The role of carbon pricing

Georg Zachmann

Key messages

The ETS does largely what it is supposed to do Credibility is key Do not start out in a second best-world More analysis is needed to convince MS that they gain from

a “first-best + redistribution” world

Agenda

1. Introduction2. Performance of the ETS 3. Details, Details, Details …4. EU vs. MS 5. Conclusion

Conceptual Framework

First best policy adresses individual externalities with optimal solutions

Mapping investment barriers to different types of climate investment

 Externalities Pub

goodInfor prob

Behavl failure

other barriers

  Env’t (–)

Tech (+)

SoS (–)

       

Low-carbon tech

P S S P S N P

Energy savings

S S S N P P N

REDD P N N P N N NSequest P S S P S N P

P = Barrier of primary importance for the investment at hand.S = Barrier of secondary importance for the investment at hand.N = Barrier of no (little) importance for the investment at hand; or not analyzed in

detail.* = Policy failures are potentially very important and, thus, merit a visual

representationin the table. However, the grading P, S, and N is not useful for policy failures as it isalways important to correct them should they be made.

Source: Calthrop, Kolev, Riess, Zachmann (2012)

Mapping investment barriers to possible solutionsProblems Externalities Pub

goodInfor prob

Behavl failure

other barriers

  Env’t ( – )

Tech ( + )

SoS ( – )

       

Markets              Establishing property rights P P N N N N NCreating new marketable goods

P N P N S S N

Incentives              Taxes P N P N N N NSubsidies S P S S S S S

Rules              Frameworks P P P P P P P*Command & control S N S N P P NNudge N N N N P P NEnhanced appraisal N N N N P N P*

               Insurance N N N N P P P**Non-market supply N N S P P N P***

Source: Calthrop, Kolev, Riess, Zachmann (2012)

2. Performance of the ETS

1. Introduction2. Performance of the ETS 3. Details, Details, Details …4. EU vs. MS 5. Conclusion

ETS emissions by country

Crisis year

Phase I Phase II

Zachmann, Abrell, Faye (2011)

ETS constraint emissions

Dependant variableGrowth rate of emissions (2008-2007) - Growth rate of emissions (2006-2005)

Phase dummy -0.036**

changes in turnover 0.191***

changes in employment 0.0007

Adj R-squared 0.17

Emissions dropped more than production Cap was binding Not compensated by leakage

Zachmann, Abrell, Faye (2011)

ETS tightening affected sectors differentlyPaper and

paper products

416 firms

Non-metallic minerals806 firms

Basicmetals

159 firmsElectricty

heat660 firms

Phase dummy -0.029 -0.087*** -0.095* -0.001

• Cap-and-trade incentivizes reductions with highest marginal abatement cost -> arguably more efficient than command-and-control

Zachmann, Abrell, Faye (2011)

But, ETS prices lower than expected

11

3862838694

3876238828

3889638964

3903039098

3916439232

3930039366

3943439500

3956839636

3970239770

3983639904

3997240038

4010640172

4024040308

4037440442

4050840576

4064440710

4077840844

4091240980

4104641114

411800

5

10

15

20

25

30

35

EEX Carbon Emission Allowance Settlement Price

Source: Datastream

Pric

e

But, Initial Allocation MattersDependant variable

Growth rate of emissions (2008-2007) - Growth rate of emissions (2006-2005)

Total Sample AF05 <1.15 AF05>1.15

Phase dummy -0.036** -0.034*** 0.002

changes in turnover 0.191*** 0.19*** 0.21***

changes in employment 0.0007 -0.03 0.07

Adj R-squared 0.17 0.21 0.23

• The tighter cap in Phase II was effective since emissions decrease

• Under allocated companies in allowances for 2005 reduced their emissions the most

Zachmann, Abrell, Faye (2011)

Profit Margin 2004-2005 2004-2008Impact of EU ETS -0.53 -0.51 *

Under allocated firms (AF<1)Impact of EU ETS -0.22 -1.95 *

Over allocated firms (AF>1)Impact of EU ETS 2.14* 2.32 *

But, Huge Windfall Profits

Overallocated firms have benefited significantly from the EU ETS in terms of profitability

Underallocated Firms did lose Overall effect surprisingly slightly negative

Zachmann, Abrell, Faye (2011)

3. Details, Details, Details …

1. Introduction2. Performance of the ETS 3. Details, Details, Details …4. EU vs. MS 5. Conclusion

Details, Details, Details …

There are a number of details that determine the performance of the EU ETS– Cap– Initial allocation– Coverage– Dealing with leakage– Locking in prices– …

All of them are disputed

Detail 1 – Cap

Present– ~2 bn allowances– -1.74 %

Future– Keep the path and – Change the path now (e.g., 2020, 30%)– Change the path in the future (e.g., 2030, 40%)

Detail 2 – Initial allocation

Grandfathering Benchmarking Auctioning

Detail 3 – Coverage

Widen: Inclusion of more sectors in the ETS Deepen: strengthen the long-term price signal in the ETS Enlarge: link to foreign systems

Detail 4 – Leakage

Indirect leakage cannot be tackled Proposals for direct leakage:

– Free allowances– Border adjustment taxes (imports or imports+exports)– Carbon consumption tax– Allowance based system

Risks:– Trade wars (see aviation)– Industrial policy– Overly complex mechanisms (calculating life-cycle emission ?)

Detail 5 – Fixing prices

Different price targets Floor price, price Collar, price Ceiling €0-€100 Fixed or moving limitMethods Taxes Managing the annual or period cap Option contracts

4. EU vs. MS

1. Introduction2. Performance of the ETS 3. Details, Details, Details …4. EU vs. MS 5. Conclusion

Distributive Effects of European Climate Policy

The three main policies (RES, ETS, EE) affect member states differently

23

ETS: Central Europe has the highest potential for reducing emissions but is also most vulnerable

Source: Zachmann (2011)

24

ETS: 2013 allocation rules to compensate primary effects

Source: Zachmann (2011)

RES: Differing competitiveness (RCA)

Wind Turbines 2008Solar Cells 2008

RES: Differing Support levels

26

RES support levels in a cross-section of EU countries (low,mean,high in €/MWh)

Source: CEER 2011

RES: Differing Support policies

27

Austr

ia

Czech

Republi

c

German

y

Denmark Spa

inFin

land

France

Hungar

yIre

land

Italy

Netherl

ands

Portug

al

Swede

n

United

Kingdom

0

50

100

150

200

250

010002000300040005000600070008000900010000

Solar RD&D for 2009 (in million USD [2010 prices and PPP])Wind RD&D for 2009 (in millon USD [2010 prices and PPP])Renewables RD&D for 2009(in millon USD [2010 prices and PPP])Net Support Expenditures In millions USD (2009)

Source: IEA 2012; EcoFys, Fraunhofer ISI, TU Vienna EEG, and Ernst &Young Report:

“Financing Renewable Energy in the European Energy Market”

Deployment

5. EU vs. MS

1. Introduction2. Performance of the ETS 3. Details, Details, Details …4. EU vs. MS 5. Conclusion

Conclusion

The big horse-trading: Burden sharing Effort sharing Initial allocation …Þ There are a lot of pretty un-distorting redistribution

schemesÞ Do not start out in a second best-worldÞ More analysis is needed to convince MS that they gain from

a “first-best + redistribution” world

Example: De-risking low-carbon investments

Public bank auctions put options to investors

Investor will choose a hedging strategy

Investor get‘s payoff if carbon price is too low

ETS exposure on the balance sheet of public banks increases credibility of the ETS for all mkt participants

30

Strike

Strike

2010 2015 2020 2025 2030

2010 2015 2020 2025 2030

ETS

Pric

eET

S Pr

ice

Examples for an Asian option 2020 to 2030

No payoffAverage ETS price higher than strike

payoffAverage ETS price lower than strike