Environmental Engineering Reference
In-Depth Information
theoretical justification of why such an approach
leads to an efficient allocation of abatement costs
across various sources of pollution. A relevant
development with particularly important implica-
tions is the establishment of emission (or carbon)
allowance markets. The European Union with the
EU ETS established under the presetting of the
Kyoto Protocol's three flexible mechanisms is
probably the best example of a carbon constraint
economy where emissions are capped, priced and
exchanged through a market mechanism.
10
In this
subsection we will discuss some of the foundations
and economics of implementing cap-and-trade
emissions markets. We start with looking at the
full picture of pricing fundamentals, then focus
on the economic impact on electricity markets
and, finally, we look at the interlinking of primary
market allocation and secondary market trading.
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•
institutional design factors
like primary
market allocations, sectors in the econ-
omy that are not subject to the emission
caps or the inter-period transfer of allow-
ances which drive both demand and sup-
ply as well as risk premiums in emissions
markets.
In fact, the factors proposed by theoretical
and empirical research are consistent with market
practitioners' perceptions. For example, Point
Carbon, one of the major information sources in
the market, continuously quotes macroeconomic
and energy figures, such as the price of oil, natural
gas and electricity, as well as seasonal deviations
in temperature and rainfall in their daily reporting
on the markets.
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These pricing fundamentals all
transform into relations and transmission chan-
nels between the respective markets for oil, gas,
coal, freight, electricity and emissions. In the fol-
lowing, we focus on the immediate interactions
and interdependencies between electricity and
emissions markets.
Pricing Fundamentals in
Emissions Markets
There is numerous research literature and empiri-
cal work on emissions pricing fundamentals and
the drivers of pricing and trading activity across
the energy markets.
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In general, the factors that
determine the pricing of emission allowances are
said to be
Cap-and-Trade Emissions
Markets and Electricity Markets
In general terms, an emissions allowance is the
right or permit to emit a certain amount of CO
2
in
the respective compliance period. The amount is
usually fixed at one ton of CO
2
. Emission targets
are usually set as a percentage reduction from a
historical level of emissions with the objective to
reduce the expected emissions trajectory under a
business as usual assumption. Since every emit-
ter covered by the cap and trade scheme needs
allowances and because allowances are scarce,
they are valuable. If allowances are tradable the
market clearance price reflects the balance of
supply and demand. More precisely, it is the price
where the marginal revenue from emitting one
ton of CO
2
equals the marginal cost of abating
CO
2
emissions by one ton. The supply curve and
•
macroeconomic factors
like GDP growth
which primarily drive the demand for en-
ergy and, in turn, electricity and emission
allowances,
•
climate factors
like temperature and cli-
matic conditions which also influence the
demand for energy, and in turn, electricity
and emission allowances,
•
energy factors
like the characteristics of the
local generation fleet and the fuel switch-
ing costs and price levels of energy sources
which all together drive the supply side of
the energy markets and, hence, demands
for emission allowances, and
