How the duration of a cap-and-trade scheme with an adjustable emissions cap affects cumulative emissions : the case of the EU ETS

Abstract: The European Union Emissions Trading System (EU ETS) is a cap-and-trade scheme, whose adjustable supply of allowances is determined by a quantity mechanism, as opposed to a price mechanism. This paper quantifies the reduction in cumulative emissions that arises from bringing the final year of a cap-and-trade scheme that operate a quantity mechanism, such as the EU ETS, forward in time. Using a dynamic simulation model of the EU ETS, the paper shows that bringing the final year forward in time will lead to cumulative emissions reductions, if the duration is sufficiently or drastically shortened. On the other hand, shortening the duration of the scheme to a lesser extent will lead to increased cumulative emissions. Moreover, the intuition behind the result is described through a three-period theoretical model of emissions trading. These results have implications not only for emissions in the EU, when the EU ETS is complemented by other policies such as the European Green Deal, but also for the design of overall quantity-based policy instruments for cap-and-trade schemes. The paper concludes by stating that careful consideration should be considered for future reforms of the EU ETS and for broader climate policies.