Evaluating the EU ETS impacts on profits,investments and prices of the Italian electricity market

Climate change is a global issue, but actions to mitigate its development are regional. Europe has taken the leadership in the carbon emission policy by introducing the Emissions Trading Scheme (EU ETS), formerly regulated by Directive 2003/87/EC and since 2013 by Directive 2009/29/EC. This new Directive imposes a full auctioning system for allocating CO₂ allowances to the power sector and encourages the use of renewable energy sources.We investigate the economic impacts of the EU ETS on the Italian electricity market using a power generation expansion model. We adopt a technological representation of the energy market that also accounts for power exchanges with foreign countries and we assume that generators operate in different zones connected by interconnections with limited capacity. We study both an oligopolistic and a perfectly competitive behavior of Italian generators and we compare the corresponding outcomes under different EU ETS scenarios. Our analysis shows that, in perfect competition, generators generally invest more than in an oligopolistic framework, but in both market configurations, investments in Italy are mainly concentrated in fossil-fired plants, especially in 2020. This happens also when incentives are given to renewables.The developed models are implemented as complementarity problems and solved in GAMS using the PATH solver.     

An overview of current research on EU ETS: Evidence from its operating mechanism and economic effect

The European Union Emissions Trading Scheme (EU ETS) is supposed to be an important mechanism for addressing climate change. Up to now, the theoretical foundation of EU ETS has been widely acknowledged, but empirical research on its current situation has only been published recently or is forthcoming. Therefore, this paper is aimed to summarize the main arguments of empirical studies on the EU ETS, in terms of two aspects, i.e., the operating mechanism and economic effect of the EU ETS, which are two crucial topics and have been attached much attention. Based on the shortcomings of current research and future requirements of the EU ETS evolution, finally, we also present some further directions of the EU ETS research. Overall, the research overview here may be helpful to recognize the features of the EU ETS and its effect on others.     

Carbon price volatility: Evidence from EU ETS

This paper examines carbon price volatility using data from the European Union Emission Trading Scheme from a nonlinear dynamics point of view. First, we use a random walk model, including serial correlation and variance ratio tests, to determine whether carbon price history information is fully reflected in current carbon price. The empirical research results show that carbon price is not a random walk: the price history information is not fully reflected in current carbon price. Second, use R/S, modified R/S and ARFIMA to analyse the memory of carbon price history. For the period April 2005–December 2008, the modified Hurst index of the carbon price is 0.4859 and the d value of ARFIMA is −0.1191, indicating short-term memory of the carbon price. Third, we use chaos theory to analyse the influence of the carbon market internal mechanism on carbon price, i.e., the market’s positive and negative feedback mechanism and the heterogeneous environment. Chaos theory proves that the correlation dimension of carbon price increases. The maximal Lyapunov exponent is positive and large. There is no obvious complex endogenous phenomenon of nonlinear dynamics the carbon price fluctuation. The carbon market is mildly chaotic, showing both market and fractal market characteristics. Price fluctuation is not only influenced by the internal market mechanism, but is also impacted by the heterogeneous environment. Finally, we provide suggestions for regulation and development of carbon market.     

A literature-based multi-criteria evaluation of the EU ETS

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.     

White certificate schemes: Economic analysis and interactions with the EU ETS

This paper examines the economic, environmental and distributional impacts of an idealised tradable white certificate (TWC) scheme and shows how the impacts are modified when the scheme operates in parallel with the EU emissions trading scheme (EU ETS). It uses simple graphical techniques to assess whether a TWC scheme will increase, decrease or have an ambiguous effect on electricity demand, wholesale and retail electricity prices, carbon emissions and investment in energy efficiency, paying particular attention to the interpretation of ‘additionality’.     

Carbon futures and macroeconomic risk factors: A view from the EU ETS

This article examines the empirical relationship between the returns on carbon futures – a new class of commodity assets traded since 2005 on the European Union Emissions Trading Scheme (EU ETS) – and changes in macroeconomic conditions. By using variables which possess forecast power for equity and commodity returns, we document that carbon futures returns may be weakly forecast on the basis of two variables from the stock and bond markets, i.e. equity dividend yields and the “junk bond” premium. Our results also suggest that the forecast abilities of two variables related to interest rates variation and economic trends on global commodity markets, respectively the U.S. Treasury bill yields and the excess return on the Reuters/CRB Index, are not robust on the carbon market. This latter result reinforces the belief that the EU ETS is currently operating as a very specific commodity market, with distinct fundamentals linked to allowance supply and power demand. The sensitivity of carbon futures to macroeconomic influences is carefully identified following a sub-sample decomposition before and after August 2007, which attempts to take into account the potential impact of the “credit crunch” crisis. Collectively, these results challenge the market observers' viewpoint that carbon futures prices are immediately correlated with changes in the macroeconomic environment, and rather suggest that the carbon market is only remotely connected to macroeconomic variables. The economic logic behind these results may be related to the fuel-switching behavior of power producers in influencing primarily carbon futures price changes.     

Installation entries and exits in the EU ETS: patterns and the delay effect of closure provisions

This paper analyses installation entries and exits in the EU ETS, over 2005–2013. Patterns of entries and exits are identified across countries, sectors, and time. The limitations of the EUTL as a data source for research purposes mean that only genuine exits (reflecting production capacity reduction), and not genuine entries (reflecting production capacity increases), can be systematically identified. Exits are found to be relatively frequent events, more so in manufacturing sectors with small average installation size. Moreover, exits were concentrated in 2007 and in 2012, the final years of Phase I and Phase II. We investigate whether the perverse incentives of closure provisions, in free allocation, explain such time pattern. A discrete-time hazard model for the exit event is estimated using a three-tier dataset combining installation-, firm-, and macro-level information. The results indicate that, most likely, closure provisions delayed installation exits, especially in Phase II.     

Price determination in the EU ETS market: Theory and econometric analysis with market fundamentals

We investigate the price determination of the European Union emission allowance (EUA) of the European Union emissions trading scheme (EU ETS). We postulate an uncertain permit price and risk-averse firms which have the possibility to hedge in the forward market. The firms produce final goods, abate their emissions and trade permits in the permit market. The dependence of the equilibrium permit price on exogenous variables is studied in a permit market model. We test our theoretical findings with empirical data from 2005 to 2010 in the EU ETS market. We use daily forward prices of EUA as our dependent variable. We use several econometric models with multiple stationary time series to discover that there is a strong relationship between the fundamentals, such as German electricity prices and gas and coal prices, with the price of EUA. We find that the EUA forward price depends on fundamentals, especially on the price of electricity as well as on the gas–coal difference, in a statistically significant way.     

Coevolution of policy,market and technical price risks in the EU ETS

Within the EU, there have been calls for governments to provide greater certainty over carbon prices, even though it is evident that their price risk is not entirely due to policy uncertainty. We develop a stochastic simulation model of price formation in the EU ETS to analyse the coevolution of policy, market and technology risks under different initiatives. The current situation of a weak (20%) overall abatement target motivates various technology-support interventions, elevating policy uncertainty as the major source of carbon price risk. In contrast, taking a firm decision to move to a more stringent 30% cap would leave the EU–ETS price formation driven much more by market forces than by policy risks. This leads to considerations of how much risk mitigation by governments would be appropriate, and how much should be taken as business risk by the market participants.     

The initial impact of EU ETS verification events on stock prices

This paper studies the impact of verified emissions publications in the European Emissions Trading Scheme (EU ETS) on the market value of participating companies. Using event study methodology on a unique sample of 368 listed companies, we show that verified emissions only resulted in statistically significant market responses when the carbon price was high and allowance scarcity was anticipated. The cross-section analysis of abnormal returns surrounding the publication of verified emissions shows that share prices decrease when actual emissions relative to allocated emissions increase. This negative relationship between allocation shortfalls and firm value is only significant for firms that are either carbon-intensive, compared to sector peers, or are less likely to pass through carbon-related costs in their product prices. The results suggest that although the EU ETS has been deemed unsuccessful so far due to over-allocation and low carbon price, shareholders initially perceived allowance holdings as value relevant. Our results highlight that a significant carbon market price and addressing pass-through costing are essential for successful future reforms of the EU ETS and other analogous carbon cap-and-trade systems implemented or planned worldwide.     

Trader types and volatility of emission allowance prices. Evidence from EU ETS Phase I

This paper studies the relation between the trading activity of market participants and the volatility of the European Emission Allowance price during Phase I of the European Union Emission Trading System (EU ETS). We focus on the contrasting roles of different trader types.We find evidence of a positive and significant trading activity–volatility relation, which appears to be stronger when accounting for trader type. The positive relation can be mainly attributed to energy providers. In contrast, industrial companies seem to have traded more frequently when volatility levels were lower. Finally, the non-liable players, represented by financial intermediaries, appear to have acted as a flexible counterparty, trading more with the energy sector when volatility was higher, and more with the industrial firms when volatility was lower. We discuss possible explanations for these contrasted positions.Understanding the trading activity–volatility link is relevant for evaluating the efficiency of the EU ETS. Although the relation is generally positive, many players remained often inactive and traded mostly when volatility levels were lower. Policies targeting the engagement of less active players could lead to a smoother incorporation of information into prices and to an increase in market efficiency.     

Estimating the economic impacts of power supply interruptions

The cost of power system rationing, which is a crucial parameter for determining optimal resilience investments, is usually estimated using reduced-form linear models or ordinary input-output analysis. However, such methods do not properly address either consumers' rational reactions to rationing policy or policy design nonlinearities. To solve this problem, this paper estimates the effects of power system rationing using a general equilibrium model. The model solution shows that the power cut distribution among industries is a critical variable for quantifying policy effects and provides insights into optimal policy design.     

Ex-post investigation of cost pass-through in the EU ETS - an analysis for six industry sectors

In the discussion on the potential risk of carbon leakage related to the EU ETS and the effect of safeguard measures, the scope for passing through carbon costs into final product prices is considered a key issue. This study investigates whether and to what extent ETS-related carbon costs have been passed through into product prices by EU industry. Literature on the issue of carbon cost pass-through in industry, other than electric power generation, is relatively sparse and we therefore aim to add to the knowledge gathered in this area so far. We investigate a number of products in six industry sectors in several European countries and regions and provide estimates for carbon cost pass-through for more than 50 product/country pairs. In line with the literature, our econometric results imply significant cost pass-through for a number of products, with results being most conclusive for the cement, iron and steel, and refineries sectors. The extent of the estimated pass-through rates diverges between products and countries/regions. These findings are aimed at informing discussions about carbon leakage protection for industries covered by the EU ETS.     

China's energy consumption under the global economic crisis: Decomposition and sectoral analysis

It is now widely recognized that there is a strong relationship between energy consumption and economic growth. Most countries′ energy demands declined during the economic depression of 2008–2009 when a worldwide economic crisis occurred. As an export-oriented economy, China suffered a serious exports decline in the course of the crisis. However, it was found that energy consumption continued to increase. Against such a background, this paper aims to assess and explain the factors causing the growth of energy consumption in China. First, we will explain the impact of domestic final use and international trade on energy consumption by using decomposition analysis. Second, embodied energy and its variation across sectors are quantified to identify the key sectors contributing to the growth. Lastly, the policy implications for long-term energy conservation are discussed. The results show that the decline in exports was one of the driving forces for energy consumption reduction in the crisis, but that the growth of domestic demand in manufacturing and construction, largely stimulated by economic stimulus plans, had the opposite effect on energy consumption. International trade contributed to decreasing energy consumption of China during and after the crisis because the structure of exports and imports changed in this period.     

Linking extreme climate events and economic impacts: Examples from the Swiss Alps

This paper focuses upon topics related to current and possible future extreme weather events in order to highlight the links between climatic change and its economic impacts. Most of the examples given here are drawn from observations in Switzerland and the Alpine region that have a wealth of climatic, environmental and socio-economic data. These enable detailed studies to be undertaken on trends in mean and extreme climates and their impacts. Model simulations for a “greenhouse climate” suggest that risks associated with various forms of extreme events that affect the Alps may increase in the future, which could lead to high damage costs. In addition to the direct impacts of extremes, it is also necessary to take into account the increasing economic value of infrastructure located in zones potentially at risk. The final part of the paper addresses some of the issues that are related to fully integrated modeling approaches that are aimed at assessing the costs of damage in the wake of an extreme event.     

The environmental and economic impacts of the UK climate change agreements

The climate change agreements (CCAs) in the UK were negotiated with a number of energy-intensive industrial sectors, and offered a reduction in the rate of the climate change levy (CCL), provided that negotiated energy efficiency targets were met. Through modelling and by analysis of the results of the first target period, this paper analyses the stringency of the targets, and the economic and environmental implications of the CCAs. It concludes that, while the targets in themselves were not stringent, and were in the main met well before the due date, the CCAs appear to have had an ‘awareness effect’ in stimulating energy savings. This has resulted in overall environmental benefits above those which would have derived from the imposition of a flat-rate tax with no rebate and no CCAs, and economic benefits for the sectors and companies with which CCAs were negotiated.     

Political,economic and environmental impacts of biomass-based hydrogen

The purpose of this study is to assess the political, economic and environmental impacts of producing hydrogen from biomass. Hydrogen is a promising renewable fuel for transportation and domestic applications. Hydrogen is a secondary form of energy that has to be manufactured like electricity. The promise of hydrogen as an energy carrier that can provide pollution-free, carbon-free power and fuels for buildings, industry, and transport makes it a potentially critical player in our energy future. Currently, most hydrogen is derived from non-renewable resources by steam reforming in which fossil fuels, primarily natural gas, but could in principle be generated from renewable resources such as biomass by gasification. Hydrogen production from fossil fuels is not renewable and produces at least the same amount of CO₂ as the direct combustion of the fossil fuel. The production of hydrogen from biomass has several advantages compared to that of fossil fuels. The major problem in utilization of hydrogen gas as a fuel is its unavailability in nature and the need for inexpensive production methods. Hydrogen production using steam reforming methane is the most economical method among the current commercial processes. These processes use non-renewable energy sources to produce hydrogen and are not sustainable. It is believed that in the future biomass can become an important sustainable source of hydrogen. Several studies have shown that the cost of producing hydrogen from biomass is strongly dependent on the cost of the feedstock. Biomass, in particular, could be a low-cost option for some countries. Therefore, a cost-effective energy-production process could be achieved in which agricultural wastes and various other biomasses are recycled to produce hydrogen economically. Policy interest in moving towards a hydrogen-based economy is rising, largely because converting hydrogen into useable energy can be more efficient than fossil fuels and has the virtue of only producing water as the by-product of the process. Achieving large-scale changes to develop a sustained hydrogen economy requires a large amount of planning and cooperation at national and international alike levels.     

Evaluation the potential economic impacts of Taiwanese biomass energy production

The Taiwanese rice paddy land set-aside program diverts a substantial land area. Given today’s high energy prices and interests in energy security, that set-aside area could be converted to produce bioenergy feedstocks. This study evaluates the economic and environmental impacts of such a policy change using a Taiwanese agricultural sector model. The results show that such a strategy provides increased farm revenue, increased rural employment, increased energy sufficiency and reduced greenhouse gas emissions but also increased government expenditures. These outcomes indicate that the agricultural sector could play a positive role by producing renewable energy.     

CAFE compliance by light trucks: economic impacts of clean diesel engine

With the popularity of light trucks increasing in the United States, their share of the US light vehicle market had doubled between 1980 and 1996, climbing from 20 to 40%. By 1996, annual energy consumption for light trucks had risen to 5.97×10¹⁵ Btu [5.97 quadrillion Btu, or “quad,” or 6.30×10¹⁸ joule (J)], compared to 7.94 quad (8.38×10¹⁸ J) for cars. In recent years (since 1995), the fuel economy of US - manufactured light trucks (almost 99% of which use gasoline engines) has been below the Corporate Average Fuel Economy (CAFE) standards. This paper analyzes a strategy to reduce the CAFE shortfalls by adopting the new, highly energy-efficient clean diesel engine. Research on such engines has been funded by the US Department of Energy, Office of Heavy Vehicle Technologies, under its Light Truck Clean Diesel Engine Program. A clean diesel engine market penetration trajectory is developed, representing an industry response to meet the CAFE standards. Whether the engine will be produced inside the country or imported remains uncertain, so two cases are defined. Values of exports/imports of clean diesel engines/trucks under these cases are estimated. The macroeconomic benefits are estimated by using a model of the US economy developed by Standard & Poor's Data Resources, Inc. On the basis of gains in the gross domestic product projected under the alternative cases, domestic production of the clean diesel engine is favored over importing it.