Transcript EU ETS - CE Delft

Emission Trading In Practice
Lecture Energy Economics EUR
Dr. Sander de Bruyn (CE Delft)
Content
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Principles of emission trading
History of the EU ETS
Design of EU ETS, phase 1 and 2
Impacts of EU ETS, phase 1
Impacts of EU ETS, phase 2
Design of Phase 3
Evaluation: does Phase 3 solves the observed problems in Phase 1 and 2?
Conclusions
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CE Delft
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Independent, not-for profit consultancy,
founded in 1978
Based in Delft, the Netherlands
Transport, Energy, Economy
15+ years of experience with design of
market based instruments for environmental
policies
Main consultant for European Commission on
inclusion of aviation in EU ETS
Important consultant for Dutch government,
EU parliament and European NGOs on EU ETS
Clients include European Commission,
national governments, international
organisations, trade associations, companies,
environmental NGOs
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1. Principles of emission trading
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Coase 1960: property rights define the right to pollute
Crocker & Dales late 1960s: efficiency is obtained if rights are being traded
Baumol & Oates 1970s: ETS as efficient as Pigovian taxes
Tietenberg (1984; 2006)
• Establishing a property right to pollute
• Allow to trade these property rights
• Limit the rights to be issued implies an instrument for emission reduction
• Because of scarcity, rights get a value.
• If transaction costs are low and participants are well informed, ETS
assures allocative efficiency >> reduction of pollution at the lowest costs
possible for society.
Experiments with emission trading systems started in the 1970s in the US
(Tietenberg, 2006) resulting in 1990 in the SO2 emission trading scheme
At present over 20 emission trading systems worldwide. EU ETS is the largest.
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1. Principles: emission trading as ec.instrument
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Economic problem of dividing a common reduction target (e.g. at the
level of a nation) among the different sources of pollution with different
cost structure and possibilities to abate emission reduction
In economics: least-cost solution is achieved if marginal costs of pollution
reduction are equalized among the sources of pollution
Economic instruments (subsidies, taxes and emission trading) can assure
that marginal costs are equalized among sources
Emission trading fixes the total reduction target and assures that by
trading the marginal costs are equalized among sources
Emission taxes fixes the marginal costs for sources >> the target is
however flexible
Subsidies fix the marginal costs for sources >> the target is flexible and
more out of reach due to negative dynamic impacts (indirectly subsidizing
pollution).
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1. Principles of emission trading: efficiency
2-industry
example:
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1. Principle of emission trading: allocation
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Issuing of emission allowances (= emission credits = emission rights)
Give the right to pollute 1 unit in a given time frame (e.g. a year) by an
entity (e.g. an installation or a factory).
Emission allowances need to be distributed by the government
Possibilities:
• Auctioning: everybody must pay for all emission allowances every year
• Grandfathering: at the start of the system the allowances are given at
no charge for every year in the future according to a fixed principle
(e.g. industry emissions in 1990).
• Free allocation: every year allowances are given at no charge
according to flexible mechanisms (e.g. industry emissions in last
year).
Problems with grandfathering/free allocation:
- What is a good benchmark for allocation (allocation rule)?
- What do we have to do with new entrants?
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1. Principles of emission trading: trading
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Outcome is only efficient if the ETS market functions well
Banking/lending can be part of an efficient market
Futures and option trading can be part of an efficient market
Markets are efficient if sufficient information is expressed in market
transations that determine the price
If not enough market transactions are taking place or if information of
market transactions does not reflect underlying scarcity suboptimal
outcomes may emerge.
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2. History of EU ETS: climate policies
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GHG are important voor life on earth
Warming impact of CO2 (radiative forcing) known since end of 19th
century Arrhenius e.a.)
Since 1960s known that CO2 concentration in atmosphere is increasing
Political attention since 1980s.
UN based negotions started at the 1990s.
1992: UN Framework Convention on
Climate Change (UNFCCC): ‘stabilization of
greenhouse gas concentrations in the
atmosphere at a level that would prevent
dangerous anthropogenic interference
with the climate system’
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2. History of the EU ETS: carbon tax?
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1997: Kyoto Protocol to the UNFCCC – developed countries obtain a cap on
their emissions
One cap for EU15: 8% reduction in GHG in 2010 compared to 1990.
In 1990s growing recognition that EU needs climate based policy
instrument
1990-1994: studies on ‘carbon tax’
Resistance of enterprises against new EU-wide tax that would undermine
competitive position
EU tax requires unanimity in the European Council
1994: European Council rejects carbon tax.
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2. History of the EU ETS: Final formation
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At the end of the 1990s: first proposals for carbon emission trading
2000: ‘Green paper’ Emission trading
2001: proposal of the Commission
2003: EU Directive on Emission Trading accepted. Free allocation
embraced as allocation mechanism that would minimize harm for
companies involved in the scheme. Companies agree with this
2005-2007: first period: trial and error
2008-2012: second period: creating a non-zero price
2013 – 2020: third period: greater emphasis on harmonized allocation
rules, auctioning and inclusion of aviation;
(2016): mid-term review
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2. History of EU ETS: role of carbon leakage
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100
Mton CO22
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Carbon leakage is due to unilateral
climate policies and not specifically
ETS
In economic language: Higher CO2 costs
for companies under a “cap” make
capital move to areas where carbon has
no cost
In normal language: loss of
competitiveness
Carbon leakage undermines
effectiveness of CO2 policies and brings
an additional welfare cost for countries
that implement climate policies
Model studies show small impacts.
Biggest impact is fossil fuel price
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Other sectors
Iron and steel
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40
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0
Germany 2020
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Turkey
Target global emissions: 200 Mton
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Mton CO22
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Target global emissions: 180 Mton
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Iron and steel
Other sectors
60
40
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Germany 2020
Turkey
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3. Design of EU ETS, phase 1 and 2
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All big installations (capacity >25MWh) are under EU ETS (electricity,
industry, buildings/hospitals).
• Are subject to yearly monitoring and reporting of CO2 emissions
• Get emission credits for free – credits issued by national governments
• Must hand in emission credits at the end of the year covering their
CO2 emissions
Sheer size of the system is unprecedented
• EU 2000 Mt CO2; NL 100 Mt CO2;
• This implies that if CO2 costs €30/ton: EU € 60 mld; NL € 3 mld
annually.
All emission from small installations are not covered by EU ETS but
responsibility of member states (e.g. transport, small buildings,
agriculture).
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3. Design of EU ETS, phase 1 and 2
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Cap
• EU divides EU-cap into a cap for member states
• member states divide their cap in an ETS and non-ETS part
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Initial allocation
• High degree of freedom of countries to choose allocation mechanism
• Mostly done on basis of free allocation
• Historical emissions used as benchmark
• Free allocation was done to minimize impacts for international
industries and minimizing loss of competitive power of national
industries.
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4. Impacts of design: allocation in Phase 1
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Strong lobby from especially industrial companies for generous allocation
and free allocation
EC aware of problem and revised allocations of especially the new-MS
Nevertheless, overallocation for industry, underallocation for e-sector
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4. Impacts of design: CO2 price in Phase 1
Overallocation became apparent when emission data for 2005 were published
Bron: ECX
ECX CFI Futures Contracts: Price and Volume
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VOLUME (million tonnes CO2)
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4. Impacts of design: market efficiency
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Why emerged a positive price in 2005/2006?
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Limited information
• Banks and analists were not familiair with ETS
• Impacts of JI/CDM resulting in CERs were unknown
• Only at the end of 2005 market analysists reports became available:
market was long but not for all firms
• Banking/lending principle obscured real market information
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Buyers: electricity companies
Sellers: industry
• Most industrial companies banked emission allowances in 2005 for use
in later years.
• Some new-MS with surplusses became only in 2006 on the market
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4. Impacts of design: Windfall profits
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Windfall profits in electricity sector
Freely obtained allowances were passed
through in prices, especially in peak
prices;
Pass through was just as micro-economic
theory would predict
Sijm et al. (2006) shows for electricity
producers
Explanation of EC: electricity is
sheltered sector and has therefore
passed through the costs…
This resulted in adjustments in Phase 3.
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4. Impacts of design: fairness Phase 1
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Free allocation based on historical emissions
Reward of inefficient carbon intensive companies
• Get more emission allowances per unit of product
• Have more and cheaper opportunities to reduce emissions;
Free allocation based on production output (e.g. steel) would be more
fair.
Auctioning would be more efficient and more fair.
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5. Phase 2 (2008-2012): correction of failures?
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European Commission applied stronger criteria for national allocation
plans
• Almost all NAPs were revised downwards.
• EU cap in 2nd phase 13% onder cap from 1st phase
• 6% below 2005 emissions
Less chances on overalloaction and zero prices
Credits can be banked for use in phase 3 as well (no zero prices)
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Auctioning remains low >> still windfall profits:
• 1st phase: 0,13% of total emission allowances auctioned
• 2nd phase: 3% of total emission allowances auctioned
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Benchmark for free allocation still largely historical (updated) emissions
Still largely unfair to cleaner companies
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5. Phase 2
•Prices remain positive and stable
•Since 2008 an indication that the market is long due to recession
•Still a positive price due to banking for use in Phase 3
•Inclusion of installations in Norway, Liechtenstein and Iceland in the scheme
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2-12-2009
2-11-2009
2-10-2009
2-9-2009
2-8-2009
2-7-2009
2-6-2009
2-5-2009
2-4-2009
2-3-2009
2-2-2009
2-1-2009
2-12-2008
2-11-2008
2-10-2008
2-9-2008
2-8-2008
2-7-2008
2-6-2008
2-5-2008
2-4-2008
2-3-2008
2-2-2008
Bron: ECX
2-1-2008
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6. Phase 3 (2013-2020): novel features
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EU harmonized allocation rules (no member states anymore)
Target: -21% divided among MS: cap decreases annually by 1.74%
Aviation included
Full auctioning for electricity sectors
Partial auctioning for industry that has no risk of carbon leakage
Free allocation for industry with risk of carbon leakage and for aviation
Free allocation up to a benchmark to reward clean companies
Additional reserves made for subsidy of CCS demonstration projects
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6. Phase 3 (2013-2020): allocation rules
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Definition of risk of carbon leakage became major discussion point in
prenegotiations in 2008;
Sectors that had risk of carbon leakage would be exempt from auctioning
Final outcome (December 2008): A sector (NACE 4-digit) has no risk of
carbon leakage if any of these 3 conditions are being met:
(1)The trade intensity with non-ETS countries <30%;
(2)EU-ETS costs in addition to value added <30% at price of €30/tCO2;
(3)The sector has not a trade intensity >10% and cost price increase>5%
Numerous exemptions were being created for sectors that would fall
under an auctioning regime
The result is that only small and carbon extensive sectors (that constitute
together 2% of industrial emisions) will be under auctioning in 2020.
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7. Analysis: are problems corrected in Phase 3?
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Overallocation and price formation (not solved)
Benchmarks and stimulus for innovation (solved)
Windfall profits and carbon leakage (not solved)
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7. Reduction achieved through EU ETS before crisis
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7. Problems: impact of crisis
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7. Problems: innovation and benchmarks
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Output based benchmarks are introduced for EU installations
E.g. Cement: proposed benchmark at 10%: 780kgCO2/t clinker
Free allocation only up to 780kgCO2/t clinker produced provides stimulus
for the more polluting firms.
However, no revision of benchmarks is foreseen in EU directive until 2020
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7. Problems: windfall profits
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Industry still obtains allowances largely for free up to the benchmark. But
will they obtain windfall profits from these?
With EU ETS an individual firm faces this abatement cost curve:
P
MAC
ETS p0
E0
E_ETS
Emission reduction
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7. Problems: windfall profits
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This implies that the marginal cost curve shifts outwards >> output will be
reduced from q0 to q1.
MC’
P
MC
p1
p0
MC’
MC
O
e0
q1
q0
Q,E
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7. Problems: windfall profits
•At product markets a reduced output implies a higher price >>
additional (windfall) profits are automatically being made
•The magnitude of this effect depends on the elasticities of demand and
supply and the possibilities of foreign competitors to invade the EU
market. Transportation costs, market niches and regulation act as
natural barriers here (see e.g. discussion on Armington elasticities).
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7. Windfall profits: empirical estimation
Technique: cointegration.
Cointegration more strict framework than correlation, it reduces risk of omitted
variables and prevents spurious results (e.g. pigs and cars: correlation can be found
between pigs and cars, but is rejected in cointegration analysis)
Model used investigates market equilibrium and market integration between EU
(with ETS and carbon policies) and US market (without ETS and carbon policies):
m
Pt , EU  t Pt ,US  (1  EU ,US )(Pt 1, EU  Pt 1,US   )  t Pco2,t  
Price change
EU market
i 1
2. Long term equilibrium relation
+ adjustments
1. Price change
US market
3. Price change
CO2 market
n

j 1
t  j ,i
Zt  j ,i   t
4. Control variables:
Stock index, exch.rates
Model selection using Johanssen Trace and Granger Causality tests – especially on
element (2).
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7. Windfall profits: empirical results
Product
D(CO-)
T-statistics
Lag (weeks)
Preferred
model
%cost-passthrough
Diesel
0,0071
1,838*
2
VEC
350%
Gasoline
0,0080
1,990*
2
VEC
500%
Gasoil
0,0090
3,260**
0
VEC
NA
Hot rolled
coil
2,193
2,300*
1 month
VAR
120%
Cold rolled
coil
2,206
2,292*
1 month
OLS
110%
PE
2,230
1,924*
4
OLS
100%
PS
1,106
1,722*
3
OLS
33%
PVC
1,595
2,067*
8
OLS
100%
 Impact of CO2 prices significant in all cases
 CO2 prices tend to be passed through with a lag on the EU markets
 Cost-pass-through rates above 100% except for PS. However, exact rates
more uncertain.
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Income effect
7. Windfall profits: results for NL
14%
12%
Niet-doorberekend
Doorberekend
10%
8%
Mln/yr
Refineries
320
Iron and Steel
200
Petrochemicals
140
Aluminium
-80
Inorganic
chemicals
-25
Paper
-17
6%
4%
Other industry
Other non-ferro metals
Aluminium
Iron and steel
Ceramics nec
Cement, calcium and gypsum
Building materials
Glass
Chemical products
Anorganic Chemicals
Other Base Chemicals
Fertilizer
Petrochemical
Refineries
Graphics
Paper
Wood
Textiles
0%
Nutrition
2%
In total about 60% of the marginal opportunity costs will be passed through. Because
the marginal costs are higher than the average costs windfall profits occur.
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7: Windfall profits: NL in 2020 at €30/tCO2
Government
50
EU ETS companies
1000
Electricity companies
300
1050
EU ETS market
Consumers
850
Income
Expenditures
Net
benefit
Government
1.0
0.0
1.0
Industry
1.1
0.5
0.5
Consumers, Services
0.0
1.9
-1.9
Total
2.1
2.5
-0.4
In billion Euros
Technics
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7. Windfall profits & carbon leakage
 Higher prices on EU markets due to ETS and windfall profits imply that
foreign competitors have most likely increased their market shares on EU
markets
 The benefit of free allocation (no carbon leakage) is not supported by the
empirical data
 Other mechanisms to address carbon leakage should be investigated
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8. Conclusions
 EU ETS can achieve emission reductions at lowest possible costs
 EU ETS is the largest ETS in the world (€60 billion annually)
 EU ETS is a political market: politics define the target and allocate
emissions
 Strong pressure on politicians to accomodate vested interests
 This resulted in various adaptations that resulted in a a less effective and
efficient economic instrument than in textbook economics is suggested.
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8. Conclusions
 Specific problems relate to effectiveness (prices and target), stimulus for
innovaton and windfall profits.
 EU ETS in Phase 1 (2005-2007) did not result in emission reductions
 EU ETS in Phase 2 and 3 combined (2008-2020) will only have limited
additional impact for emission reductions in the EU
• only 25% of the proposed 620Mt reduction in 2020
• about 10% of cumulative emission reductions (2008-2020)
 CO2 prices will stay low unless EU steps up to -30% and/or limit role of
CDM
 Stimulus for innovation is from 2013-2020 included for polluting firms with
the introduction of benchmarks
 Windfall profits remain a problem and consumers are overcompensating
companies for their costs. Carbon leakage is another negative side-effect.
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Merci!
Sander de Bruyn
[email protected]
http://www.ce.nl/ce/eu_ets/625/
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Literature
Ellerman, A. Denny, and Paul L. Joskow, 2008, The European Union’s
Emissions Trading System in perspective, PEW Center on Global Climate
Change. http://www.pewclimate.org/docUploads/EU-ETS-In-PerspectiveReport.pdf
Tietenberg, T.H., ”Emissions Trading. Principles and Practice.”, Resources
for the Future, Washington D.C., 2006
de Bruyn, S.M., A. Markowska, D. Nelissen, 2010. “Will the energy-intensive
industry profit from EU ETS under Phase 3?: Impacts of EU ETS on profits,
comptetitiveness and innovation”. CE Delft.
De Bruyn, S.M., A. Markowska, F. de Jong, M. Bles. “Does the energy
intensive industry obtain windfall profits through the EU ETS? An
econometric analysis for products from the refineries, iron and steel and
chemical sectors”. CE Delft.
Sijm, J., K. Neuhoff and Y. Chen, 2006, ‘CO2 cost pass through andwindfall
profits in the power sector’, Climate Policy, Vol. 6, pp.49-72.
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