The cost of sectoral differentiation in the EU emissions trading scheme

It is often assumed in the economic literature that the Kyoto Protocol will be implemented through a cost-efficient, comprehensive emissions trading system. However, the general experience from implementation of environmental policies suggests that governments will adopt a more differentiated approach. Emerging evidence on how the Kyoto Protocol will be implemented confirms this: climate commitments will be differentiated between sectors. This article assesses the welfare effects associated with implementing the EU Emissions Trading Directive. It also analyses how differentiation of commitments affects the sectors that have a permit obligation compared with those that are exempted from it. The findings indicate that sectoral differentiation comes at a relatively high welfare cost - almost doubling the cost of implementing the Kyoto Protocol, with only limited benefits to the sectors that are granted concessions.