Dóra Fazekas Carbon Market Implications for new EU - UniCredit ...

of CO2 or buying an allowance instead. The shadow prices rise as an increasing function of
emissions reduction (Ellerman and Decaux, 1998). If installations with different MAC achieve
emission reductions, the aggregate cost of meeting the cap is relatively lower than the case where
every installation had to reduce its own. The aggregate CO2 reduction in a country is achieved in
the least cost possible, as long as the installations trade until their MAC are equal to the market
clearing price of the allowances, where the Pareto optimum is achieved.
Montgomery (1972) was the first to develop a theoretical approach for a permit trading of non-
uniformly mixed assimilative pollutants reflecting spatial considerations of damages. He shows that
in a competitive market of permits, cost-effectiveness is achieved regardless of the initial allocation.
Classical theory (Montgomery, 1972) of course predicts that initial allocation should have no effect
on emissions decisions of firms. This statement is particularly important for this dissertation as my
findings contradict Montgomery. From the point of view of Hungarian installations there has been a
clear difference regarding initial allocation. As presented later operators not always took
opportunity costs of free allowances into account.
Ellerman (2005) argues, „environmental concerns are as old as Man, but tradeable permits are a
relatively recent innovation in dealing with these problems”. Only in the last decades have tradeable
permits been implemented and declared a success, mostly in the US, where they are still the
exception, but also increasingly in Europe. A tradeable permit is “a transferable right to emit a
substance that can create pollution” (Ellerman, 2005). Tradeable permits differ from conventional
permits mainly in focusing on a single discharge and being transferable.
Many economists favor transferable emission permits because they rely on market forces to seek
out the least cost reductions, and require no knowledge on the part of the control authority with
respect to where these least costly abatement opportunities exist (Tietenberg, 2000). Rather, the
main task of the control authority is to issue the appropriate number of emission permits. In fact, a
tradable permit system allows the policy maker to effectively separate efficiency and equity issues,
allocating permits on the basis of equity, or perhaps as an incentive for political support of the
control policy, and letting the permit market seek out where the most cost-effective reductions can
be achieved.
Ellerman (2005) identifies three requirements for an effective system of tradeable permits, which
are present in EU ETS:
(1) Measuring emissions and continuous monitoring of the regulated emissions, otherwise there is
no way to determine compliance or to define what is to be traded.
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