Emission Trading In Practice Lecture Energy Economics EUR Dr. Sander de Bruyn (CE Delft)
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Transcript of Emission Trading In Practice Lecture Energy Economics EUR Dr. Sander de Bruyn (CE Delft)
Emission Trading In PracticeLecture Energy Economics EUR
Dr. Sander de Bruyn (CE Delft)
2Sander de Bruyn, 2 december 2010
Content
1. Principles of emission trading2. History of the EU ETS3. Design of EU ETS, phase 1 and 24. Impacts of EU ETS, phase 15. Impacts of EU ETS, phase 26. Design of Phase 37. Evaluation: does Phase 3 solves the observed problems in Phase 1
and 2? 8. Conclusions
3Sander de Bruyn, 2 december 2010
CE Delft
• 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
4Sander de Bruyn, 2 december 2010
1. Principles of emission trading
• 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.
5Sander de Bruyn, 2 december 2010
1. Principles: emission trading as ec.instrument• 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).
6Sander de Bruyn, 2 december 2010
1. Principles of emission trading: efficiency2-industry example:
7Sander de Bruyn, 2 december 2010
1. Principle of emission trading: allocation
• 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?
8Sander de Bruyn, 2 december 2010
1. Principles of emission trading: trading
• 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.
9Sander de Bruyn, 2 december 2010
2. History of EU ETS: climate policies
• 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’
10Sander de Bruyn, 2 december 2010
2. History of the EU ETS: carbon tax?
• 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.
11Sander de Bruyn, 2 december 2010
2. History of the EU ETS: Final formation
• 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
12Sander de Bruyn, 2 december 2010
2. History of EU ETS: role of carbon leakage
• 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
0
20
40
60
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Germany 2020 Turkey
Mto
n C
O22
Other sectors
Iron and steel
Target global emissions: 180 Mton
0
20
40
60
80
100
120
140
Germany 2020 Turkey
Mto
n C
O22
Iron and steel
Other sectors
Target global emissions: 200 Mton
13Sander de Bruyn, 2 december 2010
3. Design of EU ETS, phase 1 and 2
• 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).
14Sander de Bruyn, 2 december 2010
3. Design of EU ETS, phase 1 and 2
• Cap • EU divides EU-cap into a cap for member states• member states divide their cap in an ETS and non-ETS part
• 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.
15Sander de Bruyn, 2 december 2010
4. Impacts of design: allocation in Phase 1
• 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
16Sander de Bruyn, 2 december 2010
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
0
2
4
6
8
10
12
VOLU
ME
(mill
ion
tonn
es C
O2)
€0
€5
€10
€15
€20
€25
€30
€35
Pric
e pe
r ton
ne (E
UR)
Total Volum eDec07 SettDec08 Sett
17Sander de Bruyn, 2 december 2010
4. Impacts of design: market efficiency
• Why emerged a positive price in 2005/2006?
• 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
• 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
18Sander de Bruyn, 2 december 2010
4. Impacts of design: Windfall profits
• 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.
19Sander de Bruyn, 2 december 2010
4. Impacts of design: fairness Phase 1
• 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.
20Sander de Bruyn, 2 december 2010
5. Phase 2 (2008-2012): correction of failures?• 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)
• Auctioning remains low >> still windfall profits:• 1st phase: 0,13% of total emission allowances auctioned• 2nd phase: 3% of total emission allowances auctioned
• Benchmark for free allocation still largely historical (updated) emissions
• Still largely unfair to cleaner companies
21Sander de Bruyn, 2 december 2010
0,00
5,00
10,00
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30,00
35,00
2-1-
2008
2-2-
2008
2-3-
2008
2-4-
2008
2-5-
2008
2-6-
2008
2-7-
2008
2-8-
2008
2-9-
2008
2-10
-200
8
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-200
82-
12-2
008
2-1-
2009
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2009
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2009
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2009
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2009
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2009
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2009
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2009
2-10
-200
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2-11
-200
92-
12-2
009
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
Bron: ECX
22Sander de Bruyn, 2 december 2010
6. Phase 3 (2013-2020): novel features
• 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
23Sander de Bruyn, 2 december 2010
6. Phase 3 (2013-2020): allocation rules
• 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.
24Sander de Bruyn, 2 december 2010
7. Analysis: are problems corrected in Phase 3? • Overallocation and price formation (not solved)• Benchmarks and stimulus for innovation (solved)• Windfall profits and carbon leakage (not solved)
25Sander de Bruyn, 2 december 2010
7. Reduction achieved through EU ETS before crisis
26Sander de Bruyn, 2 december 2010
7. Problems: impact of crisis
27Sander de Bruyn, 2 december 2010
7. Problems: innovation and benchmarks
• 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
28Sander de Bruyn, 2 december 2010
7. Problems: windfall profits
• 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:
MAC
E0 Emission reduction
P
ETS p0
E_ETS
29Sander de Bruyn, 2 december 2010
7. Problems: windfall profits
• This implies that the marginal cost curve shifts outwards >> output will be reduced from q0 to q1.
MC
q0q1 Q,E
P
p0
MC’
p1
e0
MC’
MC
O
30Sander de Bruyn, 2 december 2010
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).
31Sander de Bruyn, 2 december 2010
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):
t
n
jijtijt
m
itcotUStEUtUSEUUSttEUt ZPPPPP
1,,
1,2,1,1,,, ))(1(
Price changeEU market
1. Price changeUS market
2. Long term equilibrium relation + adjustments
3. Price changeCO2 market
4. Control variables:Stock index, exch.rates
Model selection using Johanssen Trace and Granger Causality tests – especially on element (2).
32Sander de Bruyn, 2 december 2010
7. Windfall profits: empirical results
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.
Product D(CO-) T-statistics Lag (weeks) Preferred
model
%cost-pass-
through
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%
33Sander de Bruyn, 2 december 2010
7. Windfall profits: results for NL
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.
0%
2%
4%
6%
8%
10%
12%
14%
Nu
triti
on
Te
xtil
es
Wo
od
Pa
pe
r
Gra
ph
ics
Re
fine
rie
s
Pe
tro
ch
em
ica
l
Fe
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ze
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er
Ba
se
Ch
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ica
ls
An
org
an
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als
Ch
em
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du
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Gla
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ate
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Ce
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nt,
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um
Ce
ram
ics
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c
Iro
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nd
ste
el
Alu
min
ium
Oth
er
no
n-f
err
o m
eta
ls
Oth
er
ind
us
try
Niet-doorberekend
Doorberekend
Income effect Mln/yr
Refineries 320
Iron and Steel 200
Petrochemicals 140
Aluminium -80
Inorganic chemicals
-25
Paper -17
34Sander de Bruyn, 2 december 2010
7: Windfall profits: NL in 2020 at €30/tCO2
Income Expenditures
Net benef
it
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
Government EU ETS companies Technics
Electricity companies
1000
Consumers85040
0
1050
50
In billion Euros
EU ETS market
300
250
35Sander de Bruyn, 2 december 2010
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
36Sander de Bruyn, 2 december 2010
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.
37Sander de Bruyn, 2 december 2010
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.
38Sander de Bruyn, 2 december 2010
Merci!
Sander de [email protected]
http://www.ce.nl/ce/eu_ets/625/
39Sander de Bruyn, 2 december 2010
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-Perspective-Report.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.