The European Emissions Trading System (EU ETS): Ex-Post Analysis, the Market Stability Reserve and Options for a Comprehensive Reform

42 Pages Posted: 23 Sep 2014

See all articles by Brigitte Knopf

Brigitte Knopf

Mercator Research Institute on Global Commons and Climate Change (MCC)

Nicolas Koch

Mercator Research Institute on Global Commons and Climate Change (MCC); University of Hamburg

Godefroy Grosjean

Potsdam-Institut für Klimafolgenforschung (PIK)

Sabine Fuss

Mercator Research Institute on Global Commons and Climate Change (MCC); International Institute for Applied Systems Analysis (IIASA)

Christian Flachsland

Potsdam-Institut für Klimafolgenforschung (PIK)

Michael Pahle

Potsdam Institute for Climate Impact Research (PIK)

Michael Jakob

Potsdam Institute for Climate Impact Research

Ottmar Edenhofer

Potsdam Institute for Climate Impact Research (PIK); Mercator Research Institute on Global Commons and Climate Change (MCC); Technische Universität Berlin (TU Berlin)

Date Written: September 19, 2014

Abstract

The central pillar of European climate policy, the European Emissions Trading System (EU ETS), is currently under scrutiny, as the allowance price is persistently low at around 5€/tCO2. The cap was met and emissions actually declined in recent years, ensuring the environmental effectiveness of the scheme. However, the low price may affect the long-term cost-effectiveness of the instrument by reducing the incentive for investment and deployment of low carbon technologies. No significant increase in the allowance price is expected before 2020, and probably not beyond, without reform. While the reasons for the price decline are controversial, empirical analysis shows that only a small portion of price fluctuations can be explained by factors such as the economic crisis, renewable deployment or international offsets. Therefore, it is likely that political factors and regulatory uncertainty have played a key role in the price decline. As a consequence, any reform of the EU ETS has to deliver a mechanism that reduces such uncertainty and stabilizes expectations of market participants. The Market Stability Reserve proposed by the EU Commission is unlikely to address the current problem of price uncertainty and insufficient dynamic efficiency. The key element of the alternative reform proposal described in this paper is to set a price collar in the EU ETS with lower and upper boundaries. This is likely to reinforce the long-term credibility and reliability of the price signal. In addition, a price for GHG emissions not covered by the EU ETS has to be set. If additional market failures prevent the market from functioning efficiently, specific policy instruments related to innovation and technology diffusion should be implemented in addition to carbon pricing. Carbon leakage could be addressed through tailor-made trade policies. In parallel, increasing the coalition of countries included in the carbon pricing should remain a priority. This reform package would bring the EU ETS back to life, while avoiding a relapse into potentially costly and inefficient national climate and energy policies.

Keywords: EU ETS, Emissions Trading, Carbon Price, Price Collar, Market Stability Reserve, Credibility

JEL Classification: Q42, Q48, Q54, Q58

Suggested Citation

Knopf, Brigitte and Koch, Nicolas and Grosjean, Godefroy and Fuss, Sabine and Flachsland, Christian and Pahle, Michael and Jakob, Michael and Edenhofer, Ottmar, The European Emissions Trading System (EU ETS): Ex-Post Analysis, the Market Stability Reserve and Options for a Comprehensive Reform (September 19, 2014). FEEM Working Paper No. 79.2014. Available at SSRN: https://ssrn.com/abstract=2499457 or http://dx.doi.org/10.2139/ssrn.2499457

Brigitte Knopf (Contact Author)

Mercator Research Institute on Global Commons and Climate Change (MCC) ( email )

Torgauer Straße 12-15
Berlin, 10829
Germany

Nicolas Koch

Mercator Research Institute on Global Commons and Climate Change (MCC) ( email )

Torgauer Straße 12-15
Berlin, 10829
Germany

University of Hamburg ( email )

Von-Melle-Park 9
Hamburg, 20146
Germany

Godefroy Grosjean

Potsdam-Institut für Klimafolgenforschung (PIK) ( email )

Telegrafenberg 31
Potsdam, Brandenburg 14473
Germany

Sabine Fuss

Mercator Research Institute on Global Commons and Climate Change (MCC) ( email )

Torgauer Straße 12-15
Berlin, 10829
Germany
49303385537224 (Phone)
303385537224 (Fax)

HOME PAGE: http://www.mcc-berlin.net

International Institute for Applied Systems Analysis (IIASA) ( email )

Schlossplatz 1
Laxenburg, 2361
Austria

HOME PAGE: http://www.iiasa.ac.at

Christian Flachsland

Potsdam-Institut für Klimafolgenforschung (PIK) ( email )

Telegraphenberg
Potsdam, Brandenburg 14412
Germany

Michael Pahle

Potsdam Institute for Climate Impact Research (PIK) ( email )

Telegrafenberg 31
Potsdam, Brandenburg 14473
Germany

Michael Jakob

Potsdam Institute for Climate Impact Research ( email )

Telegraphenberg
Potsdam, Brandenburg 14412
Germany

Ottmar Edenhofer

Potsdam Institute for Climate Impact Research (PIK) ( email )

P.O. Box 601203
14412 Potsdam, Brandenburg
Germany

Mercator Research Institute on Global Commons and Climate Change (MCC)

Torgauer Straße 12-15
Berlin, 10829
Germany

Technische Universität Berlin (TU Berlin)

Straße des 17
Juni 135
Berlin, 10623
Germany

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