An emerging equilibrium in the EU emissions trading scheme

The European Union's Emissions Trading Scheme (ETS) is the key policy instrument of the European Commission's Climate Change Program aimed at reducing greenhouse gas emissions to eight percent below 1990 levels by 2012. A critically important element of the EU ETS is the establishment of a market determined price for EU allowances. This article examines the extent to which several theoretically founded factors including, economic growth, energy prices and weather conditions determine the expected prices of the European Union CO₂ allowances during the 2005 through to the 2009 period. The novel aspect of our study is that we examine heavily traded futures instruments that have an expiry date in Phase 2 of the EU ETS. Our study adopts both static and recursive versions of the Johansen multivariate cointegration likelihood ratio test as well as a variation on this test with a view to controlling for time varying volatility effects. Our results are indicative of a new pricing regime emerging in Phase 2 and point to a maturing market driven by the fundamentals. These results are valuable both for traders of EU allowances and for those policy makers seeking to improve the design of the European Union ETS.     

Energy consumption and CO2 emissions of the European glass industry

An in-depth analysis of the energy consumption and CO₂ emissions of the European glass industry is presented. The analysis is based on data of the EU ETS for the period 2005–2007 (Phase I). The scope of this study comprises the European glass industry as a whole and its seven subsectors. The analysis is based on an assignment of the glass installations (ca. 450) within the EU ETS to the corresponding subsectors and an adequate matching of the respective production volumes. A result is the assessment of the overall final energy consumption (fuel, electricity) as well as the overall CO₂ emissions (process, combustion and indirect emissions) of the glass industry and its subsectors in the EU25/27. Moreover, figures on fuel mix as well as fuel intensity and CO₂ emissions intensity (i.e. carbon intensity) are presented for each of the subsectors on aggregated levels and for selected EU Member States separately. The average intensity of fuel consumption and direct CO₂ emissions of the EU25 glass industry decreased from 2005 to 2007 by about 4% and amounted in 2007 to 7.8 GJ and 0.57 _tCO₂${\mathrm{t}}_{{\text{CO}}_{\mathrm{2}}}$ per tonne of saleable product, respectively. The economic energy intensity was evaluated with 0.46 toe/1000€ (EU27).     

Rents in the European power sector due to carbon trading

The European Union Emissions Trading Scheme (EU ETS) has imposed a price on the allowances for CO₂ emissions of electricity companies. Integrating this allowance price into the price of electricity earns a rent for companies who have received these allowances for free. During Phase I, 2005–2007, rents corresponding to the aggregate value of allocated allowances amounted to roughly € 13 billion per year. However, due to the specific price-setting mechanism in electricity markets true rents were considerably higher. This is due to the fact that companies also that have not received any allowances gain additional infra-marginal rents to the extent that their variable costs are below the new market price after inclusion of the allowance price. Producers with low carbon emissions and low marginal costs thus also benefit substantially from carbon pricing. This paper develops a methodology to determine the specific interaction of the imposition of such a CO₂ constraint and the price-setting mechanism in the electricity sector under the assumption of marginal cost pricing in a liberalized European electricity market. The article thus provides an empirical estimate of the true total rents of power producers during Phase I of the EU-ETS (2005–2007). The EU ETS generated in Phase I additional rents in excess of € 19 billion per year for electricity producers. These transfers are distributed very unevenly between different electricity producers. In a second step, the paper assesses the impact of switching from free allocation to an auctioning of allowances in 2013. We show that such a switch to auctioning will continue to create additional infra-marginal rents for certain producers and will leave the electricity sector as a whole better off than before the introduction of the EU ETS.     

Implications of the EU Emissions Trading System for the South-East Europe Regional Electricity Market

As part of its climate policy, the European Union (EU) aims to reduce greenhouse gas (GHG) emissions levels by 20% by the year 2020 compared to 1990 levels. Although the EU is projected to reach this goal, its achievement of objectives under its Emissions Trading System (ETS) may be delayed by carbon leakage, which is defined as a situation in which the reduction in emissions in the ETS region is partially offset by an increase in carbon emissions in the non-ETS regions. We study the interaction between emissions and hydropower availability in order to estimate the magnitude of carbon leakage in the South-East Europe Regional Electricity Market (SEE-REM) via a bottom-up partial equilibrium framework. We find that 6.3% to 40.5% of the emissions reduction achieved in the ETS part of SEE-REM could be leaked to the non-ETS part depending on the price of allowances. Somewhat surprisingly, greater hydropower availability may increase emissions in the ETS part of SEE-REM. However, carbon leakage might be limited by demand response to higher electricity prices in the non-ETS area of SEE-REM. Such carbon leakage can affect both the competitiveness of producers in ETS member countries on the periphery of the ETS and the achievement of EU targets for CO₂ emissions reduction. Meanwhile, higher non-ETS electricity prices imply that the current policy can have undesirable outcomes for consumers in non-ETS countries, while non-ETS producers would experience an increase in their profits due to higher power prices as well as exports. The presence of carbon leakage in SEE-REM suggests that current EU policy might become more effective when it is expanded to cover more countries in the future.     

EUA and sCER phase II price drivers: Unveiling the reasons for the existence of the EUA–sCER spread

This article studies the price relationships between EU emissions allowances (EUAs) – valid under the EU Emissions Trading Scheme (EU ETS) – and secondary Certified Emissions Reductions (sCERs)—established from primary CERs generated through the Kyoto Protocol's Clean Development Mechanism (CDM). Given the price differences between EUAs and sCERs, financial and industrial operators may benefit from arbitrage strategies by buying sCERs and selling EUAs (i.e. selling the EUA–sCER spread) to cover their compliance position as industrial operators are allowed to use sCERs towards compliance with their emissions cap within the European system up to 13.4%. Our central results show that the spread is mainly driven by EUA prices and market microstructure variables and less importantly, as we would expect, by emissions-related fundamental drivers. This might be justified by the fact that the EU ETS remains the greatest source of CER demand to date.     

Causalities between CO2, electricity,and other energy variables during phase I and phase II of the EU ETS

The topic of this article is the analysis of the interplay between daily carbon, electricity and gas price data with the European Union Emission Trading System (EU ETS) for CO₂ emissions. In a first step we have performed Granger causality tests for Phase I of the EU ETS (January 2005 until December 2007) and the first year of Phase II of the EU ETS (2008). The analysis includes both spot and forward markets—given the close interactions between the two sets of markets. The results show that during Phase I coal and gas prices, through the clean dark and spark spread, impacted CO₂ futures prices, which in return Granger caused electricity prices. During the first year of the Phase II, the short-run rent capture theory (in which electricity prices Granger cause CO₂ prices) prevailed. On the basis of the qualitative results of the Granger causality tests we obtained the formulation testable equations for quantitative analysis. Standard OLS regressions yielded statistically robust and theoretically coherent results.     

Ex-ante evaluation of EU ETS during 2013–2030: EU-internal abatement

This study investigates CO₂ emission reduction within the EU resulting from the Emissions Trading Scheme (ETS) up to 2030. This is performed by constructing a baseline scenario without the ETS and assessing the impacts of the ETS, as currently designed. The results indicate that the ETS will start to impact emissions primarily after 2025 due to the prevalence of a sizable allowance surplus. The impact of approved (i.e. back-loading and 2.2% linear reduction factor (LRF)) and proposed (i.e. market stability reserve (MSR)) policy interventions and the inclusion of aviation, could accelerate the exhaustion of surplus and increase emission reductions during the investigated period. However, these measures would be insufficient to restore the scarcity of allowances and the corresponding carbon price before the start of ETS Phase IV, and the effectiveness of EU-internal abatement cannot be guaranteed until 2023. The effectiveness could be further reduced in the case of the economic shocks or the exclusion of international aviation.To restore the scarcity of allowances, other reform options are necessary. This paper extends the reasoning for the early removal of the back-loaded 900 Mtonne allowances by 2020 and broadening the scope of ETS to other sectors with potential high demand for allowances.     

Sectoral and regional impacts of the European carbon market in Portugal

Across Europe, CO₂ emission allowances represent one of the main policy instruments to comply with the goals of the Kyoto Protocol. In this paper we use microdata to address two issues regarding the impact of the European Carbon Market (EU ETS). First, we analyze the sectoral effects of the EU ETS in Portugal. The goal is to study the distributive consequences of imbalances, with the novelty of taking into account firm financial data to put values into context. We show that a large majority of installations in most sectors had surpluses and the opportunity to raise remarkable revenues in some cases. We also look at the regional impact, since the pre-existing specialization of different regions in the production of different goods and services might lead to an uneven economic impact of the allowance market. In particular, Portuguese data indicate a distribution of revenue from low income to high income regions, or rather, between installations located in those regions. We focus on the first phase of the EU ETS, using data for each one of the 244 Portuguese installations in the market as well as financial data for 80% of these installations, although we also present data for 2008 and 2009.     

Emissions trading and investment decisions in the power sector—a case study in Finland

Organizations, which consider investment in or divestment of power production licences/capacity within the European Community, are exposed to the impacts of the European Union Emission allowance Trading Scheme (EU ETS). In this paper, the consequences of the EU ETS on investment decisions are explored in a country-specific setting in Finland. First, we review the general mechanisms through which the EU ETS influences size, timing and cashflows of an investment. Next, we discuss the projected changes in Finnish power producers’ investment environment and examine the financial impacts due to the EU ETS on a case investment decision, a hypothetical condensing power plant (250 MW_e). The standard discounted cash flow (DCF) analysis is extended to take into account the value of two real options: the option to wait and the option to alter operating scale. In a quantitative investment appraisal, the impact of emissions trading not only depends on the expected level of allowance prices, but also on their volatility and correlation with electricity and fuel prices. The case study shows that the uncertainty regarding the allocation of emission allowances is critical in a quantitative investment appraisal of fossil fuel-fired power plants.     

Incentives for energy efficiency in the EU Emissions Trading Scheme

This paper explores the incentives for energy efficiency induced by the European Union Emissions Trading Scheme (EU ETS) for installations in the energy and industry sectors. Our analysis of the National Allocation Plans for 27 EU Member States for phase 2 of the EU ETS (2008–2012) suggests that the price and cost effects for improvements in carbon and energy efficiency in the energy and industry sectors will be stronger than in phase 1 (2005–2007), but only because the European Commission has substantially reduced the number of allowances to be allocated by the Member States. To the extent that companies from these sectors (notably power producers) pass through the extra costs for carbon, higher prices for allowances translate into stronger incentives for the demand-side energy efficiency. With the cuts in allocation to energy and industry sectors, these will be forced to greater reductions; thus, the non-ET sectors like household, tertiary, and transport will have to reduce less, which is more in line with the cost-efficient share of emission reductions. The findings also imply that domestic efficiency improvements in the energy and industry sectors may remain limited since companies can make substantial use of credits from the Kyoto Mechanisms. The analysis of the rules for existing installations, new projects, and closures suggests that incentives for energy efficiency are higher in phase 2 than in phase 1 because of the increased application of benchmarking to new and existing installations and because a lower share of allowances will be allocated for free. Nevertheless, there is still ample scope to further improve the EU ETS so that the full potential for energy efficiency can be realized.

Electricity pricing under “carbon emissions trading”: A dominant firm with competitive fringe model

The aim of this paper is to analyze the impact of trading of CO₂ emissions allowances on electricity pricing in the short run. We mainly refer to the European Emissions Trading Scheme (ETS) and are interested in understanding the role of electricity market structures. We carry out a simple analytical model useful to verify whether (and under which conditions) the impact of the ETS under market power could be lower (or higher) than that under perfect competition. We analyze a context where generators compete in a uniform, first price auction. Market power in the form of a dominant firm facing a competitive fringe model is assumed. The paper highlights that the marginal CO₂ opportunity costs are fully included in energy prices when the electricity market is perfectly competitive. Under market power the impact of the ETS equals or exceeds that under the competitive scenario only when there is excess capacity and the share of most polluting plants in the market is low enough. Otherwise, the impact under market power is less than under perfect competition and significantly decreases in the degree of market concentration. This especially occurs when there is not high excess capacity and regardless of either the plant mix or the allowance price. In this case, moreover, the marginal pass-through rate is lower in the peak than in the off-peak hours and can be even nil if the degree of market concentration is high enough.     

Modeling the price dynamics of CO2 emission allowances

In this paper we analyze the short-term spot price behavior of carbon dioxide (CO₂) emission allowances of the new EU-wide CO₂ emissions trading system (EU ETS). After reviewing the stylized facts of this new class of assets we investigate several approaches for modeling the returns of emission allowances. Due to different phases of price and volatility behavior in the returns, we suggest the use of Markov switching and AR–GARCH models for stochastic modeling. We examine the approaches by conducting an in-sample and out-of-sample forecasting analysis and by comparing the results to alternative approaches. Our findings strongly support the adequacy of the models capturing characteristics like skewness, excess kurtosis and in particular different phases of volatility behavior in the returns.     

Emission abatement: Untangling the impacts of the EU ETS and the economic crisis

In this study we use historical emission data from installations under the European Union Emissions Trading System (EU ETS) to evaluate the impact of this policy on greenhouse gas emissions during the first two trading phases (2005–2012). As such the analysis seeks to disentangle two causes of emission abatement: that attributable to the EU ETS and that attributable to the economic crisis that hit the EU in 2008/09. To do so, we use a dynamic panel data approach. Our results suggest that, by far, the biggest share of abatement was attributable to the effects of the economic crisis. This finding has serious implications for future policy adjustments affecting core elements of the EU ETS, including the distribution of EU emission allowances.     

Competition and environmental policies in an electricity sector

We study the impact of competition and environmental policy (feed-in tariff vs. the EU ETS) on investment, CO₂ emissions and welfare in an electricity sector. We consider different market structures (a planner who maximises social welfare vs. duopoly) and two types of consumers (those whose behaviour depends on the weather vs. those whose behaviour does not). The demand specification is innovative and takes incompressible consumption into account.Given the costs and demand functions, we find that competition can increase CO₂ emissions, as is highlighted by Mansur (2007). In duopoly, the EU ETS seems to be the only efficient policy for reducing CO₂ emissions but also to increase the share of production based on renewable energy sources. The retained feed-in tariff policy seems to be the most expensive policy in terms of “social welfare”. Even if this policy seems to increase “social welfare”, feed-in tariffs increase the CSPE, which is paid for by consumers in the form of higher electricity prices and only benefits new entrants. It is also less effective in terms of emission reduction.     

Assessment of the impact of the European CO2 emissions trading scheme on the Portuguese chemical industry

This paper describes an assessment of the impact of the enforcement of the European carbon dioxide (CO₂) emissions trading scheme on the Portuguese chemical industry, based on cost structure, CO₂ emissions, electricity consumption and allocated allowances data from a survey to four Portuguese representative units of the chemical industry sector, and considering scenarios that allow the estimation of increases on both direct and indirect production costs. These estimated cost increases were also compared with similar data from other European Industries, found in the references and with conclusions from simulation studies. Thus, it was possible to ascertain the impact of buying extra CO₂ emission permits, which could be considered as limited. It was also found that this impact is somewhat lower than the impacts for other industrial sectors.     

Analysis of the CO2 emissions and of the other characteristics of the European market of new passenger cars. 2. Segment analysis

This article analyzes the engine and vehicle characteristics and the CO₂ emissions of the new passenger cars for all segments of the European market. As in the first article of this work, the target is to find the real market parameters influencing exhaust CO₂ emissions. The present analysis is focused on the segment sales distribution (EU average and within each country) and also in four parameters of each segment influencing CO₂ emissions: average vehicle weight, average engine capacity, average maximum and specific power. The second part of this work concerns the CO₂ emissions of each segment on the New European Driving Cycle and its urban and extra urban parts.     

Exploring the price dynamics of CO2 emissions allowances in China's emissions trading scheme pilots

Establishing regional emissions trading scheme pilots in China is a newly transformative and explorative practice. In this paper, we examine the spot price dynamics, asymmetric clustering and regime-switching behaviors of CO₂ emissions allowances in the new China-wide emissions trading scheme (CETS) pilots using AR-GARCH, AR-TARCH and MRS-AR-GARCH models. The regional ETS pilots' design in China vary widely in their coverage thresholds, sector coverage, emissions allocation and caps setting methods, market trading rules and price stabilization provisions. Our empirical results indicate that the spot prices of regional emissions allowances exhibit significant dynamic behaviors, asymmetric leverage effects and regime-switching behaviors in the entire period considered; previous market overreactions in the Beijing, Tianjin and Guangdong pilots have stronger price clustering effects on future conditional variances than do the Shanghai and Hubei pilots. Unexpected market shocks and greater persistence in the Beijing, Tianjin and Guangdong ETS pilots display stronger market volatility and higher market risks, and their asymmetric leverage effects display a decreasing trend in the volatility of the BEA, TJEA and GDEA prices. The BEA and SHEA prices exhibit significant regime-switching behaviors, price jumps and higher volatility; in addition, the changes in the regime-switching phases are often related to the political mechanism design and the fundamental market factors. Those empirical results are beneficial for government decision-makers and market participants to strengthen risk management strategies, support emission-related investment decisions and optimize co-benefits of alternative energy-environmental policies.     

Technological prospects and CO2 emission trading analyses in the iron and steel industry: A global model

This article presents the Iron and Steel Industry Model (ISIM). This is a world simulation model able to analyze the evolution of the industry from 1997 to 2030, focusing on steel production, demand, trade, energy consumption, CO₂ emissions, technology dynamics, and retrofitting options. In the context of the Kyoto Protocol on climate change, the potential impacts of a CO₂ emission market (e.g. the gains in terms of compliance costs, the country trading position, the evolution of the technology and the energy mixes) are also addressed. In particular, three emission trading scenarios are considered: an EU15 market, an enlarged EU market, and an Annex B market.     

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.     

Intra-union flexibility of non-ETS emission reduction obligations in the European Union

The EU proposal on greenhouse gas emission reduction has 28 targets for 2020: an EU-wide one for CO₂ emissions covered by the European Trading System (ETS), and one target for non-ETS emissions per Member State. Implementation is more expensive than needed. I consider three alternative proposals to reduce costs. In the Irish proposal, Member States can purchase ETS permits to offset excess non-ETS emissions. In the Polish proposal, Member States can sell excess non-ETS emissions in the ETS. In the Swedish proposal, Member States can trade their non-ETS allocations. I compare these alternatives to the default policy (no flexibility outside the ETS) and the cost-effective solution (full flexibility). I calibrate a simple model to the results of the EU impact assessment, which did not disclose all details and made odd assumptions. The non-ETS allocation exceeds the projected emissions for three Member States. The alternative flexibility mechanisms would be used to only a limited extent, but would cut the costs of meeting the target. The Swedish and Polish proposals come closest to the cost-effective solution because of the hot air. The Irish proposal performs best if there are negative surprises in either abatement costs or emissions. The Swedish proposal will become policy.