Understanding the Link Between Aggregated Industrial Production and the Carbon Price - Green Energy and Efficiency: An Economic Perspective - page 116

3.1 Mechanism

What is the impact of economic activity on the growth rate of carbon prices from an
empirical point of view? Absent energy ef ciency improvements (at least in the

short-term), the link between growth and carbon pricing unfolds as follows:
1. Economic activity fosters high demand for industrial production goods.
2. In turn, companies falling under the regulation of the EU ETS need to produce
more, and emit more CO 2 emissions in order to meet consumers ' demand.
3. This yields to a greater demand for CO 2 allowances to cover industrial emis-
sions, and ultimately to carbon price increases.

Of course, it would be better to work directly with CO 2 emissions at the
installation level, but there is a high degree of complexity in accessing this data, and
making it available to the econometrician. Hence, we choose to proceed with the
industrial production index as a good proxy of economic activity in this chapter.

3.2 Previous Studies

Among early studies, we may refer to the theoretical literature reviews by [ 13 , 27 ],
who identi ed the following drivers of CO 2 allowance prices:

Policy and regulatory issues of the EU ETS : these include National Allocation
Plans (NAPs), auctioning share of allowances, banking and borrowing allow-
ances possibilities, new entrants reserve, new covered sectors, etc.;

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Emissions levels : among the factors impacting CO 2 emissions, we may distin-
guish between
1. Economic activity: industrial production by covered installation, electricity
power demand by others sectors;
2. Energy prices: Brent, natural gas, coal;
3. Weather conditions: temperature and rainfalls.

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Therefore, we observe that economic activity was directly thought as being one
of the fundamental drivers of carbon prices in the literature that was published
before the creation of the EU ETS.
However, the rst empirical studies neglected that impact, and focused more

heavily on the role played by other energy markets in shaping the price of carbon.
We may cite in this strand of literature the papers by:

Kanen [ 22 ]: the author nds that coal, natural gas and oil prices impacted carbon

futures of maturity December 2006;

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Mansanet et al. [ 25 ]: they document that Brent ICE and natural gas NBP
impacted carbon spot prices from January to November 2005;

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