As part of its commitment to the goals of the Paris Agreement, India pledged to reduce the emissions intensity of its GDP by 45 per cent by 2030, relative to 2005 levels, and increase the share of non-fossil capacity from 40 per cent to 50 per cent by 2030 (Press Information Bureau 2022). Additionally, India announced a long-term target of reducing emissions to net zero by 2070 (Press Information Bureau 2022).

To achieve its stated decarbonisation targets, India has already deployed a slew of energy policies across sectors. Promoting renewable energy (RE) in the power generation sector is a critical part of the strategy, given the sector’s significant share in India’s emissions. Policies to support this objective include guaranteed feed-in tariffs, accelerated depreciation of wind and solar assets, creation of green energy transmission corridors for evacuating RE from RE-rich states, creation of solar parks and ultra-mega electricity projects, and, most importantly, implementation of renewable purchase obligations (RPOs) (Climate Policy Database 2023). Distributed RE is also a key element in the strategy, with a focus on both rooftop solar as well as solar pumps. More recently, the attention has been on policies aimed at increasing the share of domestic manufacturing in the RE value chain through a Production Linked Incentive (PLI) scheme (Ministry of Commerce & Industry 2021).

Energy policies targeting other energy-intensive industrial sectors include the market-based Perform Achieve and Trade (PAT) scheme, which is specifically aimed at improving the energy efficiency of industrial units. Within the transport sector, the Faster Adoption and Manufacturing of (Hybrid &) Electric Vehicles in India (FAME) scheme incentivises the adoption of electric vehicles (Ministry of Heavy Industries 2020). Additionally, non-fiscal policies have also been devised to help establish a supportive ecosystem of charging infrastructure across the country. Within the residential and commercial building sector, higher penetration of energy-efficient appliances has been achieved through the Standards and Labelling programme of the Bureau of Energy Efficiency (BEE, Government of India). Efforts are also being made to enhance energy efficiency in buildings efficiencies in line with the Energy Conservation Building Codes (ECBC) guidelines. Recently, in January 2022, the Government of India initiated the Green Hydrogen Mission to significantly increase hydrogen production and bring down production costs (Ministry of New and Renewable Energy 2023).

In addition to all the existing policies, an amendment to the Energy Conservation Act, 2001 was passed in December 2022, following approval by both houses of parliament, paving the way to add another important policy instrument for emissions reduction to the existing matrix – a domestic emissions trading scheme (ETS), called the Carbon Credit Trading Scheme (CCTS) (Press Information Bureau 2023). It is proposed that after the first transition period (2023–25), the second phase (from 2026 onwards) will include a fully functional ETS, consisting of sectors and entities that are already part of the PAT scheme, which will be given a GHG emissions intensity target (tCO2 e/t product) (Singh and Chaturvedi 2023). The unique feature of this policy instrument is that, for the first time, a policy instrument in India will directly target carbon dioxide emissions compared to other energy policies, which target either energy efficiency or fuel switching. Essentially, an ETS puts a price on the carbon emitted by entities.

Carbon pricing is a policy instrument that aims to reduce carbon emissions by placing a cost on carbon. Carbon pricing could be through a carbon tax, an ETS, or a mixture of the two (hybrid policy) (Figure 1). An ETS can place an absolute cap on the total volume of GHG emissions produced by one or more economic sectors in a jurisdiction (such as the EU ETS, Korea ETS, California Cap-and-Trade, etc.), or it can be an output-based cap using emission intensity targets (i.e., emissions per unit of electricity generated or product, such as in the China and Indonesia ETSs and starting in 2026 for India). Depending on the overall cap-setting approach, the entities in the covered sectors are allotted emission allowances, either through free allocation (e.g., using emissions intensity benchmarks), auctions conducted by the state authority, or a combination of both. Depending upon their ability and the costs of reducing emissions, entities can then trade emission allowances. Entities with emission intensities lower than a predefined benchmark can sell credits to entities with higher emission intensities. This results in a process of price discovery per tonne of carbon. Carbon can also be priced through a uniform carbon tax, wherein the government levies a set fee on the GHG emissions from certain sectors, providing a price incentive to reduce emissions.

Figure 1 Different forms of carbon pricing

Source: Authors’ analysis

In most countries around the world, carbon pricing exists alongside other climate and energy policies to form a policy package. This is because carbon policies alone cannot solve the various institutional, political, and regulatory barriers to decarbonisation (Mehling and Tvinnereim 2018; Bertram et al. 2015; Klenert et al. 2018; Patt and Lilliestam 2018; Rosenbloom et al. 2020; Twomey 2012; Jaffe, Newell, and Stavins 2005). Thus, although policies co-exist due to having different objectives, due to the interconnected nature of energy flows and the sectoral overlap of policies, it is critical to understand the interaction between carbon pricing and other non-market energy policies. Poor policy integration could have negative consequences in the form of higher costs to society and increased risk of stranded assets (Hood 2013; Binsted et al. 2020; Iyer et al. 2015). Therefore, we need an optimal mix of policies that can ease both price- and non-price-related barriers to decarbonisation. Further, the policy mix must consider the impact of other policies on GHG emission reduction when setting the emission reduction targets of an ETS.

An effective ETS should align with a nation’s unique realities and contribute to its long-term decarbonisation goals. Currently, as India’s ETS is in its infancy, no analytical studies have explored its potential benefits for India’s decarbonisation strategy and sector-specific emission targets or its interaction with existing policies. Our study aims to fill this knowledge gap by addressing three core questions: i) What role can an ETS play in India’s goal of achieving net-zero CO2 emissions by 2070? ii) How will different sectors respond to the ETS? iii) What are the interactions between the ETS and existing policies such as RPOs?

The next section presents our scenario-modelling approach, followed by a presentation of the results in the third section. We devote Section 4 to discussions, including the limitations of the study, and present the conclusions in Section 5.

Reference scenario

Socioeconomic and demand trends

Our REF/NZ scenario assumes a rapid growth of the Indian economy with per capita income rising 5x in 2050 and 11x in 2070, relative to 2020 (Figure 3) (see Section A1 in the Annexures for growth rate assumptions, GDP is nominal). This rapid growth in income leads to a significant increase in the demand for all industrial commodities such as iron and steel, cement, and aluminium, which, when combined with other end-use sectors such as buildings and transportation, leads to a significant increase in energy requirements, especially electricity generation (Figure 3 and Figure 5). Both the transportation and industry sectors grow at similar rates (in terms of energy demand); however, the growth in energy demand from the building sector is almost half as much. The industry sector, which currently consumes almost 50 per cent of the total final energy (FE) demand, also continues to account for the highest share of future energy demand.

Figure 3 Growth of selected indicators to illustrate socioeconomic and demand trends in the REF/NZ scenario relative to 2015

Source: Authors’ analysis

Drivers of emission change

The Kaya Identity is a mathematical identity, developed by Japanese economist Yoichi Kaya (Kaya and Yokobori 1997) that provides a useful way of understanding the drivers of emission change in an economy. It states that the total emissions in an economy can be expressed as the product of four factors: population, GDP per capita, energy intensity (per unit of GDP), and emission or carbon intensity (emissions per unit of energy consumed). Figure 4 shows the variables of the Kaya identity for the NZ scenario for India. Until 2040, the increase in emissions (yellow) is mainly due to rising income (GDP per capita) and population (grey), with the growth in emissions is lower than the increase in income. This is mainly because of two reasons: one, the decrease in energy intensity (green) caused by energy efficiency improvements such as the increasing use of energy-efficient appliances and industrial equipment, as well as from the increased penetration of electric vehicles and the replacement of traditional biomass-based cooking with gas-based cooking; two, the slow but gradual decrease in the emission intensity of energy (orange) as more renewables and low-carbon energy sources enter the energy system. After peaking in 2040, emissions decrease strongly (to reach the net-zero 2070 target), from decrease in emissions intensity. This is because of the significant growth of RE on the supply side as well as electrification, hydrogen use, and carbon capture and storage (CCS) in the end-use sectors (illustrated in subsequent subsections).

Figure 4 Indicators of the Kaya Identity to explain the drivers of emission change in the REF/NZ scenario

Source: Authors’ analysis

Emission trends and production structure of the considered sectors in the REF/NZ scenario

In the electricity sector, most of the additional demand for electricity is met through variable renewable energy (VRE) sources, particularly solar, driven by lowering capital costs, policies supporting the development of transmission and infrastructure, and nominal intermittency costs; for example, in the form of storage. However, despite the increasing cost competitiveness of VRE, in the absence of policies targeting coal, conventional coal electricity plants continue to expand until 2040, leading in turn to a rise in electricity sector emissions (Figure 5a). The combined effect is that, by 2040, almost 36 per cent of the electricity generation comes from solar and wind compared to the current 10 per cent, while coal-based generation decreases from 68 per cent in 2020 to 48 per cent in 2040 (derived from Figure 5b, which has absolute numbers).

As mentioned in Section 2.2, based on the exogenous constraints, from 2040 onwards, there is a sharp decrease in economy-wide emissions on the path to net zero This gives rise to an endogenously derived carbon price, which permeates through all sectors, leading to a reduction in emissions. In particular, in the electricity sector, where emission reduction is relatively inexpensive, there is a significant expansion of solar photovoltaics as well as increased generation of biomassbased electricity and more efficient coal electricity plants. By 2060, the electricity system is almost fully decarbonised, with solar accounting for the dominant share and small contributions from wind, nuclear, and biomass (refer to Figure 5b).

Figure 5a Production (Mt or TWh) and emissions (MTCO2)for the selected ETS sectors considered in this study

Source: Authors’ analysis

Figure 5b Absolute electricity (TWh) generation from different technologies in the REF/NZ scenario

Source: Authors’ analysis

Figure 6 Share of final energy by fuel in the REF/NZ scenario

Source: Authors’ analysis

Figure 7 Total emission trajectories of four scenarios: REF/NZ, NZ + ETS, NZ + CC, and NZ + RPO + ETS

Source: Authors’ analysis

Beyond electricity, demand for other materials such as iron and steel, cement, and fertilisers also increases,3 driving emission growth in these sectors (Figure 5a). With the exception of emissions from the fertilisers sector – which peak in 2030 (Figure 5a) – the rest of the considered sectors peak in the same year as the whole economy, i.e., 2040. Due to the economy-wide emission constraint, after 2040, a combination of fuel-switching, higher end-use electrification, use of CCS, and hydrogen use lead to decarbonisation in the industrial sectors (Figure 6). Note that apart from the electricity sector, emissions in the other considered sectors do not fall to zero in 2070 (refer to Annexures Section A6 for sectoral-emission trajectories). This is because both the iron and steel sector as well as the cement sector consume a significant amount of coal even in 2070. Total emissions from these two sectors are ~265 MtCO2 in 2070. Emissions in these hard-to-abate sectors are compensated by negative emissions principally in the agriculture, forestry, and other land use (AFOLU) sector, leading to overall net-zero emissions in 2070.

Comparison of emission trajectories

The emission trajectories of the REF/NZ scenario and NZ + ETS scenario are shown in Figure 7. As mentioned before, the NZ scenario reaches its emissions peak in 2040, following the currently implemented energy and climate policies (except RPOs). After 2040, emissions decrease linearly to zero in 2070. In the NZ + ETS scenario, we constrain emissions only for the ETS sectors, at a level lower than in the NZ scenario. In 2040, emissions from the ETS sectors are 10 per cent lower than in the NZ scenario, leading to a ~5 per cent decline in overall emissions. The NZ + RPO + ETS scenario considers the effect of both RPOs and the ETS and leads to a ~15 per cent reduction in total emissions. This scenario is explained in more detail in Section 3.4.

Cost-effectiveness of an ETS

To demonstrate the cost-effectiveness of an ETS, we compare the policy costs of an NZ + ETS scenario with an NZ + CC scenario, i.e., where no emission trading is allowed (for the same total emission reduction in a given year). In practice, this would mean, that in an ETS, for example, the cement sector, depending upon its targets, might choose to either decrease emissions itself by investing in low-carbon technologies or buy emission permits from the market if these are cheaper. However, in a command-and-control (CC) type policy, the cement sector can only do ‘in-house’ emission reductions.

Figure 8 shows the mitigation cost for the two scenarios for 2030–40. Mitigation costs in scenarios with trading are 30–45 per cent lower compared to the scenario without trading.

The principal reason behind the lower mitigation costs in the ETS scenario is that the economy is able to harness low-cost opportunities across sectors; the carbon price that emerges in the ETS sectors when trade is permitted is an indicator of the same. Figure 9 shows that when trading is allowed, the sectors have a uniform carbon price – around USD 13/tCO2 in 2040. However, when no trading is allowed, the carbon price varies across sectors greatly, from around USD 10/ CO2 in the electricity sector to over USD 60/tCO2 in the fertiliser sector. It is important to note that the carbon price in the ETS is not a prediction but a result of specific assumptions about: i) the total ETS emission cap; ii) sectors included in the cap; and iii) the abatement costs and potentials of individual sectors. Similarly, for the NZ + CC scenario, the carbon price in individual sectors depends upon: i) the relative ease of abatement in the sector, i.e., the cost of the decarbonisation options available to the sector; and ii) the emission targets of the sectors.

Figure 8 Mitigation costs across the two scenarios, NZ + ETS (with trading) and NZ + CC (without trading), from 2030 until 2040

Source: Authors’ analysis

Figure 9 Carbon price in (2020$/tCO2) for the (a) NZ + ETS and (b) NZ + CC scenarios

Source: Authors’ analysis

Figure 10 Absolute emissions of the four considered ETS sectors in the NZ + ETS scenario vs. the NZ + CC scenario

Source: Authors’ analysis

Figure 11 Share of electricity generation by source in 2020, 2040, and 2070 in the REF/NZ and NZ + ETS scenarios

Source: Authors’ analysis

Role of the electricity sector in an ETS

If an emissions cap is levied as part of the ETS, the electricity sector emerges as the largest contributor to emission reduction. The sector not only has cheap mitigation options, mainly from the installation of RE, but it also has significant potential for absolute emission reduction. From Figure 10 (non-dashed bars), the share of emission reduction – compared to the baseline in 2040 – can be calculated. The share of emission reduction is 72 per cent in the electricity sector, followed by 17 per cent in the iron and steel sector, and 10 per cent in the cement sector, with the fertilisers sector doing almost no emission reduction.

How do emission reductions happen in the electricity sector? Under a carbon price, the operating costs of fossil-fuel-based electricity plants increase due to an increase in the fuel price, forcing them to reduce their plant load factors (see Section A5 in the Annexures for generation costs by fuel). Coal, which has the highest fossil-carbon intensity among fossil fuels, is affected the most; therefore, coal should be increasingly substituted with other lower-carbon fuels. However, although the generation costs of coal increase under the ETS, the costs of other combustible fuels that could replace coal generation, such as biomass and gas, are still much higher, preventing their uptake. Instead, the electricity demand is fulfilled by new solar and wind plants coming online. Figure 11 shows that, in the year 2050, the share of solar and wind in total electricity generation in the NZ + ETS scenario increases by almost 7 per cent and 1.4 per cent (from 51 per cent to 58 per cent for solar and 12.9 per cent to 14.3 per cent for wind) respectively, compared to the reference scenario.

The electricity sector emerges as the principal source of emission reductions. However, the specific sector selling or buying emission permits in an ETS depends on the sectoral allocation and ETS compliance strategies adopted by individual entities. In the allocation assumed in the NZ + CC scenario (all ETS sectors must perform the same percentage emission reduction; shown as dashed bars in Figure 10), the electricity sector would sell permits, while the iron and steel, cement, and fertilisers sectors would buy these permits. The financial implications of different allocation regimes are explored in Section 3.6.

Unlike between 2030 and 2040, where we assume an ETS cap with respect to the baseline for the four sectors (leading to a 10 per cent reduction in combined emissions in 2040), for the years following 2040, we assume that the sectors collectively follow a linear path and reach 183 MtCO2 in 2070 (see Figure A6 in the Annexures). We do not assume net-zero emissions from these four sectors, because in the absence of net-negative emissions from the AFOLU sector (the AFOLU sector is not part of the ETS), the cost of mitigation is so high that it results in a fall in overall production from the high carbon price.

This is particularly the case for the cement sector where mitigation options are fewer (for example, for feedstock emissions), and a high carbon price leads to high cement prices, which in turn affects demand for cement. Moreover, since CCS is not assumed to have a 100 per cent efficiency, some residual emissions will remain.

Another factor influencing emissions in the ETS sectors during the post-2040 period is the indirect impact of mitigation policies in non-ETS sectors, since these sectors must also decarbonise to reach net zero in 2070. For example, the decarbonisation of the transport sector will lead to a lower demand for refined liquids and a higher electricity demand, which in turn will affect the prices of both these commodities. This will consequently impact the cost of the decarbonisation options available to the ETS sectors.

Figure 12 Share of final energy by fuel for three ETS sectors for the NZ + ETS scenario

Source: Authors’ analysis

Decarbonisation in industrial sectors within ETS

Figure 10 also shows that although the electricity sector accounts for the maximum share of emission reductions in the ETS scenario, it does not account for all the required reductions; emission reductions also take place in both the iron and steel and cement sectors. In the presence of an ETS, these sectors can choose cheaper cost-effective options in the form of fuel-switching4 in the near term – for example, from coal to biomass or from refined liquids to natural gas. In the longer term, the decreasing ETS emission cap leads to a higher carbon price, which in turn leads to these sectors choosing more expensive options like hydrogen and electrification.

In the fertilisers sector, natural gas operates as a bridge fuel till 2050, beyond which there is a shift towards green hydrogen. The iron and steel sector moves towards electricity and hydrogen in the long run, with biomass coming in during the transition. The cement sector fuel mix shows a limited decline in the share of coal even till 2050. This implies that this sector is the hardest to abate and that heavy decarbonisation can happen in this sector only after the other industrial sectors are significantly decarbonised. Thus, even between the three industrial sectors, there is a different decarbonisation timeline depending on the cost of mitigation within each sector.

The iron and steel sector in GCAM includes three principal technologies of steel production: the blast furnace (BF) method, the direct reduced iron – electric arc furnace (DRI-EAF), and lastly, scrap iron (an EAF-based process). There are multiple technological options available within these processes; for example, BF can be combined with blast oxygen furnace (BOF), which is the conventional technology for steel production using primarily coal, but BF can also be combined with H2 or biomass, which are different technologies. Similarly, green steel, which is essentially hydrogen-based DRI-EAF, is also an available technology. Each of these three processes and/or technologies has multiple fuel options and the availability of CCS. The carbon price influences which fuels are used in existing technologies, while the carbon price along with technology and fuel costs influence technology choice for new investments.

ETS with other energy policies: Effect of an RPO

The role of complementary policies is critical in the larger decarbonisation strategy for any country. India also has a number of policies across sectors, and the ETS will interact with many of these, especially when there are common sectors involved. We explore here the interaction effect of the ETS with RPOs. RPOs mandate electricity utilities to procure a certain share of their demand from renewable electricity. While an ETS makes fossil-based technologies more expensive and promotes fuel-switching among existing electricity plants, an RPO principally aims to support the deployment of RE by creating demand. RPO mandates issued by the Government of India are one of the strictest forms of existing climate policy in the country. For example, the most recent RPO update mandates that almost 43 per cent of electricity generation should be from renewables in 2030, which when increased linearly, translates to 73 per cent RE-based electricity generation in 2040. No RPO targets are assumed beyond 2040.

Relative to the baseline, in 2040, the total emission reductions from the RPO (−690 MtCO2 ) are more than 50 per cent higher than the emission reduction in the ETS scenario (−287 MtCO2 ; see Figure 13a). With respect to the NZ scenario, total emissions in the NZ + ETS scenario decrease by ~5 per cent and ~ 17 per cent in the NZ + RPO + ETS scenario (Figure 7).

Figure 13b shows that all emission reductions in the RPO scenario happen only in the electricity sector (dashed bars). In comparison, in the NZ + ETS sectors, other sectors also contribute to emission reduction (non-dashed bars). In effect, this implies that the price of carbon will be near zero in the NZ + RPO + ETS scenario, because stringent RPOs make the ETS emission cap non-binding, such that the associated price of carbon goes to zero.

The relative stringency of policies would hence have significant implications for the supply–demand dynamics of the ETS as well as its carbon price.

Figure 13 a) Absolute emission reduction compared to the baseline for the two scenarios – NZ + ETS and NZ + RPO + ETS for the year 2040

Source: Authors’ analysis

Figure 13 b) Emission reductions w.r.t. to the baseline across the four ETS sectors for the two scenarios

Source: Authors’ analysis

Table 2 Description of the different allocation regimes

Source: Authors’ analysis

Cross-sectoral financial transfers under different allocation regimes

In the initial phase of an ETS, the government or regulator may set emission intensity targets for different sectors or provide free emission allowances to certain sectors or entities as a way of phasing in the ETS and easing the transition to a carbon-constrained economy. The targets or free allowances are often provided to sectors or entities that are considered to be particularly vulnerable to the costs of emission reduction or where there are concerns about international competitiveness. To explore the effect of different sector targets on financial transfers, we create additional scenario variants with different allocation regimes (See Table 2; see Annexures Section A8 for the exact numbers). Note that the overall ETS cap remains the same across all the scenarios.

Figure 14 shows that the allocation regimes affect both the direction and quantity of financial transfers. Specifically, in the CC_v1 scenario, the electricity sector is subject to stringent emission targets, resulting in the need to purchase permits from other sectors in the next decade, primarily the iron and steel sector. However, generally, the electricity sector is a net seller of emission allowances, whereas the other three ETS sectors are net buyers. The precise amount of these transfers changes across the different allocation regimes.

Auctioning of emission permits

Auctioning is a process in an ETS where a certain number of allowances are auctioned in the market by the government or a regulatory body. The purpose of auctioning is four-fold: i) It efficiently allocates permits across the different sectors fairly and transparently; ii) avoids the possibility of windfall profits in certain sectors, i.e., a situation where a sector increases its prices more than the increase in costs from the implementation of a carbon price; iii) generates revenue for the government that can then be used to support research and development of expensive decarbonisation technologies, fund energy efficiency programmes, build low-carbon infrastructures such as charging infrastructure and public transport and support people and regions negatively affected from the energy transition; and iv) strengthens the financial incentive to reduce emissions by requiring entities to pay for their emissions, hence embodying the ‘polluter pays’ principle.

To estimate the potential of auctioning revenue, we consider three off-model ETS auctioning variants: (a) no auctioning; (b) auctioning starting from 2030 only in the electricity sector, initially with a small share of total allowances and then increasing to 100 per cent of allowances until 2040 (‘Power_2040’); (c) similar to (b) except that 100 per cent allowance auctioning in the electricity sector is only reached in 2050, instead of 2040 (‘Power_2050’). In both (a) and (b), there is no auctioning in the industry sector.

The auctioning revenue in any year is the product of the emissions from the electricity sector in the NZ + ETS scenario, the share of emissions that will be auctioned, and the carbon price. Figure 15 shows that although the electricity sector emissions peak in 2040, the auctioning revenue peaks in 2055 – due to a higher carbon price in that year. The auction value depends on the scenario and the year; however, the revenue generated can be significant. For example, in 2045, this value is in the range of USD 65–90 billion.

Figure 14 Financial transfers across sectors (until 2050) under different allocation regimes

Source: Authors’ analysis

Figure 15 Auctioning revenue from the electricity sector under two different off-model scenarios (power_2040, power_2050) for the NZ + ETS scenario

Source: Authors’ analysis

Given India’s near-term NDC and long-term net-zero targets, the country has announced the introduction of a domestic ETS. The ETS, based on emission intensity targets, is aimed at reducing emissions and spurring low-carbon innovation, especially in the industry sector. In this study, we ran four scenarios (NZ, NZ + ETS, NZ + CC, NZ + RPO) and two scenario variants (NZ + CC_v1, NZ + CC_v2) using the integrated assessment model GCAM to understand the role of the ETS in achieving India’s net-zero target, the interaction between various industrial sectors in an ETS, and the interaction of an ETS with energy policies, specifically RPOs.

The results show that, firstly, the electricity sector has an important role to play in an ETS, not only because of its potential to provide cheap emission credits but also because of its interaction with an ETS through RPOs. A low overall emission-reduction target would lead to a low carbon price. If it remains low over a long period, this would incentivise industrial sectors to buy carbon credits from the electricity sector rather than do ‘in-house’ mitigation or invest in long-term decarbonisation strategies. At the same time, a high carbon price could disrupt industrial activity and lead to strong pushback.

Secondly, different industrial sectors have different capacities to decarbonise. Sectors where fossil fuels are raw materials are harder to abate as their substitutes are either unavailable (like limestone in cement) or expensive (hydrogen in the fertilisers industry). However, most industries do some form of fuel-switching initially (i.e., at a low carbon price), and in later stages, switch to electrification, increased hydrogen use (as electricity becomes increasingly cheaper through greater penetration of renewable energy), and CCS.

Thirdly, an emission cap across sectors (ETS) is cheaper than command-and-control type policies that do not allow trading. This is because in an ETS, mitigation starts with the cheapest options and progresses to more expensive options. In comparison, command-and-control type policies force the regulated sector(s) to mitigation, irrespective of the mitigation costs.

Fourth, auctioning even a part of emission allowances can generate significant revenue for the government, which can be used, for example, to reduce the negative impacts of an energy transition such as the loss of jobs in coal-bearing states.

Lastly, for an ETS to be successful, interactions with other energy policies must be considered. In particular, the impact of RPOs, one of the most stringent policies leading to emission reduction, should be considered when setting the reduction targets of an ETS to avoid potentially negative impacts through the suppression of the carbon price.