Kiel Working Papers, Kiel Institute for World Economics
No 1650:
Explaining European Emission Allowance Price Dynamics: Evidence from Phase II
Wilfried Rickels, Dennis Görlich and Gerrit Oberst
Abstract: In 2005, the European Emission Trading Scheme (EU-ETS)
established a new commodity: the right to emit a ton of CO2 (EUA). Since
its launch, the corresponding price has shown rather turbulent dynamics,
including nervous reactions to policy announcements and a price collapse
after a visible over-allocation in Phase I. As a consequence, the question
whether fundamental factors (fossil fuel prices, economic activity,
weather) affect the EUA price remained partially unresolved. Today, being
halfway through Phase II (2008–2012) and relying on a more mature market,
we use more reliable data to investigate the extent to which allowance
price dynamics can be explained by market fundamentals. We empirically test
for the influence of fuel prices, economic activity, and weather
variations. Fuel prices allow to test for fuel switching from coal to gas,
the most important short-term abatement option for most installations in
the EU-ETS. The empirical results show a significant influence of gas,
coal, and oil prices, of economic activity and of some weather variations.
When including the relative price of coal to gas on a forward level, we
found evidence of a switching effect. Yet, on a spot level the demand
effect seems to dominate. However, when including the absolute coal price
the coefficient is positive, contradicting theory with respect to both the
switching and the demand effect. The significant weather variations suggest
that their influence on EUA prices is less driven by their effect on energy
demand but more by their effect on the provision of carbon-free renewable
energy. Overall, our results show that the price dynamics are much better
explained by a model based on fundamentals than by a purely autoregressive
model. However, the results also show that fundamentals alone cannot fully
explain price dynamics and that forecasting is improved by the inclusion of
time series characteristics
Keywords: Carbon emission trading, EU ETS, Carbon price influence factors, Fuel switching; (follow links to similar papers)
JEL-Codes: C22,; G14,; Q54; (follow links to similar papers)
24 pages, September 2010
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