European Carbon Prices and Banking Restrictions: Evidence from Phase I (2005-2007)
The Energy Journal, forthcoming
29 Pages Posted: 3 Jan 2008 Last revised: 26 May 2014
Date Written: 2009
The price of European Union Allowances (EUAs) has been declining at far lower levels than expected during Phase I (2005-2007). Previous literature identifies among its main explanations over-allocation concerns, early abatement efforts in 2005, and possibly decreasing abatement costs in 2006. We advocate low allowance prices may also be explained by banking restrictions between 2007 and 2008, which undermined the ability of the EU ETS to provide an efficient price signal for emissions abatement. Based on a Hotelling-CAPM type analysis, our results suggest EUA spot prices do not meet equilibrium conditions in the intertemporal permits market. We also provide statistical evidence that, during the negotiation of National Allocation Plans for Phase II, the French and Polish decisions to ban banking contribute to the explanation of low EUA Phase I prices. Finally, we provide the first rigorous empirical verification that the cost-of-carry relationship between EUA spot and futures prices for delivery during Phase II does not hold after the enforcement of the inter-period banking restrictions. This situation may be interpreted as a sacrifice of the temporal flexibility offered to industrials in Phase I to give a chance to correct design inefficiencies, and achieve a price pattern leading to effective abatement efforts in Phase II.
Keywords: Carbon Emissions Trading, EU ETS, Banking, Borrowing, Hotelling Rule, Cost-of-carry Relationship, Futures Term Structure
JEL Classification: Q28, Q52, Q58
Suggested Citation: Suggested Citation