EU Emissions Trading by Energy Firms

Abstract

According to the ‘make-or-buy decision’, transactions take place within firm boundaries when transaction costs are lower vis-à-vis the market. Analyzing EU Emissions Trading Scheme (EU ETS) transactions, this paper examines whether firms follow this make-or-buy principle by behaving self-sufficiently in terms of their carbon allowance demand before they opt for the carbon market. Contrary to our expectations, we find that firms with the potential to be most self-sufficient actually conducted fewer allowance trades across their subsidiaries than on the carbon market. This result may imply that within firm boundaries, pollution abatement capacity is more expensive and/or carbon-related transaction costs are higher than on the carbon market. For these firms, the coordination of abatement through the carbon market will thus be cost-effective. Moreover, their allowance trade is indicative of carbon hedging and seizing of arbitrage opportunities. We conclude that the firms with the potential to be most self-sufficient actually depend more on the EU ETS.

Keywords: Emissions trading, energy market, EU Transaction Log, firm-level data, allowance purchases and sales, allowance hedging

JEL Classification: D22, H23, L94, Q41, Q52