The European Union Emissions Trading Scheme (EU ETS) was created on January 1, 2005 by the European Commission (EC) to foster early compliance with the greenhouse gases emissions reduction targets agreed in the Kyoto Protocol. Its successful implementation is currently being evaluated against its simplicity and the fairly transparency of the trading mechanisms instored. As such, the EU ETS covers up to 46% of CO2 emissions from European energy-intensive industries. Every year, each industrial plant is allocated EU allowances (EUA) corresponding to its cap and must restitute as many allowances as verified CO2emissions. 2.2 billion of allowances were allocated to 10,600 installations across 27 EU Member States in 2005-2007 which are tradable all around Europe on exchanges and by over-the-counter. The next two phases of the scheme are interconnected and will take place during 2008-2012 and 2013-2020.
Yet this scheme raises various design issues related to the efficiency and equity of such market-based instruments. An efficient system leads to the equalization of marginal abatement costs among participants, yielding a unique market price that acts as a medium-term signal for investors to make cost estimates of delivering different levels of energy efficiency and how much emissions abatement to undertake. An equitable system consists in allocating allowances based on a uniform criteria that is mostly perceived as fair and agreed upon by the various stakeholders.
During its Pilot Phase, the EU ETS has failed to provide these right incentives. First, after a price "collapse" on April 2006 due to the publication of the 2005 verified emissions data by the EC, the EUA spot price of maturity December 2007 has been asymptotically decreasing towards zero because of the impossibility to transfer allowances to the next period. This provision may seem justified ex-ante, since nobody had a clear idea of the exact number and the volume of traded allowances, but it prevented the scheme from delivering its price signalling message in terms of CO2 abatement efforts needed in the EU to meet the Kyoto targets. Second, the allocation of allowances based on grandfathering and prior use rules did not achieve its equity objective as some sectors such as power producers were far more constrained than other participants who received an amount of allocation close to their business-as-usual scenario.
Thus, the EU ETS Review pointed out the necessity for the EC to act more as the central authority entitled to set firmly emissions caps for Phase II and to restore the scarcity of allowances equally among sectors, including the sectors that will be included in the scheme in Phase III.
The role of coordinator, educator and enforcer played by the EC is central to the analysis of investors’ risk aversion developed in this paper. At the start of the EU ETS, most of the information available for trading was deemed as speculative. Consequently, we attempt to characterize investors’ hedging strategies for this new carbon commodity by asking the following central question: can we statistically identify a shift in investors’ risk aversion around yearly compliance events imposed by the EC?
Download
PDF Ebook Risk Aversion and Institutional Information Disclosure on the European Carbon Market
