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Abstract
Trading schemes for emission allowances have become a panacea for nations aspiring to
reduce their aggregate emissions of greenhouse gases from industry in a cost-effective
manner. The contention of this paper is that an emissions trading scheme (ETS) should
not be based on blanket coverage of installations on a downstream level, but should rather
be designed to include some installations, and from some industrial sectors. In the case of
an ETS there are high costs of administration, monitoring and transacting imposed on the
installations covered. These costs are supposed to be more than offset by the cost savings
realised through trading in the market for emission allowances. However, the paper
shows that not all installations can fully offset administrative costs, and are therefore
exposed to higher cost compared to a situation under an alternative instrument (e.g.
standard). The paper formulates a conceptual framework for analysing overall cost and
benefits from an ETS in the light of administration and transactions costs. It theoretically
establishes a threshold point for optimal coverage of installations on a downstream level.
The paper uses data from EU ETS to empirically determine optimal coverage for selected
sectors. The results indicate that blanket coverage is more costly than the determined
optimum coverage plan.