The EU ETS as an Environmental Instrument - Green Energy and Efficiency: An Economic Perspective - page 357

exposure has a decisive impact on prices, as can be seen clearly in the above graph,
which charts the behaviour of carbon prices in the EU in the last few years.
An analysis of price trends in the EU ETS from 2005 to 2012 reveals that the
main price drivers in Phase I were related to intrinsic elements (major differences
between veri

ed emissions and the cap, no possibility of banking between Phase I
and II) while in Phase II extrinsic elements such as energy prices and economic
performance had a stronger impact on prices.

4 Intrinsic Elements

The intrinsic factors of the EU ETS can be split into three groups: the number of
allowances to be allocated, the method of allocation and the existence of an off-
setting mechanism. All three are long-term factors, i.e. their impact takes more than
one or two years to make itself felt.

4.1 The Size of the Cap

As extensively discussed elsewhere, this is the most obvious factor of any cap and
trade system, since the (the balance between supply and demand)

is the ultimate driver of abatement. However, this is a key factor not just for the EU
ETS but for every carbon market. What makes this an EU ETS element is the
reiterated failure over these eight years to build up a substantial de

“ level of scarcity ”

cit of allow-
ances. A tighter cap would increase prices, incentivising more abatement actions to
make total emissions meet the cap [ 12 ].

4.2 The Allocation Method

The decision to set the cap is independent of the decision of how to allocate
allowances according to the cap. Allowances can be allocated for free or by auction.
Free allowances can be assigned according to two criteria: grandfathering or
benchmarking.
The EU ETS is not the

rst to incorporate
facilities from completely different economic sectors, leading to different situations
depending on transport costs, international competitiveness and whether or not the
cost of carbon can be transferred to the end customer.
During phases I and II the behaviour of Member States in the EU ETS was very
homogeneous, with almost all of the scarcity being allocated to the power sector,
based on the idea that there was greater potential for cheaper and easier CO 2
reductions there than elsewhere. As Ellerman et al. [ 5 ] point out:

rst cap and trade system, but it is the

“ First, abatement