KIELKielInstitutefortheWorldEconomyISSN1862–1155WilfriedRickels,ChristianRischer,FelixSchenuit,SonjaPetersonPotentialefficiencygainsfromtheintro-ductionofanemis-sionstradingsystemforthebuildingsandroadtransportsectorsintheEuropeanUnionNo.2249WORKINGPAPERKIELWORKINGPAPERNO.2249MAY2023POTENTIALEFFICIENCYGAINSFROMTHEINTRODUCTIONOFANEMISSIONSTRADINGSYSTEMFORTHEBUILDINGSANDROADTRANSPORTSECTORSINTHEEUROPEANUNIONWilfriedRickels,ChristianRischer,FelixSchenuit,SonjaPetersonIntheEuropeanUnion(EU),asecondemissionstradingsystem(EUETS2)coveringbuildings,roadtransportandsmallenergyandindustrialinstallationsisexpectedtobeintroducedfrom2027.Until2030,however,EUETS2willnotbeaseparatepillarofEUclimatepolicy,butwillsupportMemberStatesinmeetingtheirnationaltargetsundertheEffortSharingRegulation(ESR).IftherearenetregionalshiftsinemissionreductionswithintheEUETS2,forexample,ifcompaniesinone-memberstatebuyinaggregatedtermsnetallowances,thismustbecom-pensatedforatthenationallevel.WestudytheEUETS2fortheyear2030usingthegeneralequilibriummodelDART.Inouranalysis,theintroductionofanEUETS2generatesaboutaquarteroftheefficiencygainsofacomprehensiveemissionstradingsystem,assumingthatnationstatesusetheflexibilitymechanismsoftheESRandcompensateforregionalabatementleakagethroughinterstateemissionstrading.However,thisisonlytrueifthereisnoextensivepricestabilizationintheEUETS2.OuranalysissuggestsanEUETS2allowancepriceofaroundEUR300/tCO2.StabilizingtheEUETS2priceattheenvisagedinterventionpriceof45EUR/tCO2wouldrequireabout415millionadditionalallowancesandthusimplyadditionalemissionsofthesameamountin2030alone.Keywords:EuropeanUnionClimatePolicy,EmissionsTrading,ComputableGeneralEquilibriumModelJEL:Q54,Q58WilfriedRickelsKielUniversityKielInstitutefortheWorldEconomyKiellinie6624105Kiel,GermanyEmail:wilfried.rickels@ifw-kiel.deChristianRischerKielInstitutefortheWorldEconomyKiellinie6624105Kiel,GermanyEmail:christian.rischer@ifw-kiel.deFelixSchenuitGermanInstituteforInternationalSecurityAffairsLudwigkirchplatz3-410719BerlinEmail:Felix.Schenuit@swp-berlin.orgSonjaPetersonKielInstitutefortheWorldEconomyKiellinie6624105Kiel,GermanyEmail:sonja.peterson@ifw-kiel.deTheresponsibilityforthecontentsofthispublicationrestswiththeauthor,nottheInstitute.Sinceworkingpapersareofapreliminarynature,itmaybeusefultocontacttheauthorofaparticularissueaboutresultsorcaveatsbeforereferringto,orquoting,apaper.Anycommentsshouldbesentdirectlytotheauthor.PotentialefficiencygainsfromtheintroductionofanemissionstradingsystemforthebuildingsandroadtransportsectorsintheEuropeanUnionWilfriedRickels,ChristianRischer,FelixSchenuit,SonjaPetersonAbstractIntheEuropeanUnion(EU),asecondemissionstradingsystem(EUETS2)coveringbuildings,roadtransportandsmallenergyandindustrialinstallationsisexpectedtobeintroducedfrom2027.Until2030,however,EUETS2willnotbeaseparatepillarofEUclimatepolicy,butwillsupportMemberStatesinmeetingtheirnationaltargetsundertheEffortSharingRegulation(ESR).IftherearenetregionalshiftsinemissionreductionswithintheEUETS2,forexample,ifcompaniesinonememberstatebuyinaggregatedtermsnetallowances,thismustbecompensatedforatthenationallevel.WestudytheEUETS2fortheyear2030usingthegeneralequilibriummodelDART.Inouranalysis,theintroductionofanEUETS2generatesaboutaquarteroftheefficiencygainsofacomprehensiveemissionstradingsystem,assumingthatnationstatesusetheflexibilitymechanismsoftheESRandcompensateforregionalabatementleakagethroughinterstateemissionstrading.However,thisisonlytrueifthereisnoextensivepricestabilizationintheEUETS2.OuranalysissuggestsanEUETS2allowancepriceofaroundEUR300/tCO2.StabilizingtheEUETS2priceattheenvisagedinterventionpriceof45EUR/tCO2wouldrequireabout415millionadditionalallowancesandthusimplyadditionalemissionsofthesameamountin2030alone.JEL:Q54,Q58KeyWords:EuropeanUnionClimatePolicy,EmissionsTrading,ComputableGeneralEquilibriumModelWilfriedRickels,Christian-Albrechts-UniversitätKielundInstitutfürWeltwirtschaft,Kiel,Kiellinie66,24105Kiel,wilfried.rickels@ifw-kiel.deChristianRischer,InstitutfürWeltwirtschaft,Kiellinie66,24105Kiel,christian.rischer@ifw-kiel.deFelixSchenuit,StiftungWissenschaftundPolitik,13357Berlin,Felix.Schenuit@swp-berlin.orgSonjaPeterson,InstitutfürWeltwirtschaft,Kiellinie66,24105Kiel,sonja.peterson@ifw-kiel.de21IntroductionTheEuropeanUnion(EU)reduceditsgreenhousegasemissionsby24percentin2021relativeto2005(EEA2022a).TheEuropeanEmissionsTradingSystem(EUETS),whichoriginallycoveredabout40percentofemissions,primarilyintheenergyandindustrialsectors,playedasignificantroleinthis.Here,emissionswerereducedby37percent(iftheUKemissionscoveredbytheEUETSuntil2021arealsotakenintoaccount,thereductionis44percent).Incomparison,emissionsinthe27EUstates(EU27)outsidetheEUETSinthesectorscoveredbytheso-calledEffortSharingRegulation(ESR)fellbyonly13percentinthesameperiod(EEA,2022b).Inthefuture,theESRsectorswillbecomplementedbyasecondemissionstradingsystem,whichwillcoveremissionsfromtheroadtransportandbuildingssectorsinparticular.However,theEUETS2doesnotreplacethebindingnationalreductiontargetsfor2030,but"only"servesasaninstrumenttoachievethesetargets,atleastforatransitionalperiod.UnliketheexistingEUETS1,theEUETS2willthereforecontinuetodependonwhereemissionreductionstakeplace,anditwillbenecessarytousetheexistingflexibilitymechanismsintheESR,suchasemissionstradingbetweencountries,toachievetheESRtargetsinacost-effectiveway.AcomprehensiveCO2marketandsingleCO2priceforallEUemissionsistheefficientsolution—separatemarketsimplythatreductiontargetsarenotachievedcost-effectively(Böhringeretal.,2006,Böhringeretal.,2009).BurmeisterandPeterson(2016)showforthe2020reductiontargetsthatwelfaregainscouldberealizedintheEUifthereisanopportunitytoshiftemissionreductionsfromtheESRsectorstotheEUETS1.Accordingly,opportunitiesformoreflexiblecreditingofemissionreductionsbetweensectorsandsystemsmayhelptoachieveemissiontargetsmoreefficiently.However,thereareargumentsforonlygraduallyintegratingsectorsormarketsiftherearesignificantdifferencesinmarginalabatementcosts(Rickelsetal.,2019).Inparticular,theroadtransportandbuildingssectorshavehigherabatementcoststhanthepowerandindustrialsectors,andimmediateintegrationofthesesectorswouldsignificantlyincreasethepriceintheEUETS1.Accordingly,otherschemes,suchasthefreeallocationofallowances,whosephase-outisalignedwiththecurrentEUETS1structure,wouldalsolikelyneedtobeadjusted.Böhringeretal.(2014)showthatdifferentiatedCO2abatementcosts,takingintoaccounttradeeffects,justifytemporarilydifferentiatedmarkets.Differentiatedpricesmayalsobeusefultoachievedynamicefficiencyinabatementcostsforlong-livedgoodssuchascarsorbuildingheating,especiallyifmarketparticipantshavemyopicpreferencesorlimitedplanninghorizons.Atthesametime,itmakessensetocombinequantityandpricecontrols,especiallywhenthereisconsiderableuncertaintyaboutabatementcostsandthustheexpectedCO2pricesinanemissionstradingsystem(Murrayetal.2009,GoulderandSchein2013,Burtrawetal.2020).AlthoughtheEUETS1hasapriceinterventionmechanism(Article29a),ithasnotledtointerventiondespitesignificantpricespikesinthepastandisthereforeoflimiteduseinitscurrentformtocontrolthepriceintheEUETS1(WillnerandPerino2022).IntheEUETS1,themainadjustmentmechanismisaquantitytrigger.Dependingontheamountofallowancesincirculation,allowancesaretransferredtoorreleasedfroma3marketstabilityreserve(MSR),whichcanhaveadestabilizingeffect,especiallyinthecaseofshocksexpectedbymarketparticipants(Perinoetal.2022).Instead,theMSRintheEUETS2islinkedtoafixedpricetrigger(EUR45/tCO2,in2020prices)inadditiontoaquantitytrigger,whichshouldleadtothereleaseofadditionalallowances.VariousstudiesshowthatCO2pricesofwellabove100EUR/tCO2arenecessarytoachievetheplannedemissionreductionsintheroadtransportandbuildingsectors(Kalkuhletal.2023).Accordingly,thereleaseofadditionalallowancesfromtheMSRwouldhavetobesubstantialifthepriceintheEUETS2istoremainclosetothepricetrigger.Thiswouldsignificantlyincreasescarcityinthefuture,whichinturncannotleadtoacrediblepricestabilizationforbankableallowances.Inthemediumterm,therefore,theinjectionofallowancesfromCO2removalswillbenecessaryifpricesaretobecrediblystabilizedwithoutincreasingnetemissions(Rickelsetal.2020).Thisissuewillbecomepoliticallyrelevantsoonerthanisoftenassumed:IntherecentEUETS1reform,theEuropeanCommissioncommittedtosubmittingareportby2026examiningtheintegrationofCO2removalsintotheEUETS1.Theupcomingdiscussionsonthe2040target,aswellastheendoftheallocationofnewallowancesattheendofthe2030s(Rickelsetal.2022),willgivefurtherimpetustothisdebateandextendittotheEUETS2.2TheEUEffortSharingRegulationandthenewemissionstradingsystemReductioncommitmentsintheEUvarybysector.Companiesintheenergy,industry,aviation,andsoonshippingsectorshaveanaggregatetargetthatismetthroughtheexistingEU-wideemissionstradingsystem(EUETS1).1Forthesumofallotheremissions,includingthosefromhouseholds,smallbusinessesandfarms,nationalemissionreductiontargetsaresetacrosstheEU.Individualcountriesplantoachievethesetargetsusingavarietyofinstruments,includingregulatorymeasures,CO2taxesandsubsidies.ThenationaltargetsarenegotiatedaspartoftheEU'sclimatepolicy—moreeconomicallydevelopedcountrieswithahighergrossdomesticproduct(GDP)takeonmoreambitiousreductiontargets—andaresetoutintheEffortSharingRegulation(ESR)mentionedabove.TheyarecomplementedbytheLandUse,LandUseChangeandForestry(LULUCF)Regulation,alsowithnationaltargets(from2026)andanoverallEUtargetof-310MtCO2(EuropeanParliamentandCouncil,2023a).2In2022,thereductiontargetfortheESRsectorswastightenedfrom30percentto40percentcomparedto2005,andthenationaltargetsandannualemissionallocations("AEAs")weretightenedaccordinglywithanadjustedmethodologyandcalculation(EuropeanParliamentandCouncil,2023b).Thelegallybindingtargets,differentiatedbyMemberState,wereoneofthekeyelementsthatwerecontestedinthelegislativeprocessinthepast.Theresultinggradationofambitionisseenasanimportantprerequisiteforlessclimate-ambitiouscountriestoagreetothelegislativepackages(Runge-MetzgerandvanIerland2019).Thisisthesecondtimethatcountry-specifictargetshavebeenraised1By2026,theinclusionofwasteincinerationisalsounderconsideration(EC2023).2WeusethetermCO2inthearticleforsimplicity,eventhoughothergreenhousegasesareemitted,especiallyintheESR,whichareconvertedtoCO2unitsandaccordinglythecorrecttermwouldbeCO2equvi.4inthecontextoftheESR,andFigure1showstheconsiderablevariationinreductiontargetsacrosscountries,andthusalreadyimplicitlythepotentialforefficiencygainsthroughflexibleimplementationoftheoverallemissionscommitment.Figure1:DevelopmentofEffortSharingTargets(imVergleichzu2005)Note:Ownpresentation,basedondatafromEEA(2022c)andthecorrespondingregulations(ESRandESD).Figuresarerounded.Infact,theESRandLULUCFregulationsprovideforcertainflexibilitymechanismsintermsofsaving,borrowing,andtradingAEAstoefficientlyachievecompliance.Forexample,theESRRegulationallowsMemberStatestosellasurplusoftheiremissionreductionintheESRsectorstootherMemberState(PeetersandAthanasiadou,2020;Runge-MetzgerandVanIreland2019).Thereareexanterestrictionsontradablequantitiesthatlimittheextenttowhichmemberstatescantradeallowancesallocatedtothem(10percentand15percentofannualallocatedemissionsinthe2021-2025and2026-2030periods,respectively).Expost,afterdeterminingtheextenttowhichactualESRemissionsdeviatefromtargets,therearenolimitsontradingamongmemberstates(Yougova,2023;Goresetal.,2023).Todate,Germany,Malta,andIrelandhave5purchasedAEAs,withGermanypurchasing11millionAEAsfromBulgaria,theCzechRepublic,andHungary(BMWK,2022a,EEA,2022a),Maltapurchasing1.4millionAEAsfromBulgaria(GoresandGraichen,2018;Cilia,2018),andIrelandpurchasingapproximately4millionAEAs(EEA,2022a),eachforcompliancewiththe2020target.Undertheoverallincreasedreductionlevelforthe2030targetyear,itisreasonabletoexpectthatdomestictradingwillbecomemoreimportant,especiallyifthereismoreregionalrelocationofemissionreductionsthroughtheEUETS2.Inaddition,LULUCFcreditscanbeusedtooffsetESRemissions.Thislinkisbidirectional,meaningthatemissionsintheLULUCFsectorcanalsobeoffsetbyadditionalreductionsinESRemissions(PeetersandAthanasiadou,2020;Jensen,2023).3However,LULUCFcreditscanonlybeincludedintheESRiftheyresultfromnetnegativeLULUCFemissions,i.e.CO2removalandstorage,e.g.throughafforestation,mustexceedotheremissionsintheLULUCFsector(Pisarskietal.,2021).TheamountofLULUCFcreditsthatcanbeusedbyanationstatetooffsetESRemissionsislimitedtotherespectivemaximumamountoftotalnetCO2removalsasdefinedinAnnexIIIoftheESRRegulation.Theabsolutecapforthetwocommitmentperiodsis262.2MtCO2(splitequallyoverthetwoperiods)whichwouldneedtoberealizedasnetremovalontopofthe310MtCO2removaltargettobetransferredtotheESRtocompensateforemissionsreductions.Inpractice,theactualtotalamountwouldbesmallersinceitappearsunlikelythatstate-specificdemandforLULUCFcoincideswiththestate-specificcaps(definedinAnnexIIIoftheESR).Finally,certainMemberStatescanuseEUETS1allowancestomakeupforshortfallsinemissionreductionsintheESRsectors.Countriesthatareatriskofagapbetweentheirowncost-effectivereductionsandtheirGDP-basedtargets,orthathavenotreceivedfreeallocations(Malta),haveaccesstothisflexibility.Thus,Belgium,Denmark,Ireland,Luxembourg,Malta,theNetherlands,Austria,FinlandandSwedencanusethisflexibility.Thetotalnumberofallowancesforallcountriesunderthisflexibilityislimitedto100millionfortheten-yearperiod2021-2030(EUCommission,2021;Romppanen,2020).4TheCommission'sevaluationofthenationalenergyandclimateplans(2020)showsthatthetotalvolume(2021-2030)wouldbe64.1MtCO2sofar—Belgium(26.8MtCO2),Austria(18.7),Finland(17.9)andMalta(0.7)havealreadyspecifiedtheuseofthisflexibility;Denmark,IrelandandLuxembourghavenotyetdoneso(seeEUCommission,2021).However,overachievementofESRtargetscannotbetransferredtotheEUETS1,i.e.thelinkisone-way.From2027,asecond,additionalemissionstradingscheme(EUETS2)willbeintroducedforthebuildings,roadtransportandsmallenergyandindustrialinstallationssectors(not3Whileallcountriescanusethisflexibility,MemberStateswithrelativelyhighagriculturalemissionsarelessrestrictedunderAnnexIIIoftheESRRegulation(Heroldetal.,2021,Runge-MetzgerandVanIerland2019;Romppanen,2020).Splittingthisflexibilityovertwoperiodshalvesaccesstoeach(Yougova,2023).4Malta,Luxembourg,andIrelandcanaccessthisflexibilitytothegreatestextent,equivalentto7percent(Malta)and4percentof2005emissions(seeAnnexIIESR;Runge-MetzgerandVanIerland,2019;Yougova,2023).6coveredbyEUETS1).Figure2showstheestimateddistributionofemissionsbetweenEUETS1,thenewEUETS2andtheremainingESRemissions.ThestartofimplementationoftheEUETS2maybedelayedto2028duetoextremelyhighenergyprices(Duweetal.,2023).UnderEUETS2,allallowancesareauctioned.DistributorsoffuelsusedforpurposeslistedinAnnexIIIofthenewETSDirectivearerequiredtopurchaseallowancesfortheiremissions(upstreamapproach).FinalconsumersarenotdirectlyinvolvedintheEUETS2(EUParliamentandCouncil,2022;Frenz,2022;Duweetal.,2023;Dumaetal.,2022).Figure2:DistributionofemissionsbyETS1,ETS2andotherESR,basedon2021emissions.Note:Ownpresentation,basedonthedataandallocationdistributionoftheExpertCouncilonClimateIssues(2022),Öko-Institut(2021),andPauseetal.(2023).EmissionsdataarefromEEA(2023).FiguresinMtCO2eq.From2026,emissionsfromN2OandCH4frommaritimetransportaretofallunderEUETS1.CommissionpresentsareportonthefeasibilityofincludingwasteincinerationinEUETS1from2026,from2028.TheEUETS2reductiontargetfor2030is43percentbelow2005levels.Thenewallowancesauctionedeachyeardecreaselinearly,asintheEUETS1,withemissionsattributedtotheEUETS2in2024usedtocalculatethelinearreductionfactor(LRF)(Goresetal.2023).TheinitialLRFis5.1percent(basedon2024)andisexpectedtoincreaseto5.38percent.However,moreallowanceswillbeauctionedinitiallytoensuresufficientliquidityinthemarket.Thisso-called"frontloading"amountsto30percentofthe7auctionvolumeinthefirstyearandwillbedeductedfromtheauctionvolumesinsubsequentyears.Frontloadingthereforedoesnotincreasetotalemissions.SimilartotheEUETS1,theEUETS2iscomplementedbyaMarketStabilityReserve(MSR).TheETS2MSRisendowedwithavolumeof600MtCO2allowances,buttheseare"extra",i.e.theauctionvolumeuntil2030isnotcorrectedforthisvolumeandareleaseofallowancesfromtheETS2MSRwouldincreaseemissionsintheEUETS2(Goresetal.2023).However,allowancesfromtheinitialsupplyintheETS2MSRbecomeinvalidafter2030.TheallowancesintheETS2MSRaresubjecttoaquantitytriggerandapricetrigger,asintheEUETS1.Thequantitytriggerisbasedontheamountofallowancesheldbymarketparticipants.Ifthisquantityisabove440millionallowances,100millionallowancesfromfutureauctionvolumeswillflowintotheETS2-MSR;conversely,100millionadditionalallowanceswillbeauctionedifthequantityofallowancesheldbymarketparticipantsisbelow210millionallowances(EUParliamentandCouncil,2022).IftheallowancepricerisesaboveEUR45/tCO2fortwoconsecutivemonths,20millionallowanceswillbereleased;ifthepricedoubles(period:sixmonths),50millionallowanceswillbereleased;ifittriples,150millionallowanceswillbereleased(EUParliamentandCouncil,2022).However,theEUCommissioncanlifttheserestrictionsbymeansofanimplementingregulation(Goresetal.,2023),whichontheonehandindicatesthestillprovisionalandexperimentalcharacteroftheEUETS2,butatthesametimealsoshowsthatwithcorrespondingpoliticalpressure,strongerinterventionintheEUETS2tostabilizepricesispossible.TheexperimentalnatureoftheEUETS2isalsoreflectedinthefactthatitisnotaseparatepillarofEUclimatepolicyuntil2030,butisintendedtoserveasatooltohelpMemberStatesachievetheirnationaltargetsundertheESR(Duweetal.,2023;ErbachandFoukalová,2023;cf.Schlackeetal.,2022).Thus,theemissionscoveredbytheEUETS2remainundertheESRtargetsandtheresponsibilityofMemberStates'responsibilitiesforcompliance.IftherearenetregionalshiftsofemissionreductionswithintheEUETS2,e.g.ifcompaniesofamemberstatebuyinaggregatedtermsnetallowances,theERStargetstillhastobemetatthenationallevel.ThememberstatewouldthenhavetocompensateforincreasedemissionsintheEUETS2emissionsattributedtothecountrybyi)strongeremissionsreductionintheERSsectorsnotcoveredbytheEUETS2and/orii)usingtheflexibilitymechanismsdescribedabovetooffsetthe"additional"emissionsintheEUETS2bypurchasingAEAallowances,and/oriii)usingCO2removalsfromtheLULUCFsector.Thus,thereisadirectpricingofashareofESRemissionsthroughtheEUETS2,butakindofdoubleregulationthroughthecreditingofemissionsinacross-borderemissionstradingsystemagainstnationaltargets(Duweetal.,2023).Accordingly,until2030,MemberStateshavetheoptiontoopttheirsectorsoutoftheEUETS2ifanationalsystemwithCO2taxesatleastashighasthoseintheEUETS2isinplace(EUParliamentandCouncil,2022;Goresetal.,2023).Allinall,theseconsiderationsshowthattherearestillmanyopenquestionsregardingtheimplementationoftheEUETS2andthecoordinationwithnationalCO2pricingsystems.83EffectsoftheEUETS2TodiscusstheimpactoftheEUETS2,weanalyzedifferentscenariosusingtheDynamicAppliedRegionalTrademodel(DART).DARTisamulti-regional,multi-sector,globalandrecursivedynamicgeneralequilibriummodel(Klepperetal.,2003;Winkleretal.,2021).TheadvantageofusingsuchanequilibriummodelisitsabilitytocapturenotonlythedirectdomesticmultipliereffectsofaCO2price,butalsotheindirecteffectsviachangesininternationalenergypricesandtradeflows(KlepperandPeterson,2006).WeuseaversionofDARTcalibratedtotheGTAP10dataset(Aguiaretal.,2019)withabaseyearof2014andIEA(2020)emissionsandGDPdata,andupdatedtoIEA(2022)renewableenergydata.DARTcoversCO2emissionsfromfossilfuelcombustion,whichisthecoreofEUclimatepolicy.OthergreenhousegasesandtheLULUCFsectorarenotcovered.Thetimehorizonforthepresentanalysesis2030,whichisthetargetyearofthefirstNationallyDeterminedContributions(NDCs)submittedundertheParisClimateAgreement,aswellasthecurrentEUreductiontargetsundertheGreenDeal.Allresultsbelow,summarizedinTable1,arefortheyear2030.Inthereferencescenario,countriesandregionsoutsidetheEU(e.g.theUSA,Canada,orAfrica)reachtheirNDCs(seeBöhringeretal.,2021foradescriptionoftheseNDCsinnon-Europeanregions).ForEUcountries/regions(whichinDARTareDEU:GermanyandFRA:FranceasindividualcountriesandSCA:Scandinavia,BLX:Benelux+Ireland,SEU:SouthernEurope,andEEU:EasternEuropeasaggregatedregions),weassumeanemissionstradingschemeintheenergysectorandenergy-intensiveindustry(EUETS1).WetranslatetheGreenDealtargetofa43percentreductioncomparedto2005intoareductiontargetof25.9percentcomparedtothe2014calibrationyear.OutsidetheEUETS1sectors,eachEUcountry/regionachievestheESR(2021)targetasshowninFigure1,againtranslatedintoreductionscomparedto2014.ThisisachievedthroughregionalCO2pricesthatapplyuniformlytoallESRsectorsintherespectivecountry/region.Inthisreferencescenario,therearesevenCO2pricesintheEU:oneintheEUETS1andsixintheESRsectorsofthesixDARTEUcountries/regions.TheCO2pricesreflectthedifferentabatementcostsbothacrosscountriesandacrosstheenergyandindustrysectorsaggregatedintheEUETS1.Inthisscenario,theEUETS1CO2pricein2030is79EUR/tCO2,whichislowerthanthecurrentEUETS1price(whichhasbeenabove100EUR/tCO2attimes).ThisispartlybecauseanEUETSpriceofaround5EUR/tCO2isalreadyimplicitintheGTAPdataset,andpartlybecausetheaggregateproductionfunctionsinEUETS1ignorevariousrealfrictions.TheESRtargetsimplymuchhigherpricesinthereferencescenariothanintheEUETS1,andnationalCO2pricesrangefromjustunder91EUR/tCO2toaround502EUR/tCO2intheEEUandinboth,SCAandDEU,in2030,respectively(seeTable1).Notethatthemodeldoesnotreflectallinefficienciesofthecurrentsystem,firstlybecauseitimplicitlyassumesregionalemissionstradingintheESRsectorsintheaggregatedEUregions,andsecondlybecauseinrealitytheESRsectorsaresubjecttonumerousregulationsthatarefarfromauniformCO2price.Theseresultsthereforeconfirmthatitwouldbe(statically)moreefficienttoreducelessemissionsintheESRsectorandreducemoreemissionsintheEUETS1thanisthecaseintheEU.9Accordingly,thosecountriesthathaveaccesstothepossibilityoftransferringallowancesfromtheEUETS1totheESR(seeChapter2)shoulddoso.InthecomprehensiveETSscenario,EUtargetsareefficientlymetunderacomprehensiveemissionstradingscheme.ThisresultsinauniformCO2priceofEUR155/tCO2andEUwelfaregainsrelativetothereferencescenario(measuredastheHickseanEquivalentVariation,ameasureofaggregateeconomicwelfarethataccountsforpricechangesbetterthanGDP)of1.8percent,rangingfrom0.2percentintheSEUto4.7percentintheEEU,arerealized.Inthisscenario,moreemissionsareavoidedinthesectorsassignedtotheEUETS1.Accordingly,theemissionsintheERSsectorsare290MtCO2higherthaninthereferencescenario.IntheESR-ETSscenario,thereisasecondESR-wideemissionstradingscheme.ThepriceintheEUETS1changesverylittleduetoequilibriumeffectsandamountsto77EUR/tCO2.IntheESRETS,thesimulationsresultinapriceof307EUR/tCO2,whichissignificantlyhigherthantheuniformCO2priceinacomprehensiveETS.Thus,thisscenarioachievesonlyabout40percentoftheefficiencygainsofthecomprehensiveETSscenario.IntheETS2scenario,aEuropeanemissionstradingsystemisassumedtobeintroducedinthetransportandbuildingsectors.Totheextentpossibleinthemodel,thiscorrespondstotheroadtransportandbuildingsectorsasenvisagedintheEUETS2.However,therepresentationoftheroadtransportsectorinDARTdoesnotexactlymatchthecoverageenvisagedinEUETS2(seeFigure2),asthetransportsectorislessdisaggregatedinDARTandincludesemissionsfromaviationandshipping.Duetothelackofinformation,theESRtargetsaredividedbetweentheseETS2sectorsandtheremainingESRsectorsaccordingtotheiremissionsharesinthebaseyear2014.ThetargetsintheremainingESRsectorsareachievedthroughregionallydifferentiatedCO2prices.IntheEUETS2,aCO2priceof297EUR/tCO2isachieved(similartotheESRETSscenario).However,asthenationalCO2pricesfortheremainingESRsectorsvarysignificantly,onlyabout25percentoftheefficiencygainsoftheoverallETSscenariocanbeachievedhere.IntheETS2scenario,companiesinEasternandSouthernEuropesellinnettermsallowances(53MtCO2and58MtCO2,respectively),whicharepurchasedbycompaniesinGermany(47MtCO2),France(22MtCO2),Benelux(21MtCO2)andScandinavia(20MtCO2).TheresultingdeficitsintheESRemissionsofnationstatescouldonlybepartiallycompensatedinScandinaviabyincreasedreductionsintheremainingESRsectorsatminimalcost(inScandinaviatheCO2priceintheremainingESRsectorsis296EUR/tCO2comparedto297EUR/tCO2intheEUETS2);forallothercountriesthemarginalcostofabatementintheESRoutsidetheETS2ishigherthantheETS2price,andaccordinglyitismoreefficienttobuythecorrespondingAEAallowancesfromEasternandSouthernEurope.Inaddition,thereisalsothepossibilitytocompensatetheshortfallbytransferringcarbonremovalsfromLULUCFtoESR.ForGermany,however,thecapof11.15MtCO2(fortheperiod2026to2030)wouldnotallowforacompletecompensation;forFrance,however,thecapwouldallowso(29.1MtCO2).Table1.ResultsofDART-Analysis10referenceComprehensive-ETSESR-ETSETS2ETS2-MaxWelfareeffectsrelativetoreferencescenarioFRAx2,5%0,8%0,6%(5,3%)GERx2,6%0,1%0,1%(3,7%)BLXx1,1%0,1%0,1%(3,8%)SEUx0,2%0,2%0,1%(1,8%)SCAx2,5%1,0%0,6%(5,3%)EEUx4,7%4,1%2,6%(1,1%)EUx1,8%0,7%0,5%(3,2%)CO2-prices(inEUR/tCO2)FRA428xx633622GER501xx633624BLX438xx588583SEU213xx296288SCA500xx834944EEU89xx6867Full-EUx155xxxEU-ETS179x777668ESR-ETSxx307xxEU-ETS2xxx29750.56emissionsinESR(inMtCO2)FRA152220180174229GER178287233225299BLX135195161156203SEU428461364370515SCA93139118113143EEU228199157175239WelfareeffectsinthescenarioETS2-MaxarenotcomparabletootherscenariossinceadditionalcostforcompliancewithERStargetsarenotincluded.ThemodeledCO2priceintheEUETS2intheETS2scenariowouldthusbesignificantlyhigherthanthetargetedinterventionpriceof45EUR/tCO2.However,iftheinterventionpriceweretobeseenasakindofceilingprice,aconsiderableamountofadditionalallowanceswouldberequired.ThisquestionisexaminedintheEST2-Maxscenario,wheretheCO2priceiskeptat45EUR/tCO2(in2022prices:50.56EUR/tCO2).EmissionsintheEUETS2are415MtCO2orabout40percentabovetargetinthisscenario.ThereportedwelfarevaluesarehighestherebecauseinthesimulationstheadditionalemissionswiththeadditionalallowanceshavenowelfareimpactanditisnotinvestigatedwhatadditionalcostswouldariseiftheseallowancesweregeneratedbyadditionalreductionsintheremainingESRsectorsorbyCO2removalsintheLULUCFsector(withnetemissionsthenunchanged).Accordingly,thewelfareeffectsintheETS2-Maxscenarioonlyshowtheextenttowhichalowerabatementlevelhasanimpactvialowerabatementcosts.11IntheETS2-Maxscenario,ESRemissionsareabovetheESRtargetinallcountries/regions(comparecolumnwithreferencescenario)andtheESRdeficitcannotbecompensatedbyAEAtradingatthenationallevel.Similarly,nationalpricesareabovetheinterventionpriceinallcountries/regions,sooffsettingthehigherEUETS2emissionsintheremainingESRsectorswouldbecostly,especiallyconsideringthatthecumulativedeficitof415MtCO2isroughlyequivalenttothemagnitudeofagriculturalemissionsof456MtCO2intheESR(seeFigure2).OuranalysishasnoinformationonthemarginalcostofCO2removalintheLULUCFsector,butextendingthealreadyambitiousnetremovaltargetof310MtCO2byanadditional415MtCO2tooffsetESRemissionsunderthemaximumpriceseemsambitious(apartfromthefactthatthecurrentlimitsonflexibilitybetweenESRandLULUCFwouldnotallowatransferofthismagnitude;seeChapter2).ForGermanyalone,thisresultsinashortfallof121MtCO2innationalERStargets,ofwhichonly11.15MtCO2couldbecompensatedbyadditionalCO2removalsinLULUCF.Accordingly,theETS2-MaxscenariorequiresadditionalinterventionsinthesectorswithintheEUETS2andthusimplicitCO2pricesabovetheinterventionprice.EventhoughthefiguresshouldbeinterpretedcautiouslyduetotherathercoarsemodelingoftheEUETS2inDART,thecomparisonwithintheemissionsESRbetweenthereferencescenarioandthescenarioETS2orETS-MaxinTable1allowsroughconclusionsforthenecessaryeffortsofthememberstatestoreachtheirESRtargets.4DiscussionandConclusionInordertoachievetheambitiousemissionreductiontargetsfor2030setoutintheFitfor55package,theEUhasdecidedtoexpandtheemissionstradinginstrument.Theexistingemissionstradingscheme(EUETS1),whichcoversemissionsfromtheenergyandindustrialsectorswithintheEU27,willbecomplementedbyasecondemissionstradingscheme(EUETS2),whichwillprimarilycoveremissionsfromtheroadtransportandbuildingssectors.Themotivationforatransnationalemissionstradingsystemistoachievereductionswhereabatementischeapest.Inprinciple,thismakesnationalreductiontargetsobsolete,buttheyremaininplaceintheircurrentform.BasedonpreviousexperienceinEUclimatepolicy,wheredistributionaldimensionsplayanimportantroleinrankingtheambitionlevelsofindividualmemberstates(Runge-MetzgerandvonIerland2019),thereisconsiderableinsistenceondifferentiationordemandsforcompensationpayments.ThisisreflectedinthecurrentdesignoftheEUETS2,asshiftsinabatementinthecorporatesectorcreatecorrespondingcreditsordeficitsinexistingnationaltargets,whichhavetobecompensated,forexample,throughemissionstradingatthestatelevel.Accordingly,nationstateswithrelativelylowabatementcostswillexperienceaninflowoffundsfromnationstateswithhighabatementcosts,bothatthecorporateandthestatelevel.Thus,therewillbeanex-postdistributionaleffectifnationstateshavetocompensatesurplusesordeficitsresultingfromtheEUETS2throughinterstateemissionstrading.Desireddistributionaleffectscouldbebetterachievedbyanexantedistributionofauctionvolumes(orauctionrevenuesinthecaseofcentralizedauctions).Giventheuncertaintyofabatementcostsandtherelativelysmallnumberof12actorsinintergovernmentalemissionstrading,anex-antedistributionwithoutsubsequentoffsettingofemissionsagainstnationaltargetsappearssuperior.However,evenwiththeex-postdistributionchosennow,nationstatesshouldusetheflexibilitymechanismstorealizetheefficiencygainsoftheEUETS2.ToassesstheEUETS2,weexaminedifferentscenariosinthegeneralequilibriummodelDART.BoththecurrentEUclimatepolicyandafullycomprehensiveemissionstradingsystemareusedaspointsofcomparison.Inthecurrentsystem,thereisonlytheEUETS1andallotheremissionsareregulatedbynationalanddifferentpolicies.Boththevariationinnational(implicit)CO2pricesandthedifferencefromtheEUETS1priceshowtheinefficiencyoftheexistingsystem.Bycomparison,acomprehensiveemissionstradingsystemachievesemissionsreductionsatminimumcost,withmorereductionsintheenergyandindustrialsectors.Theintroductionofasecondemissionstradingsystemforroadtransportandbuildingscanbeapossibleintermediatesteptowardssuchacomprehensiveemissionstradingsystem.Inourmodel,theintroductionofanemissionstradingsystembasedontheEU'splansfortheEUETS2intheroadtransportandbuildingssectorsgeneratesaboutaquarteroftheefficiencygainsofacomprehensiveemissionstradingsystemrelativetotheyear2030.However,thiscalculationisonlyaroughapproximationoftheplannedEUETS2anddoesnotincludeallowancesfromtheEUETS2MarketStabilityReserve(MSR).TheETS2MSRhasbothavolumetriggerandapricetrigger,whichreleasedifferentamountsofadditionalallowancesfromtheMSRforauctioningdependingonthevolumesinthemarketortheleveloftheCO2price.Inourcalculations,415MtCO2allowanceswouldneedtobeauctionedextratostabilizetheCO2priceattheinterventionpriceof45EUR/tCO2(in2020prices).Inoursimulations,companiesinSouthernandEasternEuropesellnetallowancesundertheEUETS2toallotherEUcountries.Inturn,thereisalsoasurplusofESRreductionsforthesecountriesfromtheEUETS2whichwouldallowthemtoreducecorrespondinglylessinESRsectorsoutsidetheEUETS2,tooffsetemissionsintheLULUCFsector,and/orsellannualemissionsallowancestootherMemberStates.Inoursimulations,thevolumessoldin2030correspondto14percent(SouthernEurope)and23percent(EasternEurope)oftheannualemissionallocationintheESRsectors.Inaddition,thereisthepossibilitythatMemberStatestakeaccompanyingnationalmeasuresforthesectorsintheEUETS2(withcorrespondingefficiencylosses).Alsointhisvariant,MemberStatescouldrelyonapricemechanismthatallowsthemtoimplementhigherpricesthanintheEUETS2(EUParliamentandCouncil2022).Itisstillunclearhowthiscouldbeimplementedandwhetherthenationalpriceswouldthenfunctionasakindofminimumprice,withcompaniesinthememberstatepayingthedifferencebetweentheEUETS2priceandtheminimumpriceasakindoftax(comparabletotheformerclimatelevyintheEUETS1sectorsintheUK).Iftheimplicitnationalminimumpriceswerelowerthanthepricesinthereferencescenario(seeTable1),therewouldstillbeefficiencygainsfromtrading(albeitlowerthanintheEUETS2scenariowithoutnationalrestrictions).13TheintroductionoftheEUETS2willbeaccompaniedbytheintroductionofaSocialClimateFund,whichwillbeendowedwithEUR86.7billionfortheperiodfrom2026to2032(65billionthroughauctionrevenuesandfurthercontributionsthroughnationalresources)andwillsupportclimate-friendlymeasuresandinvestments(EuropeanParliament,2022b;Art.15,EuropeanParliamentandCouncil2023c).DistributingrevenuesfromCO2pricingback,forexampleinthecontextofpercapitareimbursement,isanimportantbuildingblockfortheacceptanceofaprice-basedclimatepolicy(e.g.,Klenertetal.2018).ToallowtheincentiveeffectofCO2pricesintheEUETS2towork,expendituresfromtheclimatesocialfundshouldfocusontransferpaymentsoratleastbelimitedtosubsidiesthatdonotdistortmarginalincentivesbutaddressmarketentryproblems(AntoniouandStrausz2017).TheextenttowhichadditionalmeasuresareneededwillalsodependontheCO2pricerealizedintheEUETS2.Inprinciple,itisefficienttocombinequantitycontrolwithpricecontrolwhenthereisconsiderableuncertaintyaboutabatementcosts.However,thecurrentinterventionprice(45EUR/tCO2,in2020prices)iswellbelowthepricelevelintheEUETS1,sothatahigherinterventionpriceseemsreasonablewithaviewtoaneconomicallynecessaryalignmentofabatementcostsacrossthedifferentpillarsofEUclimatepolicy.Inaddition,itmakessensenottosetafixedinterventionprice,buttoaimforadiscretionarypricestabilizationinordernottocompletelyeliminateuncertaintyforcompaniesaboutfutureabatementcosts(Rickelsetal.2022).Regardlessofthedesignofpricestabilization,additionalallowancesmustbeoffsetbyadditionalreductionsinothersectorsoradditionalCO2removalsifnetemissionsaretoremainunchanged.However,withdecliningemissionsinallsectors,boththeEUETS1andtheESR,itwillbecomeincreasinglydifficulttooffsetloweremissionreductionsinonesectorwithhigheremissionreductionsinanother.Accordingly,theLULUCFsectorwillbecomemoreimportantinachievingatmosphericCO2removals.Currently,thecreditingofnetnegativeemissionsfromLULUCFintoESRiscumulativelylimitedto262.2MtCO2by2030,butthiswouldbeinadditiontotheremovaltargetof310MtCO2tooffsetemissionswithinESR.AlthoughtheCommission'smodelingassumesasignificantexpansionoftheLULUCFsinkby2050(EuropeanCommission2020),projectionsto2030indicatethattheoppositetrendislikely,withasignificantdeclineinsinkperformance(Heroldetal.2021).Accordingly,acrediblepricecontrolintheEUETS2(andpotentiallyalsointheEUETS1)byCO2removalallowanceswillrequiretoincludefurthermethodsofnaturalCO2removalsuchasforexampleacceleratedweatheringorcoastalseagrassrestorationintotheLULUCF,aswellastointegratetechnicaloptionsforCO2removalintotheEUclimatepolicy.14AcknowledgementsChristianRischeracknowledgesfundingfromtheEUH2020programundertheOceanNETsproject(869357),FelixSchenuitacknowledgesfundingfromtheGermanFederalMinistryofEducationandResearchundertheCDRSynTraproject(01LS2101A),SonjaPetersonacknowledgesfundingfromtheGermanFederalMinistryofEducationandResearchundertheRETAKEproject(03F0895K),WilfriedRickelsacknowledgesfundingfromVolkswagenAGunderanendowedprofessorshipthroughtheStifterverband.WewouldliketothankJakobGraichen,ThorstenMüller,andJanaNystenforhelpfulcomments.ReferencesAntoniou,F.,andStrausz,R.(2017).Feed-insubsidies,taxation,inefficiententry.Environ.Res.Econ.67,925–940.doi:10.1007/s10640-016-0012-8Aguiar,A.,M.Chepeliev,E.Corong,R.McDougallundD.vanderMensbrugghe(2019),TheGTAPDataBase:Version10,JournalofGlobalEconomicAnalysis,4(1),1(Retrievedfromhttps://www.jgea.org/ojs/index.php/jgea/article/view/77).BMWK(2022a),DeutschlanderwirbtEmissionsberechtigungenfürverfehlteKlimazielezwischen2013bis2020,https://www.bmwk.de/Redaktion/DE/Pressemitteilungen/2022/10/20221024-deutschland-erwirbt-emissionsberechtigungen-fur-verfehlte-klimaziele-zwischen-2013-bis-2020.html(27.03.2023).BMWK(2022b),NewEUclimatepolicyinplace:politicalagreementinfinalizingtheFitfor55climatepackage,https://www.bmwk.de/Redaktion/EN/Pressemitteilungen/2022/12/20221218-new-eu-climate-policy-in-place-political-agreement-in-finalising-the-fit-for-55-climate-package.html(18.Februar2023).Böhringer,C.,S.Peterson,T.F.Rutherford,J.SchneiderundM.Winkler(2021),ClimatepoliciesafterParis:Pledge,TradeandRecycle:Insightsfromthe36thEnergyModelingForumStudy(EMF36),EnergyEconomics,103(2021),105471.Böhringer,C.,T.HoffmannundC.Manrique-de-Lara-Peñate(2006),TheefficiencycostsofseparatingcarbonmarketsundertheEUemissionstradingscheme:AquantitativeassessmentforGermany,EnergyEconomics,28(1),44(10.1016/j.eneco.2005.09.001).Böhringer,C.,A.LangeundT.F.Rutherford(2014),Optimalemissionpricinginthepresenceofinternationalspillovers:decomposingleakageandterms‐of‐trademotives,JournalofPublicEconomics,110(2014),101.Böhringer,C.,T.F.RutherfordundR.S.J.Tol(2009),THEEU20/20/2020targets:AnoverviewoftheEMF22assessment,EnergyEconomics,31(2009),268(https://doi.org/10.1016/j.eneco.2009.10.010).15Bundesbank(2015),DevisenkursstatistikDezember2015,https://www.bundesbank.de/resource/blob/695964/b333671744e02ceecbcf44492f977c71/mL/2015-12-devisenkursstatistik-data.pdf(06.April2023).Burmeister,J,SPeterson(2016).NationalclimatepoliciesintimesoftheEuropeanUnionEmissionsTradingSystem(EUETS),KielWorkingPapers2052,KielInstitutefortheWorldEconomy(IfWKiel).Burtraw,D,CHolt,KPalmer,WMShobe(2020),Quantitieswithprices:priceresponsiveallowancesupplyinenvironmentalmarkets.ResourcesfortheFuture,WorkingPaper(20-17),WashingtonD.C,https://www.rff.org/documents/2636/RFF_WP_20-17_Burtraw.pdf.Cilia,R.(2018),Updated:MaltabuyingemissionsallocationsfromBulgariacosting€180,000ayear,Independent,https://www.independent.com.mt/articles/2018-11-05/local-news/Malta-purchases-annual-emissions-allocations-from-Bulgaria-costing-1-4-million-PN-MP-6736198891(27.März2023).Duma,D.,C.PostoiuundM.Catuti(2022),TheimpactoftheproposedEUETS2andtheSocialClimateFundonemissionsandwelfare,EnergyPolicyGroup.Duwe,M.,J.GraichenundH.Böttcher(2023),CancurrentEUclimatepolicyreliablyachieveclimateneutralityby2050?,EcologicInstituteundÖko-Institut.EEA(2023),EEAgreenhousegases—dataviewer,https://www.eea.europa.eu/data-and-maps/data/data-viewers/greenhouse-gases-viewer(31.März2023).EEA(2022a),TrendsandprojectionsinEurope2022,https://www.eea.europa.eu/publications/trends-and-projections-in-europe-2022(27.März2023).EEA(2022b),GreenhousegasemissionsundertheEffortSharingDecision(ESD),https://www.eea.europa.eu/data-and-maps/data/esd-4März2023(27.März2023).EEA(2022c),NationalprogresstowardsgreenhousegasemissiontargetsundertheESR,https://www.eea.europa.eu/data-and-maps/figures/national-progress-towards-greenhouse-gas(03.April2023).EC(CounciloftheEuropeanUnion)(2023),InterinstitutionalFiles:2021/0211(COD),2021/0202(COD),https://data.consilium.europa.eu/doc/document/ST-6210-2023-INIT/en/pdf(05.April2023).Erbach,G.undN.Foukalová(2023),ReviewoftheEUETS,EuropeanParliamentaryResearchService.EuropäischeKommission(2021),ImpactAssessmentReportAccompanyingthedocumentRegulationoftheEuropeanParliamentandoftheCouncilamendingRegulation(EU)2018/842onbindingannualgreenhousegasemissionreductionsbyMemberStatesfrom2021to2030contributingtoclimateactiontomeetcommitments16undertheParisAgreement,https://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=SWD:2021:0611:FIN:EN:PDF(27.März2023).EuropäischesParlamentundRat(2022a),DIRECTIVE(EU)2023/...OFTHEEUROPEANPARLIAMENTANDOFTHECOUNCILof...amendingDirective2003/87/ECestablishingasystemforgreenhousegasemissionallowancetradingwithintheUnionandDecision(EU)2015/1814concerningtheestablishmentandoperationofamarketstabilityreservefortheUniongreenhousegasemissiontradingscheme,https://www.europarl.europa.eu/doceo/document/TA-9-2022-0246_EN.html(16.März2023).EuropäischesParlament(2022b),DealonestablishingtheSocialClimateFundtosupporttheenergytransition,https://www.europarl.europa.eu/news/en/press-room/20221212IPR64528/deal-on-establishing-the-social-climate-fund-to-support-the-energy-transition(05.März2023).EuropäischesParlamentundRat(2023a),REGULATION(EU)2023/…OFTHEEUROPEANPARLIAMENTANDOFTHECOUNCILofamendingRegulation(EU)2018/841asregardsthescope,simplifyingthereportingandcompliancerules,andsettingoutthetargetsoftheMemberStatesfor2030,andRegulation(EU)2018/1999asregardsimprovementinmonitoring,reporting,trackingofprogressandreview,https://data.consilium.europa.eu/doc/document/PE-75-2022-INIT/en/pdf(30.April2023)EuropäischesParlamentundRat(2023b),REGULATION(EU)2023/...OFTHEEUROPEANPARLIAMENTANDOFTHECOUNCILofamendingRegulation(EU)2018/842onbindingannualgreenhousegasemissionreductionsbyMemberStatesfrom2021to20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