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.     

Evaluation of effectiveness of China's carbon emissions trading scheme in carbon mitigation

In response to climate change issues, China has set clear targets to reduce emissions. The establishment of a carbon emissions trading scheme (ETS) has an important role in China's achievement of these targets. China designed its ETS in 2011 and implemented it in pilot regions in 2013. This study investigated whether the ETS reduces carbon emissions and how it influences carbon leakage. First, the production-based emissions, consumption-based emissions, and carbon leakage of 28 industries in 30 provinces during 2005–2015 were calculated based on provincial environmentally extended input–output tables. Then, the difference-in-differences and difference-in-difference-in-differences models were used to evaluate the effectiveness of ETS. The following conclusions were derived. (1) ETS contributes to emissions mitigation in pilot regions and industries. (2) ETS has greater effect on the mitigation of production-based emissions than consumption-based emissions. (3) ETS encourages outsourcing of emissions from pilot areas to non-pilot areas, resulting in carbon leakage (or “pollution haven” effect), which aggravates the imbalance of emissions transfers among China's provinces. The success of China's ETS in promoting emissions mitigation can serve as an example for other emerging economies.     

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.     

Allowance allocation matters in China's carbon emissions trading system

China's national carbon emissions trading system (ETS) initially started by covering the power generation sector with a rate-based allocation of emission allowances. This single-sector ETS scheme is a tradable performance standard and loosens the participants' emission abatement effort. Given the stringent emission reduction targets implied by China's Nationally Determined Contributions (NDCs) and the expectation that ETS will cover more sectors in the future, we simulate a national ETS of ten carbon-intensive sectors with mass-based, output-based allocation (OBA) of emission allowances. We uncover the impacts and mechanisms of this ETS by comparing the sectoral abatement behaviors across policy scenarios with varying allocation schemes and numbers of benchmarks. We evaluate if the simulated ETS meets important efficiency principles and exhibits desired features. The results show that this ETS achieves China's NDCs with modest macroeconomic losses. The mass-based OBA leads to evenly distributed emission reduction efforts for all ETS participating sectors. It also limits the emission trading volumes and results in slight to modest impacts on sectoral output, especially for the upstream sectors. OBA with fewer benchmarks enhances emission abatement efforts with the caveats of relatively cleaner participants being subsidized by the ETS and slightly higher impacts on the macroeconomy.     

Option value of gasification technology within an emissions trading scheme

Investment analysis is mostly implemented with Discounted Cash Flow (DCF) methods, such as the Net Present Value (NPV). The problem in a typical application of these methods is the limited ability to value real options, management's ability to adapt to changing market conditions or to revise decisions. This paper presents a simulation model, in which the investment is regarded as a single-firm problem in an operating environment with multiple exogenous and stochastic prices. The simulation model is used to explore the impact of emissions trading, and in particular the European Union Emissions Trading Scheme (EU ETS), on investments in Integrated Gasification Combined Cycle (IGCC) plants. Two real case studies are presented: modifications of an existing condensing power plant and a new combined heat and power plant. The benefit of the selected approach is that it can take into account the value of multiple simultaneous real options better than a standard DCF analysis. The results show that a straightforward application of DCF analysis can lead to biased results in competitive energy markets within an emissions trading scheme, where a number of uncertainties potentially combined with several real options can make quantitative investment appraisals very complex.     

Carbon emissions trading scheme exploration in China: A multi-agent-based model

To develop a low-carbon economy, China launched seven pilot programs for carbon emissions trading (CET) in 2011 and plans to establish a nationwide CET mechanism in 2015. This paper formulated a multi-agent-based model to investigate the impacts of different CET designs in order to find the most appropriate one for China. The proposed bottom-up model includes all main economic agents in a general equilibrium framework. The simulation results indicate that (1) CET would effectively reduce carbon emissions, with a certain negative impact on the economy, (2) as for allowance allocation, the grandfathering rule is relatively moderate, while the benchmarking rule is more aggressive, (3) as for the carbon price, when the price level in the secondary CET market is regulated to be around RMB 40 per metric ton, a satisfactory emission mitigation effect can be obtained, (4) the penalty rate is suggested to be carefully designed to balance the economy development and mitigation effect, and (5) subsidy policy for energy technology improvement can effectively reduce carbon emissions without an additional negative impact on the economy. The results also indicate that the proposed novel model is a promising tool for CET policy making and analyses.     

Factors influencing CO2 emissions in China's power industry: Co-integration analysis

More than 40% of China's total CO₂ emissions originate from the power industry. The realization of energy saving and emission reduction within China's power industry is therefore crucial in order to achieve CO₂ emissions reduction in this country. This paper applies the autoregressive-distributed lag (ARDL) co-integration model to study the major factors which have influenced CO₂ emissions within China's power industry from 1980 to 2010. Results have shown that CO₂ emissions from China's power industry have been increasing rapidly. From 1980 to 2010, the average annual growth rate was 8.5%, and the average growth rate since 2002 has amounted to 10.5%. Secondly, the equipment utilization hour (as an indicator of the power demand) has the greatest influence on CO₂ emissions within China's power industry. In addition, the impact of the industrial added value of the power sector on CO₂ emissions is also positive from a short-term perspective. Thirdly, the Granger causality results imply that one of the important motivators behind China's technological progress, within the power industry, originates from the pressures created by a desire for CO₂ emissions reduction. Finally, this paper provides policy recommendations for energy saving and emission reduction for China's power industry.     

Inducing low-carbon investment in the electric power industry through a price floor for emissions trading

Uncertainty about long-term climate policy is a major driving force in the evolution of the carbon market price. Since this price enters the investment decision process of regulated firms, this uncertainty increases the cost of capital for investors and might deter investments into new technologies at the company level. We apply a real options-based approach to assess the impact of climate change policy in the form of a constant or growing price floor on investment decisions of a single firm in a competitive environment. This firm has the opportunity to switch from a high-carbon “dirty” technology to a low-carbon “clean” technology. Using Monte Carlo simulation and dynamic programming techniques for real data, we determine the optimal CO₂ price floor level and growth rate in order to induce investments into the low-carbon technology. We find that a carbon price floor can be used to induce earlier low-carbon technology investment and show this result to be robust to a large variety of input parameter settings.     

An evaluation of possible EU air transport emissions trading scheme allocation methods

The European Commission has been requested by member states to study the incorporation of air transport into their existing emissions trading scheme (ETS). Only CO₂ is to be included, at least initially.     

China's transportation energy consumption and CO2 emissions from a global perspective

Rapidly growing energy demand from China's transportation sector in the last two decades have raised concerns over national energy security, local air pollution, and carbon dioxide (CO₂) emissions, and there is broad consensus that China's transportation sector will continue to grow in the coming decades. This paper explores the future development of China's transportation sector in terms of service demands, final energy consumption, and CO₂ emissions, and their interactions with global climate policy. This study develops a detailed China transportation energy model that is nested in an integrated assessment model—Global Change Assessment Model (GCAM)—to evaluate the long-term energy consumption and CO₂ emissions of China's transportation sector from a global perspective. The analysis suggests that, without major policy intervention, future transportation energy consumption and CO₂ emissions will continue to rapidly increase and the transportation sector will remain heavily reliant on fossil fuels. Although carbon price policies may significantly reduce the sector's energy consumption and CO₂ emissions, the associated changes in service demands and modal split will be modest, particularly in the passenger transport sector. The analysis also suggests that it is more difficult to decarbonize the transportation sector than other sectors of the economy, primarily owing to its heavy reliance on petroleum products.     

Regional differences in the CO2 emissions of China's iron and steel industry: Regional heterogeneity

Identifying the key influencing factors of CO₂ emissions in China's iron and steel industry is vital for mitigating its emissions and formulating effective environmental protection measures. Most of the existing researches utilized time series data to investigate the driving factors of the industry's CO₂ emission at the national level, but regional differences have not been given appropriate attention. This paper adopts provincial panel data from 2000 to 2013 and panel data models to examine the key driving forces of CO₂ emissions at the regional levels in China. The results show that industrialization dominates the industry's CO₂ emissions, but its effect varies across regions. The impact of energy efficiency on CO₂ emissions in the eastern region is greater than in the central and western regions because of a huge difference in R&D investment. The influence of urbanization has significant regional differences due to the heterogeneity in human capital accumulation and real estate development. Energy structure has large potential to mitigate CO₂ emissions on account of increased R&D investment in energy-saving technology and expanded clean energy use. Hence, in order to effectively achieve emission reduction, local governments should consider all these factors as well as regional heterogeneity in formulating appropriate mitigation policies.     

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.     

Temporal changes in China's production and consumption-based CO2 emissions and the factors contributing to changes

As the largest carbon emitter in the world, China is actively promoting carbon emission reduction and low-carbon sustainable development. To better formulate low-carbon transformation measures, we calculated and compared China's production-based carbon emissions (PD-CEs) and consumption-based carbon emissions (CD-CEs) from 2000 to 2014 based on the Multi-Regional Input–Output tables. We also performed a structural decomposition analysis (SDA) to investigate the factors contributing to changes in China's PD-CEs and CD-CEs. The study's findings are as follows: First, China's PD-CEs are continually larger than its CD-CEs, such that China is a net exporter of emissions. However, China's exported emissions and net exported emissions peaked at 2200 and 1786 Mt., respectively, as of 2007. In 2014, China's net exported emissions were 1371 Mt., down 23.25% compared with 2007. Second, China's PD-CEs mainly serve the domestic final demand, and China's CD-CEs are mainly emitted at home. Production and supply of electric power, steam and hot water is the biggest contributor to China's PD-CEs while Construction the largest contributor to China's CD-CEs. Third, the SDA results show that China's PD-CEs and CD-CEs mainly grew due to changes in China's final demand volume. The significant restraint to the growth of China's PD-CEs and CD-CEs is the effect of changes in the domestic emission intensity. Changes in China's ties with other economies have an important impact on China's carbon emissions. Developing economies are replacing developed economies as major destinations for China's emissions export. Fourth, the growth rate of China's PD-CEs and CD-CEs significantly slowed down and the factors contributing to the changes in China's PD-CEs and PD-CEs have changed after China's economy entered the new normal.     

Firm performance and employment in the EU emissions trading scheme: An empirical assessment for Germany

This paper empirically investigates the role of the EU Emissions Trading Scheme (EU ETS) for firm performance and employment in Germany. We provide an overview of relative allowance allocation within the EU ETS as well as an econometric analysis for a large sample of German firms covered by the scheme in order to assess the impacts of EU emissions regulation on both firm revenues and employment. The dataset indicates that the EU ETS was in an overall long position in 2005, although allowance allocation was very heterogeneous across member states. Our econometric analysis suggests that, within the first phase of the EU ETS, relative allowance allocation did not have a significant impact on firm performance and employment of regulated German firms.     

Internalizing carbon costs in electricity markets: Using certificates in a load-based emissions trading scheme

Several western states have considered developing a regulatory approach to reduce greenhouse gas (GHG) emissions from the electric power industry, referred to as a load-based (LB) cap-and-trade scheme. A LB approach differs from the traditional source-based (SB) cap-and-trade approach in that the emission reduction obligation is placed upon Load Serving Entities (LSEs), rather than electric generators. The LB approach can potentially reduce the problem of emissions leakage, relative to a SB system. For any of these proposed LB schemes to be effective, they must be compatible with modern, and increasingly competitive, wholesale electricity markets. LSE's are unlikely to know the emissions associated with their power purchases. Therefore, a key challenge for a LB scheme is how to assign emissions to each LSE. This paper discusses the problems with one model for assigning emissions under a LB scheme and proposes an alternative, using unbundled Generation Emission Attribute Certificates. By providing a mechanism to internalize an emissions price signal at the generator dispatch level, the tradable certificate model addresses both these problems and provides incentives identical to a SB scheme.     

The impact of regional convergence in energy-intensive industries on China's CO2 emissions and emission goals

In order to respond to climate change, China has committed to reduce national carbon intensity by 40–45% in 2020 and 60–65% in 2030, relative to 2005. Given that energy-intensive industries represent ~80% of total CO₂ emissions in China and that China is a large and diverse country, this paper aims to investigate the potential contribution of regional convergence in energy-intensive industries to CO₂ emissions reduction and to meeting China's emissions goals. To the best of our knowledge this matter has never been explored before. Using panel data from 2001 to 2015, we build three scenarios of future carbon intensities: business as usual (BAU), frontier (based on the directional distance function, in which all regions reach the efficiency frontier) and best available technology (BAT, in which all regions adopt the lowest-emitting technology). The frontier and BAT scenarios represent a weak and a strong form of regional convergence, respectively, and the BAU assumes that it develops following historical patterns. We then use the Kaya identity to estimate CO₂ emissions up to 2030 under the three scenarios. Our results are as follows: (1) Under BAU, the CO₂ emissions of energy-intensive industries increase from 7382.8 Mt in 2015 to 8127.6 Mt in 2030. Under the frontier scenario the emissions in 2030 are 44.23% lower than under business as usual, while under the BAT scenario this value becomes 84.81%. Electricity and ferrous metals are the sectors that most contribute to the reduction potential. (2) Even under BAU the carbon intensity of energy-intensive industries as a whole and all of its constituent sub-sectors except for electricity will decrease by more than the nationally-mandated averages. (3) Regional convergence could help the energy-intensive industries peak its CO₂ emissions before 2030, while under BAU the absolute emissions of the energy-intensive industries keep increasing.     

Next allocation phase of the EU emissions trading scheme: How tough will the future be?

The development of National Allocation Plans (NAPs) for the first phase 2005–2007 of the EU emissions trading scheme (EU-ETS) was accompanied by the stated concern of the industrial enterprises with installations that fall under the scope of the relevant Directive 2003/87, since the impacts of the allocation in their financial and technical modes of operation were judged to be severe. Thus, the intensity of the negotiations for the next allocation phase (i.e. 2008–2012), is expected to be heated. With a view to assisting enterprises, especially in the energy sector or for which energy use and its management is a crucial part of their activity, to incorporate in their business plans the impacts of the Directive in an informed manner, an attempt is made here to explore the constraints and the available options that will guide the coming EU-ETS potential allocations. In the analysis, the credits derived from the use of CDM are specifically taken into account. The results show that the next allocations would tend to be significantly more stringent than the current ones because of the combined effect of no inter-period transfer of allowances, the amount of CDM credits expected to be available compared to the amount of effort that would be required and the yield of emission reductions from existing or planned policies and measures. It becomes then crucial, if not imperative, for the enterprises involved as well as national governments to examine carefully means to address their obligations under the Directive.     

Optimal reductions in CO2 emissions.

Current optimizing climate-economy models use CO2 uptake functions that greatly underestimate both peak atmospheric CO2 concentrations and the time horizon of elevated CO2. As a result these models underestimate potential global warming damages. Here, a more realistic, but practical, carbon cycle parameterization is developed that can be incorporated within an optimizing climate-economy model framework. This method is utilized in conjunction with the DICE model (Nordhaus, 1994) to estimate optimal reductions in CO2 emissions. The results are shown to be extremely sensitive to the pore rate of time preference, rho. For rho=3% (Nordhaus' preferred value), our model predicts an optimal CO2 emission reduction of 13% by the year 2045, as compared to 11% in the original DICE model. But, for rho=0% the optimal emissions reduction rises to 79% in the year 2045 and to 97% by the year 2200. We argue that energy policy should be guided by the rho=0% results for both economic and ethical reasons. A steady-state analysis performed using the DICE model supports the argument that large fractional reductions in CO2 emissions should be undertaken.     

Participation in GVCs and CO2 emissions

This paper attempts to explore the determinants of CO₂ emissions in the context of international trade. While there exist studies that examine the roles of horizontal specialization and inter-industry trade transactions, little previous research attention has been paid to the roles of vertical specialization and intra-industry trade transactions in affecting CO₂ emissions. To fill the knowledge gap, this study uses the panel data of 62 countries and regions for the period of 1995–2011 to estimate the effect of participation in global value chains (GVCs) on per capita CO₂ emissions. Major findings include: (1) The relationship between participation degrees in GVCs and per capita CO₂ emissions is found to be inversely U-shaped at the aggregate economy-level and for most individual industries; (2) Per capita GDP shows an N-shaped relationship with per capita CO₂ emissions; and (3) Benign drivers of CO₂ emissions include R&D, energy conservation, and population control. It can be concluded that countries with low GDP or GVC participation degrees are expected to experience worsening CO₂ emissions in the short or even medium run. This trend, however, can be moderated or even reversed with more R&D investments.     

Impacts of China's emissions trading schemes on deployment of power generation with carbon capture and storage

The establishment of an emissions trading scheme (ETS) in China creates the potential for a “least cost” solution for achieving the greenhouse gas (GHG) emissions reductions required for China to meet its Paris Agreement pledges. China has pledged to reduce CO₂ intensity by 60–65% in 2030 relative to 2005 and to stop the increase in absolute CO₂ emissions around 2030. In this series of studies, we enhance the MIT Economic Projection and Policy Analysis (EPPA) model to include the latest assessments of the costs of power generation technologies in China to evaluate the impacts of different potential ETS pathways on deployment of carbon capture and storage (CCS) technology. This paper reports the results from baseline scenarios where power generation prices are assumed to be homogeneous across the country for a given mode of generation. We find that there are different pathways where CCS might play an important role in reducing the emission intensity in China's electricity sector, especially for low carbon intensity targets consistent with the ultimate goals of the Paris Agreement. Uncertainty about the exact technology mix suggests that decision makers should be wary of picking winning technologies, and should instead seek to provide incentives for emission reductions. While it will be challenging to meet the CO₂ intensity target of 550 g/kWh for the electric power sector by 2020, multiple pathways exist for achieving lower targets over a longer timeframe. Our initial analysis shows that carbon prices of 35–40$/tCO₂ make CCS technologies on coal-based generation cost-competitive against other modes of generation and that carbon prices higher than 100$/tCO₂ favor a major expansion of CCS. The next step is to confirm these initial results with more detailed modeling that takes into account granularity across China's energy sector at the provincial level.