Although formal simulation modelling is not a precondition for proactive environmental policies, it can powerfully influence public attitudes and policy making...

Perman et al. (2003 p. 269-270)

### 1. Introduction

The European Union’s $ CO_{2} $ Emissions Trading Scheme (EU ETS) is one of the key policy measures introduced by the European Union (EU) to help meet the EU’s greenhouse gas (GHG) emissions reduction targets under the Kyoto Protocol. The EU ETS is a market-based mechanism, introduced in January 2005, which seeks to incentivise the reduction of $ CO_{2} $ emissions in a cost-effective manner in energy intensive sectors such as energy generation, the production and processing of ferrous and non-ferrous metals, the mineral industry and the pulp and paper production, that represent around 45 percent of the total EU’s $ CO_{2} $ emissions.

Even though, the theoretical literature on emissions trading shows that the benefits to be realised from this market-based mechanism (in the form of least-cost property) are positive(Montgomery, 1972), in the case of the EU ETS, the concerns about this scheme’s effectiveness, cost-efficiency and fairness remain, since its scale, complexity, and international coverage, clearly differentiates it from the pioneering U.S. trading programmes.

The common practice for policy evaluation consists of two stages: (1) ex-ante computer simulations that compare existing policies with potential alternative ones; and (2) ex-post evaluations that are based upon actual policy implementation and use retrospective data that become available after the policy had been in place for a sufficient period of time. This combined ex-ante and ex-post policy evaluation approach seeks not only to discover whether the perceived ex-ante potential benefits are substantial enough to motivate a change, but also to ascertain whether such expectations were lived up to buy the actual implementation.

The experience with early environmental trading programmes has shown that ex-ante predictions about their performance diverge substantially from actual outcomes. For instance, in the case of the $ SO_{2} $ trading programme in the United States, Burtraw (1996) discusses why the early predictions of marginal abatement costs - ranging from 1,500 to 750 per tonne of $ SO_{2} $ - differ grossly from the realised equilibrium price of 170 per allowance at the beginning of the programme. He suggests that either institutional context (lack of the actions at state-level institutions, auction design, subsidising utilities that install scrubbing); or market fundamentals (increased competition in coal and scrubber markets and rail transportation sector, innovations in rail transport, fuel blending and scrubber market) explain observed low abatement costs.

In spite of objective difficulties to predict the future in the absence of any historical evidence base, and given the complex decision processes on allocation driven by strategic imperatives, many had a go at estimating the ex-ante costs of the EU ETS. As the 3-year pilot phase (2005-2007) of the EU ETS is just finished, the ex-post literature is necessarily sparse. To the best of our knowledge, so far, no study has tried to evaluate the overall cost-efficiency of this scheme and, therefore, the comprehensive comparison of the ex-ante cost predictions and ex-post cost outcomes is a difficult task which is not the purpose of this analysis. The main goal of this study is to critically review the ex-ante literature and its evolution with the particular reference to the available ex-post outcomes in order to provide some lessons for both policy makers using the ex-ante studies for policy decision-making and modellers seeking to provide more reliable predictions of policy choice impacts. A parallelisation of the ex-ante cost estimates with the