Environmental Engineering Reference
In-Depth Information
with the disruptions on price levels and liquidity
caused by the leakage of emissions data indicating
an oversupply in April 2006 and later by restric-
tions on banking towards the transfer from the
first to the second trading period in October 2007.
9
From the beginning, the implementation of pri-
mary allocation methods for emissions allowances
has also been a source of market uncertainty in the
EU ETS. There has been a long-standing debate
and power game all along the first and second
trading phase from 2005 to 2007 and from 2008
to 2012, respectively. Arguably, free allocation
brings about issues like rent-seeking behaviour
and windfall profits in incumbent industries
whilst also leading to perverse dynamics when
free allocations follow for example the so-called
grandfathering
approach where free allocations
are a function of past emissions (Hepburn, 2007;
Neuhoff, Martinez and Sato, 2006).
The policy response in the EU ETS is to
stipulate increased auctioning. But given the
sheer magnitude of volumes to be auctioned into
the market in the third trading period starting in
2013, it is obvious that any decision on the design
of the auction mechanism itself, on the contracts
and instruments to be auctioned, on eligible access
routes to the auctions and, finally, on the clearing
processes will inevitably have an impact on the
overall functioning of EU ETS markets. It is new
territory that neither financial nor commodity
markets have yet experienced. Beyond doubt, it
is a potential new source of supply distortions and
market uncertainty if markets are strained with an
improper auctioning scheme. Whilst there is a fund
of theoretical work and practical experience with
stand-alone auctioning, there is no instance deal-
ing comprehensively with the interdependencies
between auctions and trading markets.
secondary markets under the EU ETS deserves
highest priority we set out recommendations for
integrating large-scale auctions into the existing
market infrastructure and institutions.
The first subsection to follow defines the
starting position in terms of the foundations of
cap-and-trade emissions markets. Departing
from the economics of cap-and-trade markets we
introduce some considerations on the efficiency
and distributional effects of alternative primary
allocation mechanisms.
The second to next subsection will demon-
strate how theory turns out in real life carbon
trading markets. It provides some insight into the
EU ETS as it developed into the most actively
traded carbon market globally. We introduce the
market architecture in terms of secondary market
infrastructure providers, institutions and instru-
ments traded. The corresponding subsection on
the functioning of secondary markets looks at
some characteristic pricing and volume relations.
There are some indications that the market is still
susceptible to distortion and inefficiencies. Hence,
institutional changes like the introduction of large-
scale auctioning should be implemented carefully.
Finally, in the last subsection we derive some
hands-on recommendations on the institutional
implementation for large scale auctioning, the
by far most demanding challenge ahead for the
EU ETS. We draw the conclusion that auctioning
should be an integral part of today's market infra-
structure in terms of trading venues and institu-
tions to complement the efficient price discovery
and allocation function of markets with a smooth
supply of emission allowances into the market.
FOUNDATIONS AND ECONOMICS
OF CAP-AND-TRADE MARKETS
Structure of the Chapter
The use of market-based techniques for dealing
with environmental problems was initially pro-
posed in the seminal works of Coase (1960) and
In this contribution we aim at deriving an outline
for an institutional auctioning design. Against
