Climate law - Week 1B

What are the primary differences between a carbon tax and carbon trading in terms of efficiency and effectiveness?

• Carbon Tax = efficient because it internalizes carbon externalities by setting a price. However, it is often ineffective because it is difficult to determine how high the tax rate must be to reach a specific emission target.

• Carbon Trading (ETS) = efficient because companies with low-abatement costs can sell allowances to others. It is effective because total emissions cannot exceed the mandatory emissions cap..

Define Cap-and-Trade (CAT) and explain how it functions for different types of companies.

Cat is an absolute system where a cap is set on total emissions per year.

• Established companies receive rights for free via auction

• New/growing companies must buy rights from established firms or government reserves

• Closing companies can sell their remaining rights

→ It is high effectively because emissions are capped even if production rises.

What is Performance Standard Rate (PSR) trading, and why is it considered “relative”?

PSR sets an emissions standard per unity of energy or output rather than an absolute cap

• Credits are earned by emitting less than the standard

• Growing companies de facto receive more rights for free because their allowance increases with production

• Closing companies lose their rights

→ It is considered ineffective fro reaching absolute targets because total emissions rise if production increases.

Define offsets (Offset Credit Trading) and identify the main efficiency concenr associated with them

• Offsets are credits generated from individual emission reduction projects calculated against a hypothetical "Business as Usual" baseline.

• They are often considered inefficient due to high transaction costs, as every project requires individual baseline calculation and verification

What is the legal basis for the EU ETS and which sectors does it currently cover?

The EU ETS is based on Directive 2003/87/EC. It covers over 11,000 installations, representing 40% of EU GHGs, including:

    ◦ Power and heat generation

    ◦ Energy-intensive industries (e.g., steel, aluminium, cement)

    ◦ Aviation (since 2012)

    ◦ Maritime transport (as of 2024)

What is the Market Stability Reserve (MSR) and how does it address the "allowance surplus" problem?

Since 2019, the MSR manages the surplus of allowances to stabilize prices.

• Mechanism: Each year, 24% of the surplus is placed into the reserve

• Cancellation: As of 2023, any allowances in the MSR exceeding 400 million are cancelled

→ This reduces oversupply and improves the impact of overlapping climate policies, though it may increase price volatility

What is the purpose of CBAM and how does it relate to the phase-out of free allowances?

• CBAM is designed to prevent carbon leakage by requiring importers to pay a carbon price for goods imported into the EU

• It will be phased in between 2026 and 2034

• As CBAM is introduced, the free allowances currently given to EU industries to stay competitive will be phased out entirely by 2034

What are ETS-2 and the Social Climate Fund (SCF)?

• ETS-2: A new, separate "upstream" trading system for buildings and transport starting in 2028. Fuel suppliers must buy allowances at auction and will likely pass these costs to households and drivers.

• Social Climate Fund (SCF): A fund (active 2026-2032) filled with proceeds from ETS-2 auctions to provide financial support to vulnerable households experiencing energy poverty

What are the legal consequences for a firm that emits more than its held allowances in the EU ETS?

Under Article 16 of the EU ETS Directive, non-compliant firms face:

• A fine of €100 per tonne (plus inflation)

• The obligation to surrender the missing allowances in the following year

• Naming and shaming (publication of the names of non-compliant operators)

Why is the accusation of "windfall profits" from free allowances sometimes described as "economic non-sense"?

• While companies may gain financially from free allocations, economists argue that these allowances still have opportunity costs

• Because a firm could have sold the allowance instead of using it to cover its own emissions, the "free" allowance still carries the market price as a cost of production

• Nevertheless, the EU is moving toward auctioning as the primary allocation method to address political concerns