The interaction between the EU emissions trading scheme and national energy policies

National energy policies usually have a significant impact on the sectoral and overall CO₂ emissions of an EU Member State. Once the proposed EU emissions trading scheme (EU ETS) becomes operational, however, the CO₂ performance of these policies, i.e. their effectiveness and efficiency in reducing CO₂ emissions, will differ depending on whether they affect fossil fuel use by the participating or non-participating sectors of this scheme. This article discusses in particular the CO₂ performance of national energy policies affecting the participating sectors of the EU ETS. A major conclusion is that once the EU ETS becomes operational, the effectiveness of all other policies to reduce CO₂ emissions of the participating sectors becomes zero. Moreover, in a perfect economy with no market failures, these policies will lead to a lower CO₂ efficiency and less optimal market operations of the EU ETS. Hence, in such a situation, this coexistence of policy instruments cannot be justified from a CO₂ efficiency point of view. It will be argued, however, that there are three reasons why the joint use of the EU ETS and policies affecting the fossil fuel use of the participating sectors may be justified: (1) improving the design of the EU ETS, (2) correcting for market failures, and (3) meeting other policy objectives besides CO₂ efficiency. The ideas expressed in this article are illustrated by a detailed numerical example on the interaction between emissions trading and national energy policies. The article concludes with a summary of its major findings and policy implications.