Optimal Coverage of Installations in a Carbon Emissions Trading Scheme (ETS)

Trading schemes for emission allowances have become a panacea for nations aspiring toreduce their aggregate emissions of greenhouse gases from industry in a cost-effectivemanner. The contention of this paper is that an emissions trading scheme (ETS) shouldnot be based on blanket coverage of installations on a downstream level, but should ratherbe designed to include some installations, and from some industrial sectors. In the case ofan ETS there are high costs of administration, monitoring and transacting imposed on theinstallations covered. These costs are supposed to be more than offset by the cost savingsrealised through trading in the market for emission allowances. However, the papershows that not all installations can fully offset administrative costs, and are thereforeexposed to higher cost compared to a situation under an alternative instrument (e.g.standard). The paper formulates a conceptual framework for analysing overall cost andbenefits from an ETS in the light of administration and transactions costs. It theoreticallyestablishes a threshold point for optimal coverage of installations on a downstream level.The paper uses data from EU ETS to empirically determine optimal coverage for selectedsectors. The results indicate that blanket coverage is more costly than the determinedoptimum coverage plan.