The EU ETS as an Environmental Instrument - Green Energy and Efficiency: An Economic Perspective - page 355

in order to generate demand. Thus the mechanism for generating demand is
in c, tech-

nology based assessment for determining the stringency of the cap. Policymakers
must

uenced to some extent by regulatory perspectives. There is no scienti

nd a balance between the degree of scarcity associated with the cap and the
impact on the economic dynamics in the country/region where the market is
deployed. A very ambitious policy on the reduction side will give rise to a lower
overall cap on the carbon market. Thus the potential gap between projected
emissions and the free allowances allocated will be wider and demand will increase,
pushing up the carbon price.
On the other hand, if the market perceives that all the free allowances allocated
are above the forecast gure for future emissions, the expected supply-demand

balance will show a surplus, with a consequent drop in carbon prices.
Thus, a situation may arise where supply (

“ the cap ” ) may be bigger than the

demand that would have existed with no carbon market ( ). Such

a situation would not provide a price signal because scarcity, a requirement of a cap
and trade system, would not exist.

“ business as usual ”

3 Building up a Robust Price Signal for Carbon

Hence the carbon price is critical to generate incentives for operators to take
emission reduction actions and to make this environmental measure a successful
one. At the beginning of the EU ETS, the prevailing consensus was that the leg-
islator had just to set the cap for the total number of emissions to be allocated. Then
the carbon price would arise automatically as an immediate indicator of the cost of
reaching the environmental target. The main problem of the legislator, at that stage,
was to avoid a pronounced increase in the carbon price that would make the cost of
the reductions too onerous for companies, as this might potentially harm their
competitiveness.
To prevent this scenario of high carbon prices, Phase II of the EU ETS introduced
the possibility of using international offsets from Joint Implementation (the so-called
Emission Reduction Units (ERUs)) and the Clean Development Mechanism (the
so-called Certi ed Emission Reduction (CER) credits). This mechanism allowed EU

ETS compliers to meet their liabilities in a cost ef cient way. 8

8

) Linking the Kyoto project-based mechanisms to the Community scheme, while safe-
guarding the latter

“ ( …

s environmental integrity, gives the opportunity to use emission credits gener-
ated through project activities eligible pursuant to Articles 6 and 12 of the Kyoto Protocol in order to
ful ll Member States

'

obligations in accordance with Article 12(3) of Directive 2003/87/EC. As a
result, this will increase the diversity of low-cost compliance options within the Community scheme
leading to a reduction of the overall costs of compliance with the Kyoto Protocol [

'

] The plan shall
specify the maximum amount of CERs and ERUs which may be used by operators in the Com-
munity scheme as a percentage of the allocation of the allowances to each installation. The per-
centage shall be consistent with the Member State ' s supplementary obligations under the Kyoto
Protocol and decisions adopted pursuant to the UNFCCC or the Kyoto Protocol ” [ 15 ].

…