Did the EU ETS Make a Difference? An Empirical Assessment Using Lithuanian Firm-Level Data.

• Author: Jaraite, Jurate
• Position: European Union Emissions Trading System - Report - Statistical data

1. INTRODUCTION

   As the post-Doha political debate moves on from the old Kyoto framework towards a new post-2020 global policy regime, flexibility mechanisms, that theoretically facilitate the achievement of policy goals at least cost, take center stage. In this context, emissions trading systems, with the possibility they offer to link emissions reduction efforts across space and time, seem poised to become one of the pillars upon which future cost-effective mitigation efforts will be built. As a consequence, there is considerable interest in understanding how these market-based instruments perform in practice. In particular, there is a growing appetite on the part of policy makers for empirical analyses that shed light on how participation in emissions trading systems affects the economic and environmental performance of regulated entities. To date, however, only a handful of studies have attempted such an analysis.

   In this paper we exploit a previously unexplored firm-level dataset to investigate these questions in the context of the European Union Emissions Trading System (EU ETS). A rich dataset of Lithuanian firms spanning the years between 2003 and 2010 allows us to investigate the impact of the EU ETS on emissions, profitability and investment decisions.

   The unique features of the data allow us to directly compare emissions between ETS and non-ETS firms, something that, to the best of our knowledge, has not been possible before. While this is the main motivation for our choice of Lithuania as a case study, we believe that our findings can be informative about the behavior of firms elsewhere in the EU ETS. Indeed, Lithuania's ETS coverage is sufficiently broad to suggest that the average treatment effects we estimate as a result of our empirical analysis--for example, as refers to emissions and emissions intensity--are broadly transferrable to firms operating elsewhere in the EU. Lithuania has a well-developed financial sector, it officially joined the Eurozone on 1 January 2015, and it is also an extremely open economy (1) ; its larger firms, such as the ones in our dataset, operate across several markets, including ones outside of the EU. (2) Hence, information about the competitiveness challenges faced by Lithuanian firms is likely to be highly indicative of the challenges facing similar firms elsewhere. Finally, Lithuania has been one of the fastest growing economies in the EU for over a decade and, in this sense, the results from our analysis are also likely to be relevant to policy makers in other fast growing economies contemplating the introduction of emissions trading schemes.

   Our analysis adds to the scant ex-post empirical literature on the EU ETS by investigating the causal effects of the EU ETS on firm-level environmental and economic performance. (3) Exploiting the peculiar features of our data, we are able to make the most of the design characteristics of the EU ETS (4), and to construct a reliable counterfactual, i.e. believable estimate of the outcome variables that would have been observed in the absence of the EU ETS. Given that only a subset of firms in each sector were required to participate in the EU ETS, we can directly compare environmental and economic outcomes of ETS firms to those of similar firms outside the scheme. One important advantage of this approach is that the counterfactual estimates are free of the potentially confounding effects of changing economic conditions at country level, industry-wide production trends, and technological change.

   The contribution of this paper is threefold. Firstly, we are the first--to the best of our knowledge--to be able to compare the evolution over time of C[O.sub.2] emissions by ETS firms to that of firms outside of the EU ETS. We do this within a classic non-experimental program evaluation framework, using matching algorithms to derive causal inferences on the impact of the program. Secondly, by exploiting a richer dataset than previously done in the literature, we are able to investigate the effect of the EU ETS on the economic performance of firms in greater detail. For example, we complement the analysis of firms' profitability with a discussion of investment decisions. Finally, our dataset spans the first and (most of) the second phase of the EU ETS (2004-2010), thus extending and updating previous results.

   Our analysis starts by assessing the environmental consequences of the EU ETS. We first look into actual emissions reductions--so called "abatement"--by comparing actual C[O.sub.2] emissions with counterfactual C[O.sub.2] emissions. Only a handful of previous studies have documented aggregate emissions abatement in the first phase of the EU ETS. Ellerman and Buchner (2008) calculate that 130-200 Mt of C[O.sub.2] were abated in 2005 and 140-220 Mt of C[O.sub.2] 2006, across all EU member states. Anderson and [D.sub.i] Maria (2011) improve on these results using more refined data for 2005-2007 and estimate overall abatement at 247 Mt of C[O.sub.2] during the first phase. They also find evidence of emissions "inflation," however, they show that several countries had actual emissions in excess of the counterfactual. Delarue, Ellerman, and D'Haeseleer (2010), Pettersson, Soderholm, and Lundmark (2012), Linden, Makela, and Uusivuori (2013), and Widerberg and Wrake (2009) explicitly focus on abatement in power generation. Delarue, Ellerman, and D'Haeseleer (2010) analyze the power sector's C[O.sub.2] short-term abatement possibilities through fuel switching. The authors estimate abatement of the European power sector to be in the range of 34.4-63.6 Mt of C[O.sub.2] in 2005, and 19.2-35 Mt in 2006. Pettersson, Soderholm, and Lundmark (2012) use a Generalized-Leontieff model of the electricity sector calibrated on data from eight western European countries--Austria, Belgium, Germany, Ireland, Italy, Netherlands, Spain and the UK--over the time period 1980-2004 to support the view that the elasticity of substitution, especially between oil and gas, may be rather high in the short run. Their model suggests that an allowance price of US$90 would lead to a two per cent decrease in C[O.sub.2] emissions, via fuel-switching only (using 2004 as the base year, this is equivalent to 18Mt of C[O.sub.2]). Linden, Makela, and Uusivuori (2013) find that the EU ETS has short term impacts on the fuel mixes of the energy plants in Finland. The elasticity of substitution between fossil and non-fossil fuels is larger under the ETS. Widerberg and Wrake (2009) look at the effect of the carbon price on the C[O.sub.2] emissions intensity of the Swedish electricity sector for the period 2004-2008. They find no statistically significant link between the price of C[O.sub.2] and C[O.sub.2] emissions, and conclude that it is unlikely that there are significant volumes of low-cost C[O.sub.2] abatement possibilities with short response times in the Swedish electricity sector. Finally, Abrell, Faye, and Zachmann (2011), use CITL data to test whether the EU ETS induced acceleration in emissions reductions, and find some evidence to the positive. In the current paper, for the first time we are able to look at abatement at the firm level, thanks to the unique characteristics of our dataset.

   We then investigate the economic consequences of carbon pricing. Emission reductions generally entail costs as resources need to be reallocated from production activities to emissions reduction. In principle, these costs depend on the stringency of the carbon constraint, the tighter the cap the higher the marginal abatement cost or C[O.sub.2] price, and the greater the cost, all else being equal. Since the EU is the only region in the world in which a carbon price is applied on such a scale, the EU ETS might have serious implications in terms of the loss of competiveness it causes to ETS firms versus both European firms outside of the EU ETS, and their non-European competitors. We address the impact of the EU ETS on competitiveness by looking at a firm's ability to generate profits. In doing this, we can also gauge the implications of the free permits allocation for firms' profitability. Our dataset also allows us to investigate whether ETS firms exhibit a different behavior relative to their non-ETS counterparts when it comes to investment in tangible capital. This is particularly important in terms of the future competitive position and profitability of regulated firms.

   To date, only a few studies have analyzed the impact of the EU ETS on firm competitiveness, profitability or general economic performance ex-post. (5) Potentially negative impacts on competitiveness have understandably been the main concern of firms within the EU ETS, and have been the focus of most empirical analyses. Energy-intensive and trade-exposed industrial activities namely cement, glass, iron and steel, paper and pulp, refining and aluminum, are arguably the most exposed among the EU ETS sectors in terms of international competition. Empirical research using trade data (imports into the EU as well as exports from the European Union), however, has found no evidence in support of the hypothesis that the introduction of the EU ETS placed such sectors at a competitive disadvantage, at least in the first trading period (Ellerman, Convery, and de Perthuis 2010). Similar conclusions are reached by Anger and Oberndorfer (2008) who do not find that the first two years of the EU ETS had a negative effect on the revenue of German over-allocated and under-allocated ETS firms. Yu (2011) uses firm-level data to analyze the effects of ETS participation on the profitability of Swedish power generating firms in 2005 and 2006. Her results do not show any significant impact of the EU ETS on profitability in 2005, but suggest a significant negative impact in 2006, which, she argues, might be due to the collapse of the price of European Union Allowances (EUA). Abrell, Faye, and Zachmann (2011) assess the impact...