The role of carbon pricing

1. The roleofcarbonpricing Georg Zachmann

2. Key messages • The ETS does largely what it is supposed to do • Credibility is key • Do not start out in a second best-world • More analysis is needed to convince MS that they gain from a “first-best + redistribution” world

3. Agenda • Introduction • Performance of the ETS • Details, Details, Details … • EU vs. MS • Conclusion

4. Conceptual Framework First bestpolicyadresses individual externalitieswith optimal solutions

5. Mapping investment barriers to different types of climate investment Source: Calthrop, Kolev, Riess, Zachmann (2012) P = Barrier of primary importance for the investment at hand. S = Barrier of secondary importance for the investment at hand. N = Barrier of no (little) importance for the investment at hand; or not analyzed in detail. * = Policy failures are potentially very important and, thus, merit a visual representation in the table. However, the grading P, S, and N is not useful for policy failures as it is always important to correct them should they be made.

6. Mapping investment barriers to possible solutions Source: Calthrop, Kolev, Riess, Zachmann (2012)

7. 2. Performance of the ETS • Introduction • Performance of the ETS • Details, Details, Details … • EU vs. MS • Conclusion

8. ETS emissions by country Phase I Phase II Crisis year Zachmann, Abrell, Faye (2011)

9. ETS constraint emissions Zachmann, Abrell, Faye (2011) • Emissions dropped more than production • Cap was binding • Not compensated by leakage

10. ETS tightening affected sectors differently Zachmann, Abrell, Faye (2011) • Cap-and-trade incentivizes reductions with highest marginal abatement cost -> arguably more efficient than command-and-control

11. But, ETS prices lower than expected 11

12. But, Initial Allocation Matters • The tighter cap in Phase II was effective since emissions decrease • Under allocated companies in allowances for 2005 reduced their emissions the most Zachmann, Abrell, Faye (2011)

13. But, Huge Windfall Profits • Overallocated firms have benefited significantly from the EU ETS in terms of profitability • Underallocated Firms did lose • Overall effect surprisingly slightly negative Zachmann, Abrell, Faye (2011)

14. 3. Details, Details, Details … • Introduction • Performance of the ETS • Details, Details, Details … • EU vs. MS • Conclusion

15. Details, Details, Details … • Thereare a numberofdetailsthatdeterminetheperformanceofthe EU ETS • Cap • Initial allocation • Coverage • Dealingwithleakage • Locking in prices • … • All ofthemaredisputed

16. Detail 1 – Cap • Present • ~2 bn allowances • -1.74 % • Future • Keep the path and • Change the path now (e.g., 2020, 30%) • Change the path in the future (e.g., 2030, 40%)

17. Detail 2 – Initial allocation • Grandfathering • Benchmarking • Auctioning

18. Detail 3 – Coverage • Widen: Inclusion of more sectors in the ETS • Deepen: strengthen the long-term price signal in the ETS • Enlarge: link to foreign systems

19. Detail 4 – Leakage • Indirect leakage cannot be tackled • Proposals for direct leakage: • Free allowances • Border adjustment taxes (imports or imports+exports) • Carbon consumption tax • Allowance based system • Risks: • Trade wars (see aviation) • Industrial policy • Overly complex mechanisms (calculating life-cycle emission ?)

20. Detail 5 – Fixing prices Different price targets • Floor price, price Collar, price Ceiling • €0-€100 • Fixed or moving limit Methods • Taxes • Managing the annual or period cap • Option contracts

21. 4. EU vs. MS • Introduction • Performance of the ETS • Details, Details, Details … • EU vs. MS • Conclusion

22. Distributive Effects of European Climate Policy The threemainpolicies (RES, ETS, EE) affectmemberstatesdifferently

23. ETS: Central Europe has the highest potential for reducing emissions but is also most vulnerable Source: Zachmann (2011)

24. ETS: 2013 allocation rules to compensate primary effects Source: Zachmann (2011)

25. RES: Differing competitiveness (RCA) Solar Cells 2008 Wind Turbines 2008

26. RES: Differing Support levels RES support levels in a cross-section of EU countries (low,mean,high in €/MWh) Source: CEER 2011

27. RES: Differing Support policies Deployment Source: IEA 2012; EcoFys, Fraunhofer ISI, TU Vienna EEG, and Ernst &Young Report: “Financing Renewable Energy in the European Energy Market”

28. 5. EU vs. MS • Introduction • Performance of the ETS • Details, Details, Details … • EU vs. MS • Conclusion

29. Conclusion The bighorse-trading: • Burden sharing • Effort sharing • Initial allocation • … • There are a lot of pretty un-distorting redistribution schemes • Do not start out in a second best-world • More analysis is needed to convince MS that they gain from a “first-best + redistribution” world

30. Example: De-risking low-carbon investments • Public bank auctions put options to investors • Investor will choose a hedging strategy • Investor get‘s payoff if carbon price is too low • ETS exposure on the balance sheet of public banks increases credibility of the ETS for all mkt participants Examplesfor an Asian option 2020 to 2030 ETS Price Strike Average ETS pricehigherthanstrike Nopayoff 2010 2015 2020 2025 2030 ETS Price Strike Average ETS pricelowerthanstrike payoff 2010 2015 2020 2025 2030