Workshop on Institutional options for the Carbon market: Can financial

markets and institutions be a model?

Is there a need for more market oversight and regulation in the EU ETS?

Barbara Buchner, PhDClimate Policy InitiativeGraz, 25 November 2010

The EU ETS Mandatory system in place since January 2005 Legislation agreed by Member State Ministers (Council) and

European Parliament in ‘co-decision’ Extensive stakeholder dialogue

Covers currently 40% of EU GHG emissions Cap on emissions from ~11,500 energy-intensive installations

across EU Direct: regulated at source of pollution

Single largest market for GHG emissions True multi-national scheme (25/27 MSs) Link to Norway, Iceland, Liechtenstein

A “Linking Directive” governs the relationships between EU ETS & Kyoto Protocol EU ETS stimulates overall carbon market

2008 20122005 2007 20202013

EU energy & climate policy objectives

Jan 1: Start of phase I Jan 1: Start of phase II Jan 1: Start of phase III

Jan 1: Start of 1st CP of KP

Feb 15: Entry into force of Kyoto Pr.

Dec: end of 1st CP

A “broad then deep” strategy All inclusive, non-demanding beginning Increasing differentiation with greater stringency Participation of the less committed in decisions

Highly decentralized implementation MRV and enforcement by Member States But: highly uniform infrastructure for registries And: importance of central coordination (EC)

Towards harmonization and centralization From country ‘caps’ to EU-wide cap From national allocation plans towards EU-wide auctioning

and harmonized benchmarks Differentiate through auction rights

Towards common definitions, scope and criteria for inclusion

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A phased approach

learning the lessons from the pilot phase

Who? Industrial companies Energy companies Banks/intermediaries

What? Spot - a commodity Derivatives – financial instruments Standardized and non-standardized contracts

Where? Exchanges – regulated markets, MTFs OTC – brokered/non-brokered, unregulated exchanges

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The carbon market – who, what, where?

Art. 12(1a) of Dir 2009/29/EC: “Commission shall by 31 Dec 2010, examine whether the market for emission allowances is sufficiently protected from insider dealing or market manipulation….”

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EU ETS phase 1 & 2 cap

EU ETS phase 3+ cap based on linear reduction factor 2.4%

EU ETS phase 3+ cap based on linear reduction factor 1.74%

-96% vs 2005

-71% vs 2005

Scope changes

Adoption of adjusted linear reduction factor(Art 9 ETS Directive)

30% adjustment

Pilot 2nd Phase 3rd Phase 4th+ Phases

Source: Öko-Institut 2010

Note…• Linear factor to be reviewed by 2025 • Aviation to be included; will change figures correspondingly but cap not

reduced• Uncertainty re move to 30% GHG reduction target

A single, accountable long-term cap and a longer time horizon

A pilot phase is useful. Trading infrastructure and experience Data issues Everything doesn’t have to be ready on Day 1 Learning by Doing: A phased approach- allows learning and

revision Carbon now has a real price.

Phase 2 tightened overall cap (-6% wrt 2005) Agreed amendments add to scarcity (-1.74%/year)

A new commodity and liquid market emerged. Price behavior has been rational

Steady growth in volume and products Volatility not extraordinary (less than in other commodity

markets) Widespread participation in the trading

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Some conclusions from Phase I

A price signal

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Phase I Allowances (2005-2007)

OTC and BlueNext Spot

Phase II Allowances (2008-2012)

ECX Dec-08 Futures

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May 15, 2006: verified emissions

Data and design matter !• Reliable information - MRV• Market infrastructure• Flexibility/certainty/predictability

Allocation is controversial. Free allocation was price of acceptance

Also, many choices impractical due to data constraints But subsequently very controversial

Abatement occurred. A significant positive price Emissions are lower than historical levels (even after allowing for

plausible bias), despite robust economic growth and adverse energy price developments

Probably 120-300 MtCO2/year (2-5%) in 2005-2007: modest, but in line with modest ambition

Too early to observe investment effects Carbon price has had limited impact on industrial

competitiveness. No empirical evidence of market share loss due to carbon pricing:

only one price among many But: may change in the longer term 8

Some more conclusions from Phase I

The principles Simplicity & Transparency

The conditions Suitable club benefits: broader benefits than GHG Actors with varying marginal abatement costs Low transaction costs Good data availability Good decision process (a ‘center’, coordinating mechanisms)

The choices A robust, binding cap Predictability/certainty Flexibility: scope, linking, international offsets (with limits to

ensure sustained effort) Effective monitoring, reporting, verification

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Learning the lessons for carbon markets governance

Secure long term carbon price

stability & integrity of system

Combination solution Permits & “ safety valve”

Implementation Along with emission targets, government sets a “trigger price” If price of permits > trigger, government guarantees the

“safety” price Theory…

On economic grounds, they can be helpful to lower cost of achieving ambitious targets

Quantitative analysis: price floor much higher than price levels experienced in EU ETS • EUR 35/tCO2 in 2011, to EUR 120 in 2050 to reach 50% from

2005 levels by 2050• also higher than some suggested caps in other legislations (US

price collar in Senate bill: US$ 28) 10

What if…more oversight through price floors/caps/collars?

…and practice: what if we had adopted some? Implications for compliance costs: the market has worked

well, lowering cost of compliance when entities had economic difficulties

Practical implications: floor/cap levels determined by national circumstances, not science

• Linking of trading systems proves challenging (environmental ambition, GHGs, activities, etc.)

– Collars, here but not there, make linking unwieldy/meaningless

– Coordinating floor/cap levels unlikely to facilitate matters• The issue of the rents: a reserve price in auctioning has a value …

especially for sellers into the system (CDM, AAUs?)

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More oversight through price floors/caps/collars?

Do not address the wrong issues Low prices criticized for lack of sufficient signal: blame the

target, not the mechanism Maximize confidence in system

Learn from mistakes, allow adjustments Consider that regulatory interference with the carbon price

undermines the market and investment decisions, and thus confidence from the beginning

Important to set proper instruments to hedge against future risk What hedging instruments in presence of gov’t guaranteed

prices?Experience tells us that markets can deal with price

uncertainty, while policy uncertainty is much more difficult to handle

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How to optimize market regulation?

CO2-emissions are no longer free in the European Union Importance not so much in price per se, but in institutions &

thinking From rather dubious initiative to accepted fact and

cornerstone of EU policy Achieved despite significant obstacles and problems

Pre-existing institutions, powerful club benefits facilitated EU ETS But significant obstacles: time schedule, inexperience with trading

Importance of pilot phase Provided infrastructure and lessons: balance flexibility & regulation Illustrates incentives: carbon price has induced some abatement

Importance of continuous learning by doing Market oversight – based on stocktaking exercise

EU ETS shows that multi-national systems can be successfully implemented

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Bottom line

more than least-cost abatement

Thank you!barbara.buchner@CPIVenice.org www.climatepolicyinitiative.org