Decoupling the EU ETS from subsidized renewables and other demand side effects: lessons from the impact of the EU ETS on CO2 emissions in the German electricity sector

This paper analyzes the impact of the EU ETS on CO2 reduction in the German electricity sector. We find an ETS-induced emission abatement which is not exceeding 6% of total emissions with a maximum already in 2010. Thereafter the ETS has not induced additional reductions. This outcome corresponds to the recent debate about sub-optimal performance of the EU ETS caused by excessive allowances. Following up on this we develop a unilateral flexible cap to eliminate demand side effects which lead to excessive allowances. The unilateral flexible cap is based on emission intensities. Using the works of Newell and Pizer (2008); Sue Wing et al. (2009) we prove that an intensity-based emission cap is advantageous in the German electricity sector when compared to an absolute cap. An ex-post analysis shows that the amount of excessive allowances resulting from the economic crisis during the second trading period could have been significantly lowered with a unilateral flexible cap. This approach also decouples the EU ETS from a simultaneous promotion of renewable energy.