Environmental Engineering Reference
In-Depth Information
INTRODUCTION TO EUROPEAN
EMISSIONS TRADING
argued that the initiation of the EU ETS has resulted
in a significant increase in electricity prices since
emission allowances can now be considered as
a direct production cost factor (Linares, Santos,
Ventosa and Lapiedra, 2006; Smale, Hartley,
Hepburn, Ward and Grubb, 2006). For example,
there are early empirical findings for Germany and
the Netherlands that, depending on the electricity
generating technology employed, an allowance
price of 20€ could result in an emission related
power production costs mark up ranging between
3€ and 18€ per MWh (Sijm, Neuhoff and Chen,
2004). For the UK there are estimations that a
1% shock in carbon prices translates into a 0.42%
shock in electricity prices (Bunn and Fezzi, 2007).
Finally, there are some forward looking estima-
tions for the Nordic area saying that in the second
trading period from 2008 to 2012 the average
electricity spot price might increase by 0.74€ per
MWh for every 1€ increase per ton of CO
2
(Kara
et al., 2008) .
Abstracting away from these empirical obser-
vations, it follows intuitive reasoning that electric-
ity price levels and risk premiums in electricity
markets are a function of the risk premium induced
by emissions markets. In an emissions constraint
economy the decision of an electricity producer
whether to produce electricity in what capacities
is closely related to the decision on when to abate
emissions. For example, prior to the initiation of
the EU ETS in 2005, the operators of a gas-fired
power plant in Europe would have calculated the
so-called
spark-spread
for deciding on whether
to produce power (e.g., see Fiorenzani, 2006).
This is defined as the net income from selling 1
MW of electricity and buying the gas required for
generating it. Electricity producers would proceed
with producing electricity only if the spark-spread
was at least covering the running costs.
Under the EU ETS the consumption of
emissions allowances constitutes an additional
production cost factor. Hence, electricity pro-
ducers' calculus is now based on the so-called
Arguably, the climate change talks in Copenhagen
in December 2010 did not deliver on the high ex-
pectations the world had raised for a post-Kyoto
agreement. But the commitment to confront cli-
mate change at the highest level is beyond doubt.
To underpin its leadership claim and continued
commitment to a global and comprehensive agree-
ment for the period beyond 2012, the European
Union recently reiterated its conditional offer
to move from a set 20% to a 30% reduction of
greenhouse gas emissions by 2020 compared to
1990 levels.
1
Irrespective of the target level of reduction,
the European Union Emission Trading Scheme
(EU ETS) faces a fundamental change with the
introduction of large scale auctioning for commit-
ment periods starting from 2013.
2
At the time of
writing this contribution, the EU Commission is to
propose a draft regulation on auctioning which is
due for adoption by June 30, 2010.
3
Integrity and
credibility of the EU ETS could be at stake if the
EU fails in setting proper grounds for auctioning
as an integral part of the overall EU ETS market
design. In short, a wrongly designed auctioning
scheme could result in arbitrary liquidity shocks,
excessive volatilities and distortions to secondary
markets functioning.
Interactions with European
Energy Markets
Structural breaks and distortions in the EU ETS
markets could have an impact on the adjacent
European energy markets. Whilst many sectors of
the economy are directly and indirectly affected
by the price levels of emissions allowances, the
energy sector continues to be the sector carrying
the highest burden in terms of emissions reduc-
tions. Hence, the energy market is most sensitive
to changes in price levels and volatility in carbon
