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  1. What overallocation at the system level are we facing and what are the perspectives to reform the EU ETS to avoid overallocation in the future? • Anne Schopp and Karsten Neuhoff • German Institute for Economic Research (DIW Berlin) • Overallocation– a scourge of emission trading systems, Zurich CMA • Zurich, 12 March 2014

  2. Outline Surplus in the EU ETS Actorsbankingsurplusallowances Reformingthe EU ETS

  3. EU ETS surplus • 1 Cumulativesurplus High RenewableEmissions Scenario 3.0 CurrentPolicy Initiative Emissions Scenario 2.0 Reference Emissions Scenario International CDM / JI creditslinkedtoEU CO2 surplus allowances in billion tonnes Time profileofauctions 1.0 Cap minus Emissions 0.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: Neuhoff, Schopp, Boyd, Stelmakh, andVasa (2012)

  4. Carbon price development Source: EEX

  5. Actors banking surplus allowances • Power sector: sells power on forward contracts up to three years in advance and buy in parallel fuel inputs and CO2 to hedge • Industry sector: banks free allowances that are not needed to cover annual emissions • Banks: bank allowances and sell forward contracts at 3-5% to cover cost of capital • Speculative investors: bank allowances if they can realise their required rate of return 10-15% Emitter/ Hedger Arbitrageur/ Speculator Source: Neuhoff, Schopp, Boyd, Stelmakh, andVasa (2012)

  6. 100% Power hedged with non-fossil generation Power hedged with fossil generation 50% 0% 3 years ahead 2 years ahead 1 year ahead Hedging strategies by power generators 84% Percentageofpower hedged 46% 20% Source: Annual reports 2011, Eureelectric 2010

  7. Aggregate hedging corridor 2.0 7.5 € /tCO2 1.6 1.2 CO2 hedgingvolume in billiontonnes 0.8 0.4 0.0 - 5% 0% 5% 10% 15% Expectedgrowth rate ofcarbonprice < market rate of 5% = market rate of 5% > market rate of 5% Source: Schopp andNeuhoff(2013)

  8. EU ETS surplus vs hedging corridor 3 Cumulative surplus in EU ETS Speculative investment 2 CO2 surplusallowances in billiontonnes 1 Hedging volumeby power sector 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: Schopp andNeuhoff(2013)

  9. Gap between today's price and price expectations 35 Price in period 2 Speculators 30 entermarketat 15% discount rate 25 Price in period 2 20 Price equilibriums in Euro/tonne 15 Price in period 1 with unlimited banking at 5% 10 5 Price in period 1 withmarketdemandforhedgingandbanking - 1.0 1.2 1.5 1.7 2.1 2.2 Cumulativesurplusallowances in billiontonnes CO2 Source: Schopp andNeuhoff(2013)

  10. EU ETS reform options 3 Cumulativesurplus Billion tonnes CO2 Backloading 0.9 bn 2 30% CO2 reduction Reserve price 1 Set aside 1.4 bn Hedging volumeby power sector 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: Neuhoff, Schopp, Boyd, Stelmakh, andVasa (2012)

  11. Market stability reserve 3 Cumulativesurplus Billion tonnes CO2 2 Hedging volumeby power sector 1 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

  12. Conclusion • Surplus in EU ETS accumulated in Phase II and is estimated to grow • CO2 hedging by power sector can absorb surplus some allowances • With increasing surplus the discrepancy between today's price and price expectations widens • Surplus of allowances in the EU ETS needs to be reduced to a level corresponding to hedging demand