Offset Credits in the EU ETS: A Quantile Estimation of Firm-Level Transaction Costs

Abstract

International offset certificates trade at lower prices than European Union Allowances (EUAs), although they are substitutes within the EU Emissions Trading System (EU ETS) for CO2. Firms therefore had a strong incentive to use the cheaper certificates. However, a considerable number of firms did not use their allowed offset quota and, by doing so, seemingly forwent profits. While most of the literature on emissions trading evaluates the efficiency of regulation in a frictionless world, in practice firms incur costs when complying with regulation. In order to assess the relevance of managerial and information-related transaction costs, this study examines the use of international offset credits in the EU ETS. It establishes a model of firm decision under fixed entry costs and estimates the size of transaction costs rationalizing firm behavior using semi-parametric binary quantile regressions. Comparing binary quantile results with probit estimates shows that high average transaction cost result from a strongly skewed underlying distribution. I find that for most firms the bulk of transaction costs stems from participation in the EU ETS in general, rather than additional participation in the offset trade.