Transaction Costs and Tradable Permits: Empirical Evidence from the EU Emissions Trading Scheme

In this paper, transaction costs of German firms, regulated under the EU emissions trading scheme (EU ETS) are examined empirically. Introduced in 2005, the EU ETS currently regulates carbon dioxide emissions of roughly 11,000 installations in the 27 EU member states, Norway, Liechtenstein and Iceland. Its aim is to reduce greenhouse gas (GHG) emissions in energy intensive industry branches and utility companies by 21 percent until 2020 compared to 2005. Transaction costs can be seen as costs for managing the EU ETS and carrying out necessary administrative tasks. As the data reveal, transaction costs depend on annual emissions and annual volumes of traded emissions allowances of firms in a nonlinear fashion, based on OLS and nonparametric estimation. This implies the presence of scale economies in the management of the EU ETS. Overall transaction costs increase for firms that have emissions levels ranging from zero to approximately one million tons of CO2 emissions per year. Overall transaction costs decrease for firms with more than one million tons of CO2 emissions (see figure 3). Based on the results, overall annual transaction costs for all German firms regulated under the EU ETS are estimated at 8.7 EUR million c.p. in average. In contrast to assumptions made by standard economic theory, marginal transaction costs also depend on annual emissions levels and annual trading volumes respectively. This implies that firms also take the costs of managing the EU ETS and costs for general administrative obligations into account when minimizing costs under the EU ETS. As a consequence, the firm’s incentives for greenhouse gas abatement are different than in a ‘first-best’ case with zero transaction costs. In practice, firms with less than one million tons of annual emissions (which do not profit from economies of scale in the management) will emit less (abate more) than emitters with more than one million tons of annual emissions. Although the changes are small and will not affect environmental effectiveness of the EU ETS, economic efficiency is decreased by transaction costs, resulting in a welfare loss. The average transaction costs (transaction costs divided by annual emissions) are highly different for firms of different sizes. Average transaction costs are relatively high for smaller emitters (up to EUR 1.00 per ton CO2), but trickle down with rising annual emissions of a firm. At low emissions levels, such as 5,000 or 10,000 tCO2 p.a., doubling emissions leads to a reduction of average transaction costs by almost 50 percent (see figure 2).

Heindl, Peter (2012), Transaction Costs and Tradable Permits: Empirical Evidence from the EU Emissions Trading Scheme, ZEW Discussion Paper No. 12-021, Mannheim.