chapter 4.2 & 4.3 review questions

Basic features of a cap-and-trade system.

• gov sets absolute ceiling (cap) on total GHG volume that regulated sectors can emit over a specific timeframe

• then they issue corresponding number of tradable emission allowances , each representing the right to emit 1 ton of CO2

• regulated firms must surrender enough allowances to cover verified emissions at the end of the period

• result: market where allowances can be bought & sold to establish a carbon price

What is the difference between a downstream and an upstream system?

• downstream: regulates end-users of energy at point of pollution → targets power plants, heavy factories, manufacturing, forcing them to pay for emissions they release

• upstream: regulates entry point of fossil fuels into the economy → targets producers, importers, & refiners, forcing them to pay for the carbon content of the fuels they sell

How a firm’s marginal abatement cost determines its demand for emission rights.

• MAC curve serves as its inverse demand curve for emission allowances

• if prevailing market price of an allowance > firm’s abatement costs for a ton of carbon → they abate emissions & sell excess permits for profit

• if internal abatement costs > market price of an allowance → they increase market demand by purchasing allowances to cover its pollution

What is currently the share of global GHG that is covered by Emission trading systems?

• compliance emission trading systems operate across multiple regions worldwide & cover 17-23% of global GHG emissions

• expansions of those systems was driven by a launch of china’s national ETS & ongoing updates to regional frameworks across europe & north america

Explain features of current EU ETS: coverage, linear reduction factor, and market stability reserve.

• coverage: heavy industrial installations, electricity generation, intra-european aviation → 40% of EUs GHG emissions

• linear reduction factor: mechanism that shrinks total cap of available allowances by a fixed % each year → guarantees predictable pollution reduction over time

• market stability reserve: regulatory vault that absorbs excess allowances from market during gluts & releases them during shortages → stabilise prices & prevent collapse in carbon value

Why is the Carbon Border Adjustment Mechanism to prevent carbon leakage?

• imposes carbon price on carbon-intensive goods imported into EU from countries with weaker climate regulations

• ensures carbon goods from foreign countries face same carbon costs as goods produced domestically (in EU)

• eliminates financial incentive for companies to move production abroad to avoid costs

Please explain the main features of the EU ETS 2 system.

• separate, parallel emissions trading system to expand carbon pricing to sectors omitted from original EU ETS, specifically building heating & road transport

• upstream system → puts compliance obligation directly on fuel producers

• has its own cap , allocation rules, & dedicated price-containment mechanism to shield consumers from extreme fuel price spikes

Why the price for EUAs collapsed fast after starting Phase I of the EU ETS.

• european commission allocated emissions caps based on historical business projections, not verified data

• result: over-allocation of free permits

• phase 1 rules prohibited firms from banking unused allowances for use in phase 2

• market was oversupplied → value of permits became 0 since they couldn’t be saved for future years

Explanation for EUA price decline (2008–2018) and subsequent rise post-2018.

• triggered by global financial crisis: sharply reduced industrial output & left market with surplus of unneeded allowances

• post-2018 rise: major structural reforms, implementation of the Market Stability Reserve → aggressively removed excess permits from the market

• regulatory tightening & announcement of more ambitious 2030 climate targets signalled future scarcity & restored investor confidene

What has happened to EUA prices during Phase IV? Explain two contributing developments.

• reached historic highs → sometimes 80-100+ euros per ton

1. EU’s ‘fit for 55’ legislative package which tightened the linear reduction factor & accelerated the annual shrinkage of the cap

2. structural shift away from russian natural gas forced power plants to burn more carbon-intensive coal, triggering a sudden, urgent surge in demand for allowances to cover the higher emissions

Average empirical evidence regarding EU ETS impact on emission reductions and carbon leakage.

• drove down emissions in regulated sectors, particularly in power generation where it accelerated the phase-out of coal

• significant carbon leakage was avoided so far, because EU provided free allocation of to vulnerable industries during earlier phases

Please explain 3 advantages a cap-and-trade system has in comparison to green taxes.

1. environmental certainty: gov sets fixed ceiling on emissions → tax can’t guarantee precise level of pollution reduction

2. automatically adjusts macro-economic shifts → in recessions, demand for permits drops & prices fall

3. more politically palatable to industry, as govs can distribute free initial allowances to ease the transition → harder to replicate under rigid tax structure

Please explain 3 advantages a green tax has in comparison to a cap-and-trade system.

1. price predictability → allows businesses to plan long-term investments with knowledge of future carbon liabilities without facing volatile market swings

2. avoids big admin complexity, regulatory overhead, & monitoring costs needed to establish & police a tradeable asset market

3. prevents large market players from hoarding allowances or manipulating permit prices → equal playing field

Why companion energy reduction policies have no impact on overall emissions under a cap-and-trade system.

• total volume of allowed emissions is locked by aggregate number of permits issued under the cap

• if a separate policy successfully lowers electricity consumption, it reduces power plants demand for permits → allows price drop

• these cheap, unused allowances are purchased & used by other regulated industries to expand their own emissions → net-0 change to overall emissions

Compare emission ceilings, green taxes, and emission trading with respect to economic efficiency.

• green taxes & emission trading systems: market-base tools, achieve static & dynamic economic efficiency by equalising MAC across firms, minimising total clean up costs

• emission ceilings: economically inefficient, as they force every firm to meet same target regardless of cost differences → prevents low-cost abaters from taking on more burden & deprives firms of financial incentives to improve tech beyond legal requirements

Explain two advantages of ceilings and bans compared to green taxes and emission trading.

1. clarity & performance simplicity: ideal for managing localised, highly toxic substances where exposure is an immediate hazard

2. bypass the complex admin machinery & monitoring networks needed to run permit markets or collect tax revenues → effective in jurisdiction lacking sophisticated institutional capacity

Impact of the Global Commercial Whaling Moratorium on whales killed and population recovery.

• led to immediate, dramatic drop in total number of whales killed worldwide, halting industrialised commercial hunting

• ban provided vital ecological breathing room, allowing depleted whale populations to recover structurally

• some species still struggle due to illegal or non-compliant hunting conducted & modern threats