Project Appraisal in the Reformed EU ETS: Looking for Shortcuts

Abstract

The European Union’s Emissions Trading System, EU ETS, has been reformed, shifting the system from a fixed-cap system into a system with an endogenous supply of permits. This paper discusses how to handle the scheme in project appraisal. The focus is on a few relatively straightforward empirical approaches that can be used to approximate how the path of the endogenous supply of permits is affected by an exogenous change in emissions. A particularly surprising feature of the reformed scheme is that an exogenous increase in emissions could cause a reduction in total emissions, a kind of Green Paradox. In addition, overlapping national policies as well as the Paris Agreement to combat climate change that entered into force on 4 November 2016 could neutralize any exogenous impact of the project, reintroducing the ‘waterbed’ so that the project is evaluated as if it sorted under a fixed-cap system. The paper proposes a couple of shortcuts that hopefully simplify economic evaluations of projects affecting the supply of permits. For convenient reference, the paper also lays out the mechanics of the reformed system.