Simulating emissions trading in southwest Germany

According to the planned EU-Directive, large installations from energy and most other carbon-intensive industries will be part of an EU-wide CO2-trading system starting in 2005. Since in many Member States, including Germany, environmental policy has historically been command-and-control-type regulation, companies (and decision-makers) tend to have no experience with this market-based instrument. This paper presents results of a recent CO2-trading simulation project, launched in early 2002 in Southwest Germany with a group of 15 companies, including producers of electric power, cement, glass, steel and paper. Once companies had quantified emissions, and identified and evaluated reduction measures for the simulation period of 2005-2013, they could buy and sell allowances via an internet platform at the (endogenously determined) market price. Keeping the rules of the game as close as possible to the proposed Directive, two types of simulations were carried out, which primarily differ in the method of allocation (grandfathering / hybrid auction system). In addition, using companies' data, a student control group carried out both simulations, too. Strategies and market outcomes of both types of simulations are compared within and across both groups of participants. After discussing the implications of the simulations for energy efficiency, policy recommendations are presented, which focus on the method of allocation and on the banking of allowances.