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The European Union Emission Trading Scheme (EU ETS) – by far the largest in its kind-has inspired several other carbon markets in the world. Based on interviews with plant managers from almost all Belgian ceramics, lime and cement producers, this study describes how manager's perceptions on emission trading affected investment decisions. In line with behavioural economics, reference-dependence is found to explain why free allocation below emissions creates a greater incentive to abatement investment compared to allocation above emissions. In the ceramics sector, allocation above emissions refrained managers from including carbon gains in payback times. This contradicts the famous Coase theorem, which predicts that free allocation has no effect on abatement incentives. The results indicate that auctioning part of the emission rights will reduce barriers to abatement investment. Carbon price uncertainty is seen as a disincentive for abatement investment by some managers and as an incentive by others. Intermediate levels of uncertainty add option value to abatement investments because the associated gradual learning adds flexibility in an uncertain carbon constrained future. However, high levels of uncertainty, creating a risk of offshoring even when companies innovate, creates an option value to postpone abatement investments. Narrow framing, misperceiving the risk-hedging counter-cyclicality of carbon costs, reinforces the option value to wait. Therefore, policy should aim to reduce price uncertainty for very low and very high carbon prices, not for an intermediary price range. [ABSTRACT FROM AUTHOR]

Abstract: This article reviews the existing literature on the European Union Emission Trading Scheme (EU ETS), focusing on empirical ex-post research since the end of the first period (2007). The literature is presented through a multi-criteria evaluation. Concerning environmental effectiveness, despite over-allocation during the first period, abatement is estimated between −2.5% and −5%. Trade-driven carbon leakage was not observed, even if long-term economic models predict divergent leakage estimates for certain at-risk sectors. The abatement target was likely to be below an economically efficient level, but was reached in a fairly cost-effective way, even if free allocation gave rise to several distortional effects. Equity concerns were manifold and constitute a major drawback to the policy. Finally, institutional feasibility can be considered positive in that the EU ETS passed the European legislative process, unlike the previously proposed EU-wide carbon tax. [Copyright &y& Elsevier]