Causes of the EU ETS price drop: Recession, CDM, renewable policies or a bit of everything? - New evidence

TLDR: In this article, the authors examined whether and to what extent the EUA price drop can be justified by three commonly identified explanatory factors: the economic recession, renewable policies and the use of international credits.

About: This article is published in Energy Policy.The article was published on 2014-10-01 and is currently open access. It has received 324 citations till now. The article focuses on the topics: Carbon price & Emissions trading.

Figures

Table 1: Summary statistics Panel A reports test statistics of the Augmented–Dickey–Fuller (ADF) test for monthly data for EU Allowance futures (EUA), NBP natural gas futures (Gas), API2 coal futures (Coal), STOXX EUROPE 600 index (Stock), Economic Sentiment Indicator (ESI), electricity production from wind/solar and hydro and the amount of issued Certified Emissions Reductions (CERs). Panel B presents descriptive statistics of the stationary time series used in the analysis. Panel C reports the corresponding cross-correlations of the variables. Panel D presents statistics for ARCH LM tests based on Engle (1982). The sample period is from January 2008 to October 2013. *, **, and *** denote significance at 10%, 5% and 1% levels, respectively.

Fig. 2. Decomposition of the adjusted R 2 based on the estimation of Eq. (1) in row (1) of Table 2 into contributions of the different marginal abatement cost (MAC) drivers based on Shapley values.

Fig. 1. Evolution of EU Allowance (EUA) prices (on the left y-axis) jointly with (a) fuel (switching) prices, (b) indicators of economic activity, (c) the deployment of electricity from renewable energy sources and (d) the amount of issued Certified Emissions Reductions (CERs) (on the right y-axis, respectively).

Frequently asked questions

Q1. What have the authors contributed in "Causes of the eu ets price drop: recession, cdm, renewable policies or a bit of everything? – new evidence" ?

In this paper the authors examine whether and to what extent the EUA price drop can be justified by three commonly identified explanatory factors: the economic recession, renewable policies and the use of international credits. Capitalizing on marginal abatement cost theory and a broadly extended data set, the authors find that only variations in economic activity and the growth of wind and solar electricity production are robustly explaining EUA price dynamics. In view of the new evidence, the authors evaluate the EU ETS reform options which are currently discussed. 

Q2. What have the authors stated for future works in "Causes of the eu ets price drop: recession, cdm, renewable policies or a bit of everything? – new evidence" ?

Given that 90 % of the EUA price variation remains unexplained by abatement-related fundamentals, it is necessary in further research to identify the true allowance price drivers. The authors believe that a key issue for future research is to verify whether structural weaknesses – and a lack of credibility in particular – are at the root of the inefficient carbon pricing mechanism. Although a conclusive answer to this question exceeds the scope of this paper, their robustness analysis suggests that policy events and a lack of credibility may be alternative explanations for the weak price signal. Indeed, a preliminary analysis of policy announcement effects suggests that several announced reform policies apparently do not change the current perception of market agents that the EUA price will remain low for long periods. 

Q3. What is the motivation behind the inclusion of the gas and coal price?

In addition, the inclusion is motivated by the fact that it allows controlling for market disturbances such as the 2008/09 financial crisis. 

Q4. How much of the emission from the Kyoto Protocol was surrendered?

During the period 2008-2012, companies had already surrendered for compliance more than 60% of the total permissible 2008-2020 quota (Point Carbon, 2014). 

Q5. What is the data used to obtain a representative EUA price series?

The authors rely on settlement prices of the year-ahead EUA December futures contract traded on the ICE ECX platform to obtain a representative EUA price series. 

Q6. What is the main reason for the low EUA price?

Overlapping policies and more specifically the deployment of renewable energy sources (RES), have been cited as an additional possible explanation of the low EUA price. 

Q7. How much is needed to provide a price advantage to wind energy?

For instance, Gavard (2012) shows that a carbon price of 46€ is necessary to provide a price advantage to wind energy over electricity production from gas. 

Q8. What is the main reason why the EU ETS has experienced a sharp decline in permit prices?

The EU Emissions Trading Scheme (EU ETS), considered the flagship climate policy of the European Union, has experienced a sharp decline in permit prices between 2008 and 2013. 

Q9. What are the main factors that determine the price of EUAs?

In addition, exogenous factors such as economic activity or weather conditions are identified as relevant price fundamentals, since they determine business-as-usual emissions, i.e. the need for abatement (Hintermann, 2010). 

Q10. How does Van den Bergh and Alberola (2013) find that RES deployment reduces?

For instance, simulations in Van den Bergh et al. (2013) suggest that RES deployment reduces the EUA price by 46€ in 2008 and more than 100€ in 2010. 

Q11. What is the theory of the price of a permit?

Theory predicts that the permit price should reflect market fundamentals related to the marginal costs of emissions abatement; see e.g. 

Q12. How much of the EUA price discovery is done by the ICE ECX?

market microstructure analyses of Mizrachand Otsubo (2014) indicate that the ICE ECX is providing between 75% and 88% of price discovery for EUA trading. 

Q13. How much of the shortfall of EUAs is offset by carbon credits?

For instance, Berghmans and Alberola (2013) estimate that the power sector offsets around 65% of its shortfall of EUAs using Kyoto credits. 

Q14. Why do the authors not include highly endogenous variables in the analysis?

the authors do not include highly endogenous variables such as electricity prices or clean spark and dark spread (as in Alberola et al. 2008a; Bredin and Muckley, 2010), since endogeneity may lead to biased estimates of the price drivers in the analysis. 

Q15. How is the stationarity of the data examined?

The stationarity properties of the data are examined through the Augmented-Dickey-Fuller test that tests the null hypothesis that an observable time series contains a unit root (i.e. isnon-stationary). 

Q16. What are the main reasons for the low use of carbon credits in Phase III?

More specifically, in Phase III credits originating from hydrofluorocarbon (HFC) and adipic acid nitrous oxide (N2O) projects are no longer permitted. 

Q17. What could be attributed to the collapse in credit prices?

This might be attributed to the collapse in credit prices (due to the non-ratification of the Kyoto protocol by major emitters) as well as the European Commission’s change in the regulations regarding the imports of credits from certain projects. 

Q18. What is the effect of the simulation of De Jonghe et al. (2009)?

In the simulation of De Jonghe et al. (2009) the allowance price could even drop to zero depending on the stringency of targets (see also Unger and Ahlgren, 2005; Weigt et al., 2013). 

Q19. What is the main reason why the results are biased?

this result could be biased due to the limitations of the publicly available CER data which requires us to assume that the number of issued CERs also reflects the number of surrendered CERs in the EU ETS.