instead purchase allowances. In the past years, the allow- ance price ranged between €6 and €9. This relatively low price is mainly attributed to a huge surplus of allowances in themarket. A surplus emerges if the cumulated number of allowances exceeds the (veriﬁ ed) actual emissions. There are manifold reasons for the huge surplus of excess allowances. One reason is the unexpected low emission levels as a consequence of the longstanding and se- vere economic crisis that erupted in 2008. Most notably, Southern European countries have been strongly afﬂ icted by the crisis and have not yet recovered economically. Another reason is the generation of green electricity in Europe. Both the Commission and individual member states deﬁ ned targets for the shares of green electricity in consumption and established promotion schemes that overlap with the ETS. In Germany, for instance, the gen- eration of CO 2 -free electricity, which is promoted by ﬁ xed feed-in-tariffs for renewable energy sources (RES), leads to a decreased demand for emission allowances in the German power sector. This is illustrated in Figure 2 by a shift of the demand curve from D 0 to D 1 .
60 ever before” (p. 432) and introduced a new method called “the buy, bank, burn program where, as the name suggests, one buys and banks allowances to be burned only in the future, once the emission cap has become exogenous; that is, when emission flows into the MSR end” (ibid.). Hence, since the allowances bought by nongovernmental organi- zations are not directly canceled like before but banked, they are not withdrawn from themarket but count as banked instead which is why they do not reduce but might even in- crease the intake into the MSR and with that the potential cancelation via the cancelation mechanism (ibid.). The point in time when the bought allowances are burned is decisive since before burning them, the allowances are a part of the bank and it depends on the size of the bank whether there is an intake in the MSR in the next year. Since it might be the case that the size of the bank fluctuates around the threshold value, i. e. falls below it several times and rises above it again, like estimated by Osorio et al. (2020), the allow- ances should only be irreversibly cancelled if it is safe to expect that the threshold value will not be exceeded again. With this “buy, bank and burn” method, “[p]arties outside EU ETS can burn allowances at more than 100% efficiency, partly paid for by regulated in- dustries” (ibid., p. 433) since “[i]n order to offset 1 ton of emissions, an agent need only buy and bank 3/5 tons worth of allowances” (ibid.). This is why today a new service to buy, bank and later burn EU ETS allowances is offered by organizations like Compensa- tors*, 50ZERO or ForTomorrow (Compensators* e.V., 2020a). As an advantage of their offsetting service, they emphasize that emissions are avoided within Europe where per capita emissions are comparatively high and with this the incentives for European indus- tries to reduce emissions are strengthened whereas other offsetting organizations focus rather on projects in the global south (ibid.). Some of them directly work together with scientists, e. g. Grischa Perino controls the operations of the Compensators* organization as an additional authorized account holder of the allowance account (Compensators* e.V., 2020b). To conclude, consumers can use these services to buy, bank and later burn allow- ances to contribute to a reduction of total emissions in theEU and campaigns might hence also recommend this option. Compared to campaigns aiming at a demand reduction where consumers might spend their money elsewhere and the clean input might leak to other sectors, campaigns recommending to donate to a buy, bank and burn program seem to not face these leakage effects.
national mitigation policies in order to achieve their more ambitious domestic mitigation goals. However, reliance on domestic policy instruments would create an inefficient pattern of regulation across theEU and would add tothe factors working towards reducing the EUA price. TheEU ETS is embedded in a multi-level governance structure, with Member States having diverging preferences over their technology mix and level of climate policy ambition. TheEU ETS is not the only instrument for climate and energy policy, but based on the national sovereignty of the energy mix, Member States can implement additional measures, such as renewable support schemes, energy efficiency measures, or additional domestic carbon prices (UK) that interact with theEU ETS. This is likely to intensify asymmetries in marginal abatement costs across Member States and thus increase overall policy cost. In addition, these policies also do only reallocate but not on net reduce emissions and can add to an even stronger reduction of the EUA price by exogenously reducing the allowance demand through channels identified in section 2.2, thus intensifying the problems of theEU ETS. At the same time, given the differences in envisaged levels and timing of climate policy targets across Member States, the question arises as to whether theEU ETS can be adjusted to help guide these divergent national preferences towards mutually beneficial outcomes. These points are revisited in the discussion of reform options in the next sections.
When it was launched in 2005, the European Union emissionstradingsystem (EU ETS) was projected to have prices of around €30/ton CO2 and to be a cornerstone of the EU’s climate policy. The reality was a cascade of falling prices, a ballooning privately held emissions bank, and a decade of low prices providing inadequate incentive to drive investment in the technologies and innovation necessary to achieve long-term climate goals. The European Commission responded with administrative measures, including postponing the introduction of allowances (backloading) and using a quantity-based criterion for regulating future allowance sales (themarketstabilityreserve); although prices are beginning to recover, it is far from clear whether these measures will adequately support the price into the future. In the meantime, governments have been turning away from carbon pricing and adopting overlapping regulatory measures that reinforce low prices and further undermine the confidence in market-based approaches to addressing climate change. The solution in other carbon markets has been the introduction of a reserve price that would set a minimum price in allowance auctions. Opponents of an auction reserve price in theEU ETS have expressed concern that a minimum auction price would interfere with economic operations in themarket or would be tantamount to a tax, which would trigger a decision rule requiring unanimity among EU Member States. This Article reviews the economic and legal arguments for and against an auction reserve price. Our economic analysis concludes that an auction reserve price is necessary to accommodate overlapping policies and for the allowance marketto operate efficiently. Our legal analysis concludes that an auction reserve price is not a “provision primarily of a fiscal nature,” nor would it “significantly affect a Member State’s choice between different energy sources.” We describe pathways through which a reserve price could be introduced.
► MarketStability Mechanisms: Key determinants of price levels have been and will likely remain the long-term target set by the declining cap and marketstability mechanisms. As mentioned in section 2.1.5, prices settling at or near the floor were highly likely from the outset of the program, the impact of complementary policies, and low price-responsiveness of abatement (Borenstein et al., 2019). These factors have elevated the importance of California’s marketstability mechanisms in managing volatility and have largely done so successfully, as prices have increased gradually, largely in step with the rising Auction Reserve Price. The effectiveness of California’s complementary policies for key sectors, including renewable portfolio and low-carbon fuel standards, will also continue to play a strong role in the system’s long-run price trajectory. To conclude, the CaT system provides evidences that a price corridor, in particular in conjunction with complementary policies (which decrease the demand for allowances), has a strong tendency to decrease short-term price volatility, as the floor supports prices at thereserve price.
Outside of the European debate, flexibility mechanisms have been built into legislated emission trading schemes in North America and Australia. For example, the Californian and Québec emissionstrading systems insure against unforeseen events via a reserve price at auction combined with an allowance reserve. The minimum price at auction acts as a quasi-price floor as no permits are sold unless the trigger price is hit. In addition, a reserve containing five per cent of total allowances is used to contain price hikes by releasing permits at a fixed price, once certain price triggers have been reached. Alternatively, Australia has opted for a five- year rolling cap, to maintain greater flexibility in setting medium term targets. Under the rolling cap mechanism, at the end of each year, the year n+5 emissions cap is set based on advice from an independent Climate Change Authority. As discussed by Sartor (2012) the approach seeks to combine flexibility to adjust supply in response to unforeseen events with predictability and credibility regarding long- term emission pathways.
Furthermore, they emphasised the importance of unrestricted access tothe credits from the CDM and JI “as they are fundamental to achieving theEU‟s emission reduction goals and engaging developing countries in a global emissions reduction process” (Eurelectric 2007: 7). Contrary tothe power producing sector, the energy-intensive industries are not represented by one organisation, but submitted a common position paper through the Key Stakeholders Alliance for ETS Review as well as individual ones (Skjærseth and Wettestad 2010a: 112; European Commission 2016e). In general, they were rather averse to an EU ETS reform. In their joint position paper they requested policy makers remove distortions of the free market and create „regulatory stability‟ (Alliance of Energy Intensive Industries et al. 2007: 1). They refused an auctioning system of allowances as this would harm the competitiveness of theEU industry on global markets (Alliance of Energy Intensive Industries et al. 2007: 1). Instead, they proposed “sectoral approaches and performance-based allocation based on actual production” for example through benchmarks, a baseline or a credit system (Alliance of Energy Intensive Industries et al. 2007: 1f.). The performance-based allocation should be applied for “large emitting, homogeneous processes [whereas] other more dispersed activities may remain with an allocation based upon grandfathering based on historical emissions” as this would create a level playing field (Alliance of Energy Intensive Industries et al. 2007: 2). BusinessEurope even lobbied for a total free allocation of allowances until a global emissionstradingsystem, which includes all main emitting countries, has been created. They argued that European companies would otherwise be disadvantaged on the global market (BusinessEurope 2007: 6). They further claimed to be „careful‟ about performance-based allocation as this might be a good option for some sectors whereas it would be „inappropriate‟ for others (BusinessEurope 2007: 8).
The policy-event dummies give us some evidence, although limited, that regulatory uncertainty might play a role in price forma- tion. This ﬁnding, if conﬁrmed, would imply different reform options than the ones merely aimed at adjusting to short-term shocks (e.g. due to economic downturn or large renewable deployment). Such reform options should seek to stabilize the expectations of market partici- pants. From this perspective, two types of approaches are discussed in the literature: (i) reducing policy uncertainty and (ii) decreasing the long-term commitment problem ( Brunner et al., 2012 ). The former induces for instance the establishment of mid- to long-term legally binding CO 2 emissions reduction targets. The current debate is focusing on the 2030 targets but to ensure long-term cost effective- ness, it might be necessary to provide tomarket participants a long- term decarbonization pathway. Nonetheless, as discussed in Grosjean et al. (2014) such a strategy might not be suf ﬁcient to bring the necessary level of stabilitytothe expectations of market participants. Tackling the long-term commitment problem in order to stabilize expectations is a delicate task. In monetary policy, the experience has favored delegation in setting the money supply as a tool to overcome the problem ( Barro and Gordon, 1983; Kydland and Prescott, 1977; Rogoff, 1985 ). In the context of the reform of theEU ETS, one could foresee the delegation of the governance of the carbon marketto an independent authority whose goal would be to ensure that the short-term EUA price is in line with long-term target (e.g. Clò et al., 2013; de Perthuis and Trotignon, 2013 ). However, this will not be without dif ﬁculties. The exact mandate of this institution as well as the instrument used to achieve its goal will not be easily de ﬁned ( Grosjean et al., 2014 ). Nonetheless, what an independent authority may achieve is a smoother decision-process for making reforms as well as locating the decision outside of the political sphere ( Newell et al., 2012 ). This might create more stable expectations on the way decisions are taken over time, even if the goals are modi ﬁed to adapt to new information and circumstances.
Source: EEX (2015).
However, because this measure only temporarily limits the amount of emission permits without solving the structural problem of certificate surpluses and their low prices, the European Commission (EC 2014b) is currently preparing the introduction of a Market Sta- bility Reserve. According tothe European Commission’s proposal, this was planned to commence with the start of the 4th trading period in 2021. After negotiations with theEu- ropean Parliament, the reform is planned to come into effect in 2019 (EP 2015). The idea is to regularly take allowances off themarket and hold them in reserve when the number of surplus emission allowances goes above a certain maximum limit. Conversely, allowan- ces will be taken out of thereserve and put on themarket when the number of surplus emission allowance goes below a certain minimum limit. The goal of this intervention is to stabilize the certificate prices on a higher level than the current one.
This paper explores how regulators can improve market efficiency under uncertainty, while reducing the need for discretionary intervention. The analysis is set in the context of theEU ETS, although the results are generally applicable.
As part of theEU ETS reform, the European Commission has indicated a preference for an automatic quantity- based mechanism, the so-called MarketStabilityReserve (MSR). The key rationale for using a quantity-based supply management mechanism is to remove the need to specify a price range for triggering allocation ad- justments. In the current EU context, the prospect of specifying an acceptable price range for a price-collar mechanism has been faced with significant political challenges. Thus, a quantity-based mechanism provides a practical advantage. Still, how the parameters determining the timing and the intensity of quantity-based adjustments are selected remains an open question both in the political and the academic spheres.
The beforementioned changes in prices will naturally bring about some changes in the distribution of income in the economy. Samuelson’s factor price equalization theory suggests that after opening to trade, the relative prices of goods in participating countries should adjust. Same story could be applied to linking emissionstrading schemes. The allowance price will increase in one system but decrease in the other. As a result of such price convergence, buyers from an ETS with a higher pre-link permit price and sellers from an ETS with a lower pre-link permit price will be better off, while buyers from a lower pre-link ETS and sellers from a higher pre-link ETS will be worse off (Haites 2016). Furthermore, the change in allowance price will affect the price of energy or price of emissions-intensive goods which will in turn affect households or other non-participating firms that rely on such goods as inputs in their production. Such changes in production costs could also affect these firms’ competitiveness. Consequently, it can be said there will be winners and losers, even though we observe overall cost savings (Jaffe and Stavins 2008), (Flachsland et al. 2009). By using a large-scale computable general equilibrium (CGE) model, Alexeeva and Anger (2016) have analyzed the macroeconomic and trade-based competitiveness impacts of linking theEU ETS with another ETS in four different scenarios, the first (EU scenario) is the no linking scenario and others (EU+, EU++ and EU+++) being only different in how many countries join. The results showed reduced welfare costs from emissions regulation for both EU members and non-EU states, however for non-EU members the gains decrease as more members join (see Table 4). The assessment of international trade effects showed different results. By linking with another ETS, theEU members have improved their terms of trade, while the non-EU members faced a loss in competitiveness, as seen in Table 5. They attribute these results to different roles of EU and non-EU members in the linking agreement, by theEU being permit importers and the rest being permit exporters which is due to different (initial) carbon prices in different regions. Lower permit prices translate to decreased abatement costs and make the production and exports of theEU ETS participants cheaper in relation to imports from non-EU regions.
Most existing estimates for Armington elasticities rely on time series data. There are 5 large studies for the US: Stern, Francis and Schumacher (1976), Shiells, Stern and Deardorff (1986), Reinert and Roland-Holst (1992), Shiells and Reinert (1993) and Gallaway, McDaniel and Rivera (2003). The most recent study by Gallaway, McDaniel and Rivera (2003) should be highlighted, since they estimate long- and short-term Armington elasticities for 309 sectors at the 4-digit level of Standard Industrial Classification (SIC) for the period 1989 - 1995 in the US (see columns 2 and 3 in Table 5). The authors conclude that long-term elasticities are on average double the size of short-term elasticities. This means, for the same change in the relative price, the percentage change in the share of the demand for the domestic commodity is twice as high in the long run as in the short run. A comparison with the estimates by Reinert and Roland-Holst (1992) (column 2) also shows that a higher disaggregation of the sectors results in higher estimated substitution elasticities. 16 . Erkel- Rousse and Mirza (2002) rely on panel data for industrialized countries and find high price elasticities. The majority of their estimates range from 1 to 13. As expected, the highest estimates tend to correspond to industries producing homogeneous goods.
2.3. The Role of Hot-Air
In addition tothe project-based mechanism, the Kyoto-Protocol allows the transfer of AAUs (Assigned Amount Units under the Kyoto Protocol) between Annex B countries. As far as trade between countries with a binding cap is concerned, this option is of minor importance since the project credits are perfect substitutes and can in many cases be obtained at lower prices. This is not the case for countries, which do have a cap that is above their expected business-as-usual emissions in 2012. These excess emission rights are called hot-air. The countries with hot-air are mainly the countries of the Former Soviet Union and to a smaller degree the Eastern European countries. In an extreme scenario where these countries sell all their hot- air, most models, including DART (Klepper and Peterson 2003) predict that the excess supply of allowances is so large that the carbon price falls to zero. Thus, the Kyoto targets can be reached at zero cost, however without any emission reduction in the Annex B countries. Such a scenario is not very likely though. Different studies have estimated that it is optimal for the hot-air countries to restrict their sales of hot-air to around 40% (Haites and Seres 2004, Klepper and Peterson 2003). If some of the hot-air is supplied on themarket, the use of CDM and JI credits will be reduced and international carbon prices will fall.
The CGE literature has neglected participation thresholds, leaving the issue for discussions among lawyers and lobbyists. We are not aware of any CGE simula- tions that address the issue. In contrast, CGE modelers have intensively looked at the question what share of emission permits should be auctioned. Most publi- cations emphasize the existence of windfall profits from grandfathering and con- trast them with positive welfare effects of auctioning when revenues are recycled such that overall efficiency increases, see e.g. Edwards and Hutton (2001) for the UK, Goulder et al. (2010) for the USA. Jensen and Rasmussen (2000) show the same qualitative results for Denmark, but also underline for the case of full auctioning the high adjustment costs in energy-intensive industries e.g. in terms of stranded investment. It is thus important to consider both sectoral effects and economy-wide welfare effects.
However, market imperfections can result in deviations from an efficient outcome. Transaction costs can limit trade between firms and hence reduce static efficiency (Stavins, 1995). Uncertainty about abatement costs and risk aversion can yield inefficient investment levels in low carbon technologies and thus reduce dynamic efficiency (Baldursson and Von der Fehr, 2004). We examine a further factor that may result in deviations from the efficient abatement pathway. Because of market and regulatory risks, speculative investors require a high risk premium for holding CO2 allowances or derivative contracts (Bessembinder, 1992; Wang, 2001). This is not of concern, if the surplus of allowances is limited and used by market participants to hedge their production costs in future years. However, if the surplus of allowances exceeds hedging volumes, then today’s carbon price declines compared tothe carbon price to be expected in future years until the return requirements are sufficiently attractive for speculative investors. Such a carbon price trajectory exceeding the social discount rate may no longer result in dynamically efficient operational and investment choices (Neuhoff et al., 2012).
As far as domestic policies are concerned, for theEUto best navigate in the future global tradingsystem, Europe- ans must improve their productivity and competitiveness in order to recover part of the ground lost in recent dec- ades as compared tothe US at the frontier of technol- ogy. Furthermore, they must implement vital structural reforms. These issues, which have to do with further Eu- ropean integration, are dealt with in the other contribu- tions to this Forum. The one priority I would insist on is achieving, at last, a true single market for goods and ser- vices, including digital services, in order to build a much needed cost efﬁ ciency comparative advantage for EU exporters.
and by doing so, ensure an efficient abatement pathway for the long-term decarbonisation of the European economy (Climate Strategies 2015 ).
In October 2014 the European Council expressed support for a policy intervention “in line with” the Commission’s proposal. After some debate, in February 2015 the ENVI Committee also voted in favour of an MSR similar to that proposed by the Commission, albeit with some amendments ( ENVI, 2015 ). Alternative design options have been put forward by Member States including Germany, the United Kingdom, France and Latvia (in its role as theEU Presidency).
As Skjærseth et al. (2016, p.103-111) argue, the change of direction reflected in the 2002 proposal is best explained by the discussion process ensuing the publication of the Green Paper in 2000. In fact, this period was marked by strong dissent among the EU’s member states concerning several key areas of the proposed ETS. Whereas there was widespread support for the general concept of implementing a harmonized system relying on a common allocation method as well as on community-wide monitor- ing, reporting and verification standards, there was no consensus on both the mandatory nature of thesystem and on the allocation strategy. For instance, Germany and the UK as the two most influential member states, whereas for diferent reasons, favored a voluntary ETS for at least the initial trading phase. In Germany, the discussion process was influenced by industrial organizations such as the BDI (Bundesverband Deutscher Industrie) or the VCI (Verband der Chemischen Industrie), which vehemently opposed the country’s participation in a centralized European ETS. Accordingly, Germany’s negotiating position, which can be interpreted as a compromise between the BMU (Bundesministerium für Umwelt, Naturschutz und nukleare Sicherheit) arguing in favor of the proposed ETS Directive and the BMWA (Bundesministerium für Wirtschaft und Arbeit) taking the opposite stance, was aimed at promoting a voluntary structure including opt-out options on a national, sectoral or installation level. However, after extended negotiations lasting until December 2002, Germany was ready to accept the European Union’s terms and give in to a mandatory ETS. Among the concessions made by theEU in the process, the most notable is certainly the pooling provision which entered the ETS Directive as Article 28 and enabled "member states" to "allow operators of installations...to form a pool of installations from the same activ- ity for...the first five-year period" (European Commission, 2003). The UK, in turn, originally opposed a centralized European ETS in favor of their own, domestic system, which was initiated as planned in 2002, comprising 34 industrial companies on a voluntary basis. Intended to run for five years until 2007, the UK ETS also differed from its European counterpart in the inclusion of six GHGs instead of one as well as in the sectors covered. Eventually, the UK, which had aimed at modelling theEU ETS to its own approach during the negotiations, had to give in and reconsider their position – however, not without theEU conceding an opt-out clause for installations on a national level (Skjærseth & Wettestad, 2016, p.111).
While one position holds on tothe exemptions for food and rents motivated by dis- tribution policy, another position argues for a full elimination of VAT reductions and notes that an abolition of reduced rates would have only a slight regressive effect (ZEW 2004). In addition, life cycle effects can become relevant in terms of distributi- onal effects, for example in the case of household appliances and mobility (Ochmann et al. 2012; De Camillis & Goralczyk 2013). A tax reduction or exemption is often rather a disguised industry subsidy than a social policy tool (Experian 2009). Some- times, resource- and carbon-intensive sectors and product groups such as the agricu- ltural and food system benefit from a two-level subsidization, in other words, the sec- tor receives on-budget subsidies at the beginning of the value chain as direct financi- al support and a preferential treatment through VAT reductions as off-budget subsi- dies at the end of the value chain (IEEP 2012). These points contribute tothe fact that VAT rates are a hotly contested terrain, both as a direct incentive as well as an indirect subsidy.
Table 1 details the regional and sectoral dimensions of the model. We aggregate the GTAP dataset to 28 regions representing the 27 European countries as sepa- rate regions and an aggregate “Rest of the World” (ROW) region. We identify 12 commodity groups with specific detail on five energy supply and conversion sectors separating various fuels (natural gas, coal, crude oil) and secondary en- ergy supply (electricity and refined oils) and on other energy-intensive industries. Our choice of sectoral aggregation is guided by the considerations to separately identify sectors which supply primary energy, are large in terms of economic size, exhibit a high energy-intensity, or are subject totheEU ETS. Three final demand sectors represent private and government consumption, and investment demand. Based on the GTAP data, our model further includes value-added taxes, im- port tariffs by commodity, sector-specific output taxes and subsidies, and energy- related taxes including mineral oil taxes. Primary factors in the dataset include labor and capital.