Abstract
The trading of carbon dioxide (CO2) emission allowances, or permits, has been established in recent years as one of the primary mechanisms for tackling global warming and climate change. The European Union (EU) has taken an important initiative in this direction by establishing in 2003 the first ever mandatory cap-and-trade system for CO2 permits: the EU Emissions Trading Scheme (EU ETS). The purpose of this paper is to initially provide a brief introduction to the EU ETS and subsequently assess its operation during the years 2005–2010 from a financial market perspective. The insights gained through this analysis are particularly important not only for policy makers and market stakeholders but also for the growing community of the so-called ‘carbon’ investors.
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Notes
- 1.
These goals are part of the so-called ‘Climate-energy legislative package’ adopted by the EU Commission on April 2009 (see: 8434/09 (Presse 77), ‘Council adopts climate-energy legislative package’, European Commission, Brussels, 2009).
- 2.
The European countries were free to decide whether or not to allow emission allowance banking between Phase I and Phase II of the EU ETS. With the exception of France and Poland, all other member states decided against this possibility. Even in these two cases however, banking was strictly limited since it could only be implemented after the approval of the EU Commission. Furthermore, there was a maximum limit on the number of EUAs that could actually be banked, equal to the difference between the initially allocated allowances and the effective emissions of the installation. More importantly, any EUAs purchased in the EU ETS markets during the preliminary period of the scheme could not be banked. For Phase II onwards though, inter-phase banking is permitted (see MEMO/06/452).
- 3.
There is a debate on whether carbon markets are part of the energy markets with convincing arguments from both sides. From a regulation perspective however this is considered to be the case.
- 4.
See: COM (2009) 332 final, ‘Ensuring efficient, safe and sound derivatives markets’, European Commission, Brussels, (2009).
- 5.
See: ECFIN/ARES 205086, ‘Report on oil price developments and transparency issues (Note for the attention of the Economic Policy Committee, DG Economic and Financial Affairs)’, European Commission, Brussels, (2010).
- 6.
See: COM (2009) 332 final, ‘Ensuring efficient, safe and sound derivatives markets’, European Commission, Brussels, (2009).
- 7.
This is to be expected however since the prices of the intra-phase futures are directly linked to spot prices through the cost-of-carry relationship with zero storage costs and convenience yield. In other words, intra-period carbon futures prices are simply discounted expected future spot prices (see Daskalakis et al. 2009).
- 8.
Again the free initial allocation of emission allowances in the firm level was against the consensus view in the literature. Specifically, the initial allocation can take the form of either free allocation, based on the historical emission patterns of the relevant sectors (the so-called ‘grandfathering’), or through auctions, or through a combination of both (see Boemare and Quirion 2002; Böhringer and Lange 2005; Vesterdal and Svendsen 2004 among others). Researchers however point out that auctions should be preferred since only then there would be a clear price signal for the permits that could in turn foster price transparency in the market (Grubb and Neuhoff 2006).
- 9.
Although it can be argued that these profits were far from unexpected for electricity producers.
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Daskalakis, G., Ibikunle, G., Diaz-Rainey, I. (2011). The CO2 Trading Market in Europe: A Financial Perspective. In: Dorsman, A., Westerman, W., Karan, M., Arslan, Ö. (eds) Financial Aspects in Energy. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-19709-3_4
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