for the public to submit comments on ETS rule modifications. In addition to the metrics proposed, it is important to track the outcome of engaging stakeholders during any rule modification process so as to fairly assess its effectiveness in achieving consensus.
With the exception of RGGI and California, stakeholder engagement is not explicitly emphasized in other ETS programmes. California schedules stakeholder meetings and public town halls when a rule change is proposed and receives public comments on the rule changes. California’s ETS has received significant public support, with 54% of the state’s residents favouring the programme even if it raised consumer prices (Baldassare, Bonner, Kordus, & Lopes, 2016Baldassare, M., Bonner, D., Kordus, D., & Lopes, L. (2016). PPIC statewide survey: Californians & the environment. California: Public Policy Institute of California. Retrieved fromhttp://www.ppic.org/content/pubs/survey/S_716MBS.pdf [Google Scholar]). RGGI conducts regular quarterly stakeholder meetings and receives public comments on major rule changes. There is some evidence that the RGGI may have fared better in building constituency support for the full auctioning of allowances when compared to California (Rabe, 2016Rabe, B. G. (2016). The durability of carbon cap-and-trade policy. Governance, 29(1), 103–119. doi:10.1111/gove.12151[Crossref], [Web of Science ®], [Google Scholar]). RGGI and its state constituents regularly framed the auction process as delivering significant benefits to both the environment and the economy while there are claims that California equivocated over its plans for using auction revenues and alienated stakeholders in the process (Rabe, 2016Rabe, B. G. (2016). The durability of carbon cap-and-trade policy. Governance, 29(1), 103–119. doi:10.1111/gove.12151[Crossref], [Web of Science ®], [Google Scholar]).
The KETS is a good example of learning from the successes and failures of prior implementation when it comes to planning and engaging stakeholders early. Prior to introducing KETS, the Korean government launched a GHG and Energy Target Management System (TMS), a mandatory negotiated agreement aimed at curtailing energy use and GHG emissions, thereby easing firms into the process of monitoring and verifying emissions data (Oh, Hyon, & Kim, 2016Oh, H., Hyon, J., & Kim, J. (2016). Korea’s approach to overcoming difficulties in adopting the emission trading scheme. Climate Policy, 1–11. doi: 10.1080/14693062.2016.1213696[Taylor & Francis Online], [Web of Science ®], [Google Scholar]). The Chinese ETS pilots, in turn, represent experimentation in the marketplace, engaging and familiarizing stakeholders with new forms of regulations and testing compliance enforcement prior to the launch of its nationwide ETS (Duan, Pang, & Zhang, 2014Duan, M., Pang, T., & Zhang, X.(2014). Review of carbon emissions trading pilots in China. Energy & Environment, 25(3–4), 527–549. doi: 10.1260/0958-305X.25.3-4.527[Crossref], [Web of Science ®], [Google Scholar]).

4. Overall assessment

Table 6 provides an overall assessment of the eight ETSs as defined in the assessment framework (see Table 1). Relative to other systems, the California–Québec linked system performs the best in terms of environmental effectiveness with near full coverage of key emitting sectors, including transportation and a tightening of the cap by 3% every year. The New Zealand and Chinese pilots perform relatively poorly with significant exemptions of coverage to EITE sectors and no policies aimed at tightening the emissions cap over time. As best practice, an ETS covering a substantial portion of a jurisdiction’s point-source emissions with scheduled timetables for tightening of emissions caps over time is ideal (Haites et al., 2018Haites, E., Maosheng, D., Gallagher, K. S., Mascher, S., Narassimhan, E., Richards, K. R., & Wakabayashi, M.(2018, January). Experience with carbon taxes and greenhouse gas emissions trading systems. Retrieved from SSRN:https://ssrn.com/abstract=3119241. doi: 10.2139/ssrn.3119241[Crossref], [Google Scholar]).

Table 6. Overall assessment of ETS regimes based on Table 1.

In terms of economic efficiency, the lack of data regarding the cost of compliance and cost of ETS administration hamper us from making an assessment. In terms of marginal abatement cost, RGGI performs the best with a low marginal cost of abatement that encompasses the entire electricity sector through full auctioning of allowances. A low marginal abatement cost, however, may not be the best indicator of a system’s performance because ETSs that cover only the entities that are easiest to mitigate may push more costly sectors out of the system to be regulated through alternative means. Low permit prices may also arise owing to overallocation of allowances or hoarding of allowances by firms from a previous compliance period.
In the primary market, RGGI, California and Québec perform the best with full auctioning or majority auctioning with free allocations benchmarked by sector emissions. The EU and Switzerland perform relatively well with improved allocation methodologies and an increasing auctioning schedule in their later compliance periods. This indicates significant institutional learning about effective allocation from prior compliance periods within the ETSs. New Zealand and Korea are assessed as low-performing systems due to 100% free allocations and indefinite extension of free allocations to EITE-exposed industries with minimal or no increase in auctioning. As best practice, an ETS with near full coverage and free allowances is more politically palatable in many jurisdictions. Transitioning to full auctioning over time, however, ensures revenue generation, helps with price discovery and assigns allowances to highest valued use (Burtraw & McCormack, 2017Burtraw, D., & McCormack, K.(2017). Consignment auctions of free emissions allowances. Energy Policy, 107, 337–344. doi: 10.1016/j.enpol.2017.04.041[Crossref], [Web of Science ®], [Google Scholar]).
In the secondary market, the RGGI demonstrates a stronger price signal commitment and system flexibility with clearly defined auction schedules, tightening of the emissions cap every year, a price ceiling that triggers the price containment reserve (i.e. economic effectiveness) and an upcoming price floor of $6 per tonne which triggers the emissions containment reserve (i.e. environmental effectiveness). The EU–Switzerland linked system is assessed as medium performing because the market stability reserve (MSR) set to become active in 2019 is triggered based on a quantity collar rather than a price floor/ceiling and cannot be adjusted dynamically (Acworth, 2014Acworth, W. (2014). Can the market stability reserve stabilise the EU ETS: Commentators hedge their bets (No. 23). DIW Roundup: Politik im Fokus. [Google Scholar]; Holt & Shobe, 2015Holt, C. A., & Shobe, W. (2015). Price and quantity ‘collars’ for stabilizing emissions allowance prices: An experimental analysis of the EU ETS market stability reserve. [Google Scholar]). Unlike RGGI, California and Québec, the allowances pulled out of the EU market are proposed to remain for future use in the reserve without any expiration date. California–Québec’s linked system is assessed as medium because of the uncertainty in the direction of the ETS beyond 2020. As best practice, a well-defined emissions cap schedule with price collar and a price-triggered allowance reserve that automatically cancels upon being retired from the market ensures a credible price signal to firms regulated by the system (Holt & Shobe, 2015Holt, C. A., & Shobe, W. (2015). Price and quantity ‘collars’ for stabilizing emissions allowance prices: An experimental analysis of the EU ETS market stability reserve. [Google Scholar]).
Owing to lack of data, we are unable to assess the ETSs for their stakeholder engagement practices. However, there is evidence that the RGGI and California systems conduct scheduled quarterly meetings with stakeholders and receive public comments on rule modifications (CARB, 2017bCARB. (2017b). Public meetings. Retrieved fromhttps://www.arb.ca.gov/cc/capandtrade/meetings/meetings.htm [Google Scholar]; RGGI Inc., 2017dRGGI Inc. (2017d). Stakeholder comments. Retrieved fromhttps://rggi.org/design/2016-program-review/stakeholder-comments-2016 [Google Scholar]). There is also evidence of Korea’s active engagement with stakeholders throughout the process of initiating its ETS starting with the emissions inventory system two years prior to the start of the ETS.
Finally, in terms of revenue generation and use, the EU, RGGI, California and Québec raise significant revenue through auctioning. RGGI devotes a larger percentage of its revenue to address social, environmental and economic needs such as supporting EITE industries, energy efficiency programmes and low-income communities (Ramseur, 2017Ramseur, J. L. (2017). The regional greenhouse gas initiative: Lessons learned and issues for congress (No. R41836). Washington, DC: Congressional Research Service. [Google Scholar]) than other ETSs. Québec earmarks all of its revenues to additional climate change mitigation. Overall, many ETSs seem to strive for a ‘double dividend’ in emissions reductions by reinvesting a good portion of their revenues into additional emissions-reduction activities.

5. Other findings and knowledge gaps

Each national context creates unique opportunities and constraints resulting in no ETS policy being alike. Certain attributes such as free allowance allocations or auctioning lend themselves better to particular national circumstances, while others, such as price collars and price/emissions containment reserves, can help achieve market efficiency irrespective of where the ETS is implemented. RGGI, California-Québec, the EU ETS (in phases three and four) and Korea all have shown good administrative prudence by implementing these market management features.
We find patterns of learning from a system’s own prior experience and from other ETSs. Korea officially cooperated with the EU for assistance in managing its ETS and help regulated firms learn from the EU on compliance and allowance trading (European External Action Service, 2016European External Action Service. (2016). EU–Korea emissions trading system cooperation project launches a series of activities to benefit Korean businesses. Retrieved fromhttps://eeas.europa.eu/headquarters/headquarters-homepage/14138/eu-korea-emissions-trading-system-cooperation-project-launches-series-activities-benefit_en [Google Scholar]). Similarly, the Chinese ETS pilots signed agreements with California, the UK, France, Norway, Finland, Germany, Québec and the European Commission to get technical assistance on ETS implementation (Swartz, 2016Swartz, J. (2016). China's national emissions trading system: Implications for carbon markets and trade (Issue paper no. 6). Geneva: International Center for Trade and Sustainable Development. [Google Scholar]). Within an ETS, the EU evolved in its allocation methodology and price stability measures. California appears to have learned significantly from exchanges of knowledge with the EU ETS and RGGI in shaping allocation of permits and offset rules to avoid mistakes like overallocation, double counting and windfall profits to permit holders (Bang, Victor, & Andresen, 2017Bang, G., Victor, D. G., & Andresen, S. (2017). California’s cap-and-trade system: Diffusion and lessons. Global Environmental Politics, 17(3), 12–30. doi: 10.1162/GLEP_a_00413[Crossref], [Web of Science ®], [Google Scholar]).
Knowledge gaps on the administrative cost of running an effective ETS, the cost of compliance to the firms and the extent of stakeholder engagement currently make comparisons on economic efficiency and stakeholder engagement across the eight ETSs impossible. Finally, this article assesses ETS regimes in isolation from other policies, but research is needed to assess the impact of complementary policies on the overall emissions coverage and the efficacy of ETSs themselves. The presence of complementary policies can achieve significant emission reductions but contribute to an overabundance of supply in the ETS market, which places downward pressure on permit prices (Schmalensee & Stavins, 2015Schmalensee, R., & Stavins, R.(2015). Lessons learned from three decades of experience with cap-and-trade (No. w21742). Cambridge, MA: National Bureau of Economic Research. doi: 10.3386/w21742[Crossref], [Google Scholar]). These knowledge gaps need to be addressed in order to guide future market-based climate policy design and implementation.

Acknowledgements

While final responsibility rests with the authors, they would like to thank Joseph Aldy, Ottmar Edenhofer, Christian Flachsland, Dirk Forrister, Nat Keohane, Ulrike Kornek, Gilbert Metcalf and Patrick Verkooijen for their valuable suggestions and comments.

Disclosure statement

No potential conflict of interest was reported by the authors.

Appendices

Appendix 1. Studies assessing the performance of ETS regimes

Table

Appendix 2. Brief description of ETS systems

EU ETS
Begun in 2005, the EU ETS was one of the main policy tools used by the EU to implement the 1997 Kyoto Protocol to the UN Framework Convention on Climate Change (UNFCCC). The programme now operates in 28 EU member states plus Iceland, Liechtenstein and Norway. The ETS covers about 11,000 entities accounting for 45% of EU-wide GHG emissions from multiple sectors. The EU ETS has proceeded through three distinct trading periods, with phase three (2013–2020) employing an allowance cap reduction of 1.74% per year, a market stability reserve (MSR) to begin in 2019, banking and borrowing restricted to a year, offsets capped at 50% of total emissions reductions, a noncompliance penalty of 100 EUR per ton of regulated emissions, and 50% of auction revenue directed towards climate and energy related investments (European Commission, 2016aEuropean Commission. (2016a). The EU emissions trading system (EU ETS)(Factsheet). Luxembourg: Publications Office of the European Union. doi: 10.2834/6083[Crossref], [Google Scholar]; European Commission, 2017aEuropean Commission. (2017a). Report from the commission to the European parliament and the council: Report on the functioning of the European carbon market. Luxembourg: Publications Office of the European Union. (EC). Retrieved fromhttps://ec.europa.eu/commission/sites/beta-political/files/report-functioning-carbon-market_en.pdf [Google Scholar]; Frunza, 2013Frunza, M. (2013). Fraud and carbon markets: The carbon connection. Abingdon: Routledge. [Google Scholar]; Meadows, 2017Meadows, D. (2017). Update on the EU ETS and EU climate policy. Luxembourg: European Commission. [Google Scholar]).
Switzerland ETS
Switzerland follows a hybrid approach to reducing its GHG emissions with a carbon tax (i.e. the CO2 levy covering 51% CO2 emissions) and ETS (covering 33% CO2 emissions) operating simultaneously. The first phase of the ETS, from 2008–2012, was voluntary for firms wanting to be exempt from the CO2 levy. Energy-intensive industries could voluntarily participate and receive free allowances based on a company’s potential to reduce emissions (CDC, EDF & IETA, 2015bCDC, EDF, & IETA. (2015b). Switzerland: An emissions trading case study. Brussels: CDC Climate Research, Environmental Defense Fund (EDF) and IETA. [Google Scholar]). Non-complying firms simply faced a price cap imposed by the CO2 levy. In the latest phase, 2013–2020, the Swiss ETS imposes an economy-wide emissions cap, mandatory enrolment for large entities, a combination of free and auctioned allowances with auctioning set to increase to 70% by 2020, creation of an allowance reserve for new entrants, non-compliance penalties equal to the EU ETS, an offset mechanism aligned with the EU ETS rules, and inclusion of the aviation sector under a linked system with the EU ETS (FOEN, 2016bFOEN. (2016b). Federal office for the environment FOEN: Linking the Swiss and EU emissions trading schemes. Retrieved fromhttps://www.bafu.admin.ch/bafu/en/home/topics/climate/info-specialists/climate-policy/emissions-trading/linking-the-swiss-and-eu-emissions-trading-schemes.html [Google Scholar]; Hawkins & Jegou, 2014Hawkins, S., & Jegou, I. (2014). Linking emissions trading schemes: Considerations and recommendations for a joint EU–Korean carbon market. International Centre for Trade and Sustainable Development. [Google Scholar]; Rutherford, 2014Rutherford, A. P. (2014). Linking emissions trading schemes: Lessons from the EU-Swiss ETSs. Carbon & Climate Law Review, 282–290. [Google Scholar]).
Regional Greenhouse Gas Initiative (RGGI)
The RGGI covers 23% of GHG emissions in nine north-eastern states in the United States (i.e. 2% of US emissions) by capping CO2 emissions from 165 regulated electricity generating units in total (EIA, 2016EIA. (2016, November). Energy information administration (EIA): State carbon dioxide emissions. Retrieved fromhttps://www.eia.gov/environment/emissions/state/ [Google Scholar]; Ramseur, 2017Ramseur, J. L. (2017). The regional greenhouse gas initiative: Lessons learned and issues for congress (No. R41836). Washington, DC: Congressional Research Service. [Google Scholar]). RGGI is a transparent system with full auctioning of allowances, an allowance cap that reduces at 2.5% per year until 2020 and at 3% thereafter, an allowance reserve to manage permit prices, a price floor of $2.15, unlimited banking without borrowing from future compliance periods, offsets up to 3.3% of emissions obligation, and periodic adjustments of the programme through consultative review meetings (EIA, 2016EIA. (2016, November). Energy information administration (EIA): State carbon dioxide emissions. Retrieved fromhttps://www.eia.gov/environment/emissions/state/ [Google Scholar]; ICAP, 2017eICAP. (2017e). USA – Regional greenhouse gas initiative (RGGI). Berlin: International Carbon Action Partnership. [Google Scholar]). A recent programme innovation is the emissions containment reserve (ECR); set to be implemented in 2021, which will allow states to withhold allowances from the total pool of allowances if prices fall below $6 in 2012, with a 7% annual escalator. Participation is voluntary among RGGI states, with New Hampshire and Maine opting not to participate (RGGI, 2017). An emissions containment reserve is essential the opposite of a cost containment reserve. A CCR releases allowances when prices are high, while a ECR absorbs allowances when prices are low (RFF, 2017Resources for the Future. (2017). An emissions containment reserve for RGGI: How might it work?(Presentation). Washington, DC. Retrieved fromhttp://www.rff.org/files/document/file/170207_EmissionsContainmentReserveforRGGI.pdf [Google Scholar]).
California Cap-and-Trade (CAT)
The California cap-and-trade programme began in 2013 after it was granted legal authority through the Global Warming Solutions Act of 2006 (AB 32), requiring the state to reduce emissions to 1990 levels by 2020. During the first compliance phase (2013–2014), the programme covered 35% of the state’s emissions and all six major GHGs. In the second compliance period (2015–2017), the programme regulates 85% of California’s emissions (the three-year average cap being 382.4 MMTCO2e). Electric utilities are allotted allowances on behalf of their ratepayers with investor-owned utilities obligated to consign allowances to state auctions, while publicly-owned utilities may either consign to state auctions or bank in an allowance account. Industrial facilities receive a declining amount of free allowances in order to avoid leakage and to promote a smooth transition. The remaining allowances, roughly 6% of current year vintage in the first compliance period, are auctioned. The total number of auctioned allowances is expected to increase in each subsequent compliance period (ICAP, 2017hICAP. (2017h). USA – California cap-and-trade program. Berlin: International Carbon Action Partnership. [Google Scholar]). An additional feature of the programme is the allowance price-containment reserve (APCR), which gives regulators the power to remove or add allowances into the market, up to 4% of the annual allowances budgets through 2020, in the event of a drastic allowance price increase. The APCR allowances are priced at three tiers with various escalation mechanisms and can only be used by the regulated entities and cannot be resold. The APCR will be replaced in 2021 with two price containment points below a hard price ceiling (State of California, 2017State of California. (2017). Assembly bill no. 398 chapter 135 – Global Warming Solutions Act of 2006. Retrieved fromhttp://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201720180AB398 [Google Scholar]), a $10 price floor with 5% escalator per year, offsets up to 8% of a firm’s emissions, linkage to the Québec cap-and-trade programme, free allowances to energy-intensive and trade-exposed (EITE) industries to reduce leakage, and rigorous monitoring of allowances, offsets and emissions reductions (ICAP, 2017).
Québec Cap-and-Trade
In 2009, Québec adopted a GHG emissions reduction goal of 20% below 1990-levels by 2020. In 2011, Québec initiated its emissions trading scheme with its first compliance period beginning in 2013. Subsequently in 2014, the programme formally linked with the California cap-and-trade system, creating the largest carbon market in North America and the first sub-national programme to link internationally (CDC, EDF, & IETA, 2015aCDC, EDF, & IETA. (2015a). Québec: An emissions trading case study. Brussels: CDC Climate Research, Environmental Defense Fund (EDF), and IETA. [Google Scholar]). The 2018 cap for the third compliance period is 58.96 million allowances with a 3.5% yearly cap reduction, covering 132 entities, roughly 85% of the province’s GHG emissions. (ICAP, 2017) The ETS allocates allowances freely but decreases free allowances by 1 to 2% per year, directs auctioned revenues to the Québec Green Fund, sets a price floor averaging the highest minimum price between California and Québec markets, maintains an allowance price containment reserve, and utilizes stringent and transparent monitoring, reporting and verification (MRV) processes (Government of Québec, 2015Government of Québec. (2015). Québec’s cap-and-trade system for greenhouse gas emission allowance(Technical overview). Gatineau: Gouvernement du Québec. [Google Scholar]; ICAP, 2017aICAP. (2017a). Canada – Québec cap-and trade system. Berlin: International Carbon Action Partnership. [Google Scholar]).
New Zealand ETS
In 2008, the New Zealand ETS (i.e. NZ ETS) was introduced by legislation in order to meet the country’s international obligations under the Kyoto Protocol, with the objective of delivering emissions reduction in a cost-effective manner while increasing the long-term resilience of New Zealand’s economy (Richter & Chambers, 2014Richter, J. L., & Chambers, L. (2014). Must uncertain times mean uncertain measures? Restoring What?, 57. [Google Scholar]). Until 2015, the ETS covered all sectors under a Kyoto-based target without a nationwide emissions cap. From 2016, the ETS imposes a nationwide emissions-intensity-based cap, upstream regulation in the energy sectors, voluntary opt-in for downstream users, output-based grandparenting of allowances to eligible EITE sectors such as agriculture with a linear phase-out of free allowances by 2030, unlimited Kyoto offsets until 2015, and strict MRV process with audits of self-assessment and penalties for non-compliance (ICAP, 2017cICAP. (2017c). New Zealand emissions trading scheme (NZ ETS). Berlin: International Carbon Action Partnership. [Google Scholar]; Leining & Kerr, 2016Leining, C., & Kerr, S. (2016). Lessons learned from the New Zealand emissions trading scheme. Wellington: Motu Economic and Public Policy Research. [Google Scholar]).
Republic of Korea ETS
In 2012, the Act on ‘Allocation and Trading of Greenhouse Gas Emissions’ established an ETS, beginning in January 2015. The Korean government followed a careful approach of defining timelines, establishing strategic governance architecture and an independent allowance committee, creating market stabilizing measures, and providing support for losses incurred by entities participating in the ETS. The Korean ETS (KETS) allocates allowances freely based on historical GHG emissions, both upstream at the point of electricity generation and downstream at consumption, and it benchmarked allowances for other sectors (EDF, CRIK, & IETA, 2016EDF, CRIK, & IETA. (2016). South Korea: An emissions trading case study. Brussels: Environmental Defense Fund (EDF), Climate Change Research Institute of Korea (CRIK), and IETA. [Google Scholar]; PMR & ICAP, 2016PMR & ICAP. (2016). Emissions trading in practice: A handbook on design and implementation. Washington, DC: Partnership on Market Readiness (PMR), International Carbon Action Partnership (ICAP), and World Bank. [Google Scholar]). In addition, KETS has an allowance price containment reserve, a reserve auction price of €12, credits for emissions reductions achieved prior to joining KETS, unlimited banking with borrowing up to 20% within phases, offsets up to 10% of a firm’s obligation, and a non-compliance penalty up to $70 per ton of regulated emissions (Oh et al., 2016Oh, H., Hyon, J., & Kim, J. (2016). Korea’s approach to overcoming difficulties in adopting the emission trading scheme. Climate Policy, 1–11. doi: 10.1080/14693062.2016.1213696[Taylor & Francis Online], [Web of Science ®], [Google Scholar]; PMR & ICAP, 2016PMR & ICAP. (2016). Emissions trading in practice: A handbook on design and implementation. Washington, DC: Partnership on Market Readiness (PMR), International Carbon Action Partnership (ICAP), and World Bank. [Google Scholar]).
China: Provincial ETS Pilots
In 2011, the Chinese government initiated seven pilot ETS programmes for CO2 emissions (Beijing, Tianjin, Shanghai, Chongqing, Shenzhen, Guangdong, and Hubei) requiring the regions to launch by 2013 and fully initiate by 2015 (Zhang, Karplus, Cassisa, & Zhang, 2014Zhang, D., Karplus, V. J., Cassisa, C., & Zhang, X. (2014). Emissions trading in China: Progress and prospects. Energy Policy, 75, 9–16. doi: 10.1016/j.enpol.2014.01.022[Crossref], [Web of Science ®], [Google Scholar]). Chinese ETS pilots covered indirect electricity emissions within the pilot regions and emissions from imported electricity outside of the pilot regions (Zhang, 2015Zhang, Z. (2015). Carbon emissions trading in China: The evolution from pilots to a nationwide scheme. Climate Policy, 15(supp. 1), S104–S126. doi: 10.1080/14693062.2015.1096231[Taylor & Francis Online], [Google Scholar]). Nearly all of them allocated allowances for free, except for a small percentage of auctioning in Guangdong, Shenzhen, and Hubei, but the systems differed in their method of allocation (Dong, Ma, & Sun, 2016Dong, J., Ma, Y., & Sun, H. (2016). From pilot to the national emissions trading scheme in China: International practice and domestic experiences. Sustainability, 8(6), 522. doi: 10.3390/su8060522[Crossref], [Web of Science ®], [Google Scholar]; Duan et al., 2014Duan, M., Pang, T., & Zhang, X.(2014). Review of carbon emissions trading pilots in China. Energy & Environment, 25(3–4), 527–549. doi: 10.1260/0958-305X.25.3-4.527[Crossref], [Web of Science ®], [Google Scholar]). All of them accepted offsets through CERs generated outside the pilot regions, established market stabilizing mechanisms using auctions triggered by price ceilings, allowance reserves, buy-back of surplus allowances in the market, or a combination of these features (Pang & Duan, 2016Pang, T., & Duan, M. (2016). Cap setting and allowance allocation in China's emissions trading pilot programmes: Special issues and innovative solutions. Climate Policy, 16(7), 815–835. doi: 10.1080/14693062.2015.1052956[Taylor & Francis Online], [Web of Science ®], [Google Scholar]).
Incomplete reporting practices, a lack of a legal framework to enforce compliance, and weak penalties are identified as some of the key challenges that emerged in the seven pilots (Yu & Lo, 2015Yu, X., & Lo, A. Y. (2015). Carbon finance and the carbon market in China. Nature Climate Change, 5(1), 15–16. doi: 10.1038/nclimate2462[Crossref], [Web of Science ®], [Google Scholar]). A survey of Chinese firms conducted in 2015 revealed that the carbon price failed to ‘stimulate companies to upgrade mitigation technologies’ and that the majority of firms considered participation in the ETS pilots only a means of improving ties with governments and earning a good social reputation (Yang, Li, & Zhang, 2016Yang, L., Li, F., & Zhang, X. (2016). Chinese companies’ awareness and perceptions of the emissions trading scheme (ETS): evidence from a national survey in China. Energy Policy, 98, 254–265. doi: 10.1016/j.enpol.2016.08.039[Crossref], [Web of Science ®], [Google Scholar]).

Notes

1. Primary market refers to the allowance allocation and distribution stage of an ETS, in which governments distribute emission allowances for free based on assessed firm-level quotas, through auctioning, or a combination of both.
2. The secondary market is the ETS jurisdiction’s trading market where participating firms are allowed to buy and sell the allowances they received initially in the primary market.

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Additional information

Funding

Funding for this work was provided by (in alphabetical order), BP, Energy Foundation, China and The William and Flora Hewlett Foundation.

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