The Impact of the EU ETS on Prices,Profits and Emissions in the Power Sector: Simulation Results with the COMPETES EU20 Model

This paper analyses the impact of the EU Emissions Trading Scheme (ETS) on electricity prices, in particular on wholesale power markets across the EU. To study this impact, this paper discusses the major results of a bottom-up modelling analysis of the implications of emissions trading for the performance of the wholesale power market in 20 European countries. The analyses show that a significant part of the costs of (freely allocated) CO₂ emission allowances is passed through to power prices, resulting in higher electricity prices for consumers and additional (‘windfall’) profits for power producers, even in cases of full auctioning. In addition, they show that the ETS-induced increases in power prices depend not only on the level of CO₂ prices but also on the structure of the power market, i.e., the incidence of market power, and the price responsiveness of power demand. Finally, the analyses show that the internalization and pass-through of carbon costs are crucial elements in a policy regime to reduce CO₂ emissions by both changing the mix of power generation technologies and lowering total electricity demand.     

Futures price dynamics of CO2 emission allowances

We analyze the pricing and lead–lag relationship between spot and futures prices of CO₂ emission allowances in the EU emission trading scheme. We show that the cost-of-carry hypothesis between spot and futures prices holds for the trial period. In this period we focus on how fast a deviation from equilibrium due to shocks is restored. We derive testable restrictions on the loading coefficients and the short term dynamics within a vector error correction model. Previous studies in this field did not take into account the effects of lagged differences in the determination of the speed of adjustment. The results indicate that deviations from equilibrium are restored faster for the futures price series maturing in 2006 than for the futures price series maturing in 2007. Furthermore, we conduct an impulse response analysis using local projections with conditional confidence bands. Finally, we give an outlook for the Kyoto commitment period which is already running. In this time period so far we find that the cost-of-carry hypothesis does not hold.     

The effectiveness of anti-leakage policies in the European Union: results for Austria

With the third trading period of the EU emissions trading scheme (EU ETS) starting in 2013, the system of allocating emission allowances will significantly change: In contrast to the previous two trading periods, auctioning of the allowances should now be the rule rather than the exception. Accompanying this policy change, concerns over competitiveness of energy intensive, trade exposed sectors as well as over limited environmental effectiveness via the channel of carbon leakage, have regained prominence. In this paper, we thus explore the impacts of potential EU policies to counter losses in international competitiveness and carbon leakage from the perspective of Austria. Based on numerical simulations with a computable general equilibrium model, we evaluate three policy options: an input subsidy for carbon allowances (thus reflecting the planned partially free allocation mechanism in the third EU ETS phase), a subsidy for domestic production, and an export rebate based on sectoral CO₂ costs. Our results show that each policy has the potential to support domestic production in exposed sectors relative to a full auctioning scenario and thus increase competitiveness. However, none is imperatively effective at reducing Austria’s net carbon emissions: while the carbon trade balance is improved and hence leakage declines, the tradability of emission permits within the EU ETS allows CO₂ emissions from Austria’s ETS output to increase. A cost benefit analysis indicates that the two policies promoting domestic output and exports are more cost effective than the CO₂ input subsidy.     

Testing the martingale difference hypothesis in CO2 emission allowances

This study examines the martingale difference hypothesis (MDH) for the carbon emission allowance market within the European Union Emission Trading Scheme (EU ETS) during the Phase I and the Phase II, using both daily and weekly data over the 2005–2009 period. We analyze the MDH for spot prices negotiated on BlueNext, European Energy Exchange and Nord Pool along with futures prices negotiated on BlueNext and European Climate Exchange, using the new variance ratio tests developed by Kim (2009) and the generalized spectral test proposed by Escanciano and Velasco (2006). For the Phase I, the results show that the spot price changes of these three markets are predictable, suggesting the possibility of abnormal returns through speculation, except during the period April 2006 to October 2006, namely after the compliance break and before the ECs of stricter NAP II. Finally, we find that the CO₂ spot and futures price changes are unpredictable during the Phase II because we failed to reject the MDH based on both daily and weekly data. Thus, these markets are found to be weak-form efficient.     

On the risk premium in Nordic electricity futures prices

This paper examines empirically the relationship between electricity spot and futures prices, by analysing a decade of data for a set of short term-to-maturity futures contracts traded in the Nordic Power Exchange. It is found that, on average, there are significant positive risk premiums in short-term electricity futures prices. The significance and size of the premiums, however, varies seasonally over the year; whereas it is greatest during winter, it is zero in summer. It is also found that time-varying risk premiums are significantly related to unexpectedly low reservoir levels. Furthermore, before the unprecedented supply-shock that hit the market around the end of year 2002, the risk premiums were related to the variance and the skewness of future spot prices.     

Nonlinearities in carbon spot-futures price relationships during Phase II of the EU ETS

This paper uses the Vector Autoregressive (VAR) model and the Switching Transition Regression-Exponential GARCH models (STR-EGARCH) to examine the dynamic relationships between the EU Emission Allowances (EUA) spot and futures prices during Phase II. Compared to the majority of previous studies, our empirical approach allows us to simultaneously capture asymmetry and nonlinearity effects in both return and volatility processes of carbon allowance prices. Our main findings show that carbon spot and futures returns are asymmetrically and nonlinearly linked, suggesting the usefulness of nonlinear models in pricing and forecasting carbon allowances prices.     

中国黄金期货与黄金现货价格的实证分析

意旨探索中国黄金现货价格对黄金期货价格形成的作用机制。借助ADL模型和共同因子贡献法进行实证分析,研究了中国黄金期货价格与黄金现货价格的关系。研究表明,中国黄金期货价格与现货价格长期趋势是一致的,但是短期存在比较大的偏差,同时中国黄金期货和现货价格波动率序列之间有较高的依存度。由此中国黄金期货市场已具备一定规避风险的功能。     

The volatility of prices in the English and Welsh electricity pool

The volatility of spot prices has been a notable feature of the English and Welsh Electricity Pool since its formation in 1990. This study investigates the possibility that the volatility of spot prices is strongly affected by the functioning of the contract market for electricity. This paper suggest that generators with market power may have an incentive to create volatility in the spot market in order to benefit from higher risk premia in the contract market. A simple theoretical model is used to illustrate this argument. Nonparametric techniques are used to test for changes in volatility after the expiry of the coal contracts in 1993 and during the price cap of 1994–1996. Strongly significant increases in volatility are found in the latter period.     

Over-Allocation or Abatement? A Preliminary Analysis of the EU ETS Based on the 2005–06 Emissions Data

This paper provides an initial analysis of the EU ETS based on the installation-level data for verified emissions and allowance allocations in the first 2 years of the first trading period. These data reveal that CO₂ emissions were about 3% lower than the allocated allowances. The main objective of the paper is to shed light on the extent to which over-allocation and abatement have taken place in 2005 and 2006, when a significant CO₂ price was observed. We propose a measure by which over-allocation can be judged and provide estimates of abatement based on emissions data and indicators of economic activity as well as trends in energy and carbon intensity. Finally, we discuss the insights and implications that emerge from this tentative assessment. The ideas expressed in this paper are those of the authors and do not necessarily represent views of the International Energy Agency or its Member Countries.     

Forecast Errors and Efficiency in the US Electricity Futures Market

In March 1996 the US introduced electricity futures contracts which provided for delivery at the California/Oregon border (COB) and Palo Verde switchyard. These were followed in July 1998 by contracts which provided for delivery of electrical energy into the Cinergy and Entergy systems, and in March 1999 by a contract for the Pennsylvania/New Jersey/Maryland (PJM) area. This paper employs the forecast error approach to study the informational efficiency of these markets (the model prediction and event studies approaches are not feasible). COB and Palo Verde spot and futures prices are stationary, while Cinergy spot and futures prices are I(1) and cointegrated (Entergy and PJM data were not utilised due to insufficient observations). All forecast errors, therefore, are stationary. Estimation is by instrumental variables in the presence of a lagged dependent variable and overlapping observations. For the period 1996 (04) to 1999 (12), with COB and Palo Verde data, the efficient markets hypothesis (EMH) is rejected. This outcome is confirmed by cointegration of the COB and Palo Verde futures prices. A significant M-GARCH term in the forecast error relationship for both contracts supports the view that a time-varying risk premium was present. A significant negative relationship between forecast errors and volume for the COB contract suggests that agents were still learning the true model driving this market, and that Stein's 'Bayesian error' was non-zero.
For the period 1998 (07) to 1999 (12), with COB, Palo Verde and Cinergy data, the EMH cannot be rejected. Finally, an attempt is made to relate this study to the recent electricity crisis in California.     

Implications of CO<Subscript>2</Subscript> emissions trading for short-run electricity market outcomes in northwest Europe

We examine the short-run implications of CO₂ trading for power production, prices, emissions, and generator profits in northwest Europe in 2005. Simulation results from a transmission-constrained oligopoly model are compared with theoretical analyses to quantify price increases and windfall profits earned by generators. The analyses indicate that the rates at which CO₂ costs are passed through to wholesale prices are affected by market competitiveness, merit order changes, and elasticities of demand and supply. Emissions trading results in large windfall profits, much but not all of which is due to free allocation of allowances. Profits also increase for some generators because their generation mix has low emissions, and so they benefit from electricity price increases. Most emission reductions appear to be due to demand response not generation redispatch.      

U.S. industry-level returns and oil prices

This paper empirically investigates and provides further support for the oil price effect documented in Driesprong et al. (2008) in the U.S. industry-level returns. We find that oil price predictability is concentrated in a relatively small number of industry-level returns, the relevant measure for a study of the oil effect is percentage change in oil spot prices, and changes in oil futures prices have virtually no prediction power for industry-level returns. With percentage changes in oil spot prices as the predictor, approximately one fifth of industry returns are oil-predictable. We detect a two trading weeks delay in reaction to oil price changes which is consistent with the Hong and Stein (1996) underreaction hypothesis. These results are robust to various alternative specifications, and are shown to be unrelated to time-varying risk premia. Moreover, we demonstrate that trading strategies based on the oil effect generate superior gains in comparison with buy-and-hold strategy in the presence of reasonable trading costs.     

Do environmental benefits matter? Evidence from a choice experiment among house owners in Germany

Residential buildings strongly contribute to global CO₂ emissions due to the high energy demand for electricity and heating, particularly in industrialised countries. Within the EU, decentralised heat generation is of particular relevance for future climate policy, as its emissions are not covered by the EU ETS. We conducted a choice experiment concerning energy retrofits for existing houses in Germany. In the experiment, the approximately 400 sampled house owners could either choose a modern heating system or an improved thermal insulation for their home. We used standard and mixed logit specifications to analyse the choice data. We found environmental benefits to have a significant impact on choices of heating systems. However, they played no role in terms of insulation choices. Based on the estimated mixed logit model, we further obtained willingness-to-pay (WTP) measures for CO₂ savings.     

On the comparison of Schwartz and Smith’s two- and three-factor models on commodity prices

Since Schwartz and Smith (2000) published their study on two-factor model on commodity prices, many studies have used this model and others have extended it. The authors also proposed the three-factor model due to the poor fitting of the two-factor one on long-term futures prices. At that time the authors had only long-term prices from a private source to calibrate, test and compare these models. No public data on long-term future contracts were available. On the other hand, during the last decade the commodity prices soared as did the liquidity of long-term contracts. This means that the interest of the agents in the management of their risk on long-term positions increased the same way and this is the motivation for this study. In this article, we revisit the comparison between two- and three-factor models using public data for short- and long-term contracts (we use up to the 67-month-ahead contract). We also provide a detailed derivation of the three-factor model differently from that of the original article. Following the original article of Schwartz and Smith, we used oil futures prices traded on the New York Mercantile Exchange to calibrate the model. The results show a better fit of the three-factor model for the term structure of prices and volatilities mainly for long maturities contracts, while the two-factor model in most portions of the curve underestimates the risk premiums. This type of analysis is important not only for daily agents negotiating the physical commodities through long-term contracts but also for investment decisions on development of real projects.     

Impacts of EU carbon emission trade directive on energy-intensive industries — Indicative micro-economic analyses

The cost impacts from the European emission trading system (ETS) on energy-intensive manufacturing industries have been investigated. The effects consist of direct costs associated to the CO₂ reduction requirements stated in the EU Directive, and of indirect costs of comparable magnitude that originate from a higher electricity price triggered by the ETS in the power sector. The total cost impacts remain below 2% of the production value for most industries within the ETS in the Kyoto period. In the post-Kyoto phase assuming a 30% CO₂ reduction, the total cost impact may raise up to 8% of production value in the heaviest industry sectors. In steel and cement industries the cost impacts are 3-4 fold compared to the least affected pulp and paper and oil refining. Electricity-intensive industries outside the ETS will also be affected, for example in aluminum and chlorine production the indirect cost impacts from ETS could come up to 10% of production value already in the Kyoto period. As industry sectors are affected differently by the ETS some correcting mechanisms may be worthwhile to consider in securing the operation of the most electricity-intensive sectors, e.g. balancing taxation schemes that may include as income source a levy on the wind-fall profits of the power sector due to ETS. A future improvement in ETS for industries within the scheme could be scaling of the emission reduction requirement so that the relative total emission reduction costs are at about the same level.     

The futures price of a commodity in fixed supply

This letter shows that in a general equilibrium model of homogeneous population with production risk, the futures price of a commodity which is in fixed supply is always below the expected futures spot price (e.g., normal backwardation). It also shows that the difference between the futures price and the expected spot price increases as the representative individual's risk aversion rises. An important application of this model is to the housing market since houses are in fixed supply in the short run and buying a house is like holding a long position in a forward contract. Therefore, if population is homogeneous, houses are not a good consumption hedge and the prices of houses are below their expected rental prices.     

OTC trades and liquidity in the European carbon market more than meets the eye

ABSTRACT

This study investigates whether the previously reported price impact of OTC trades in the EU ETS can be attributed to their distinctively larger size (liquidity related) or to their discretionary feature (information related). The findings suggest that OTC trades induce volatility shocks that are higher in magnitude and faster resolved than those of solely high trading-intensity trades, which appears to be driven mainly by their presence, rather than by their size. An analysis of intraday price premia reveals that they are strategically placed by interacting with the organized market whenever their price and volatility impact is lower.     

Macroeconomics,finance, commodities: Interactions with carbon markets in a data-rich model

This article assesses the transmission of international shocks to EUA spot, EUA futures, and CER futures carbon prices using a broad dataset that includes 115 macroeconomic, financial and commodities indicators with daily frequency from April 4, 2008 to January 25, 2010 totalling 463 observations. The framework adopted is a Factor-Augmented Vector Autoregression model with latent factors extracted from the dataset, as proposed by Bernanke et al. (2005). The main results can be summarized as follows. First, based on impulse responses, we show that carbon prices tend to respond negatively (between ? 0.2 and ? 1.2 standard deviation) to an exogenous shock that reduces global economic indicators by one standard deviation. Second, we find evidence that the responses are heterogeneous among the different kinds of carbon prices: CER futures prices tend to react much more significantly than EUA spot and futures prices. Third, the factors explain about 50% of the total variance of all variables in the dataset. The largest contribution is accounted for by the factor correlated with commodities markets, which explains about 28% of the total variability.     

Time-varying correlations in oil,gas and CO2 prices: an application using BEKK,CCC and DCC-MGARCH models

Previous literature has identified oil and gas prices as being the main drivers of CO₂ prices in a univariate Generalized Autoregressive Conditional Heteroscedasticity (GARCH) econometric framework (Alberola et al., 2008; Oberndorfer, 2009). By contrast, we argue in this article that the interrelationships between energy and emissions markets shall be modelled in a Vector Autoregressive (VAR) and Multivariate GARCH (MGARCH) framework, so as to reflect the dynamics of the correlations between the oil, gas and CO₂ variables overtime. Using the Baba–Engle–Kraft–Kroner (BEKK), Constant Conditional Correlation (CCC) and Dynamic Conditional Correlation MGARCH (DCC-MGARCH) models on daily data from April 2005 to December 2008, we highlight significant own-volatility, cross-volatility spillovers, and own persistent volatility effects for nearly all markets, indicating the presence of strong Autoregressive Conditional Heteroscedasticity (ARCH) and GARCH effects. Besides, we provide strong empirical evidence of time-varying correlations in the range of [?0.3;?0.3] between oil and gas, [?0.05;?0.05] between oil and CO₂, and [?0.2;?0.2] between gas and CO₂, that have not been considered by previous studies. These findings are of interest for traders and utilities in the energy sector, but also for a broader applied economics audience.     

Greenhouse gas policy and California electricity prices

California has adopted a policy of mandatory reductions in greenhouse gas (GHG) emissions to 1990 levels by the year 2020. (California Legislature (2006) Assembly Bill 32, the Global Warming Solutions Act of 2006, California Air Resources Board (2008) Climate change draft scoping plan, Sect. 2) Electricity utilities will need to recover related expenses, such as for the purchase of emissions permits. Economists often assume that raising usage prices for the commodity is the best way to recoup such expenses. However, regulated usage prices to California residential customers already exceed the cost of electricity generation plus a plausible externality cost for carbon dioxide (CO₂) emissions. Instead, recovering compliance expenses through usage insensitive charges could avoid causing unnecessary economic harm to consumers.