The EU Emissions Trading Scheme: Disentangling the Effects of Industrial Production and CO2 Emissions on Carbon Prices

Abstract

This article critically examines the impact of industrial production for sectors covered by the EU Emissions Trading Scheme (EU ETS) on emissions allowance spot prices during Phase I (2005-2007). Using sector production indices and CO2 emissions compliance positions dened by a ratio of allowance allocation relative to baseline emissions, we show that the eect of industrial activity on EU carbon price changes shall be analysed in conjunction with production peaks and compliance net short/long positions at the sector level. The results extend previous literature by showing that carbon price changes react not only to energy prices forecast errors and extreme temperatures events, but also to industrial production in three sectors covered by the EU ETS: combustion, paper and iron.

Modeling persistence of carbon emission allowance prices

“…Some recent studies have focused on the efficiency of carbon emission markets (see, for example, Daskalakis and Markellos, 2008;Joyeux and Milunovich, 2010;Charles, Darné and Fouilloux, 2011); determinants of CO 2 allowance prices (see, for example, Alberola et al, 2007Alberola et al, , 2008aChevallier, 2009;Hintermann, 2010;Hitzemann andUhrig-Homburg, 2013 andHammoudeh et al, 2014a,b among many others), comovements of carbon allowance prices and the prices of other financial assets (see, for example, Chevallier, 2011a,b), while other studies have analyzed the relationship between carbon spot and futures prices (see, for example, Uhrig-Homburg and Wagner, 2009;Joyeux and Milunovich, 2010;Chevallier, 2010;Arouri et al, 2012 andRittler, 2012, among others).…”

“…Some papers that analyze price drivers of CO 2 emission allowance prices are Alberola et al (2007Alberola et al ( , 2008a, Chevallier (2009), Hintermann (2010, Kim and Koo (2010), Hitzemann and Uhrig-Homburg (2013), Wang et al (2013) andHammoudeh et al (2014a,b) among many others. Price drivers of CO 2 emission allowances are temperature (Alberola et al, 2008a;Hinterman, 2010), prices of fuel, crude oil, coal and natural gas (Alberola et al, 2008a;Hintermann, 2010;Kim and Koo, 2010;Hammoudeh et al, 2014c), macroeconomic variables, production structures change and population growth (Chevalier, 2009;Conrad et al, 2012;Wang et al, 2013).…”

Understanding the Link Between Aggregated Industrial Production and the Carbon Price

“…These first stylized analyses are due to Alberola et al (2008Alberola et al ( , 2009, who provide the first rigorous econometric exercises aimed at disentangling the potential impacts ranging from production to environmental conditions on carbon prices. By instrumenting industrial production indices at the EU ETS sector-level, the authors show empirically that fluctuations in the level of economic activity are a key determinant of the level of carbon price returns in the combustion, paper and iron sectors (which account for nearly eighty percent of allowances allocated), and in four countries (Germany, Spain, Poland, UK).…”

“…The "macroeconomic" approach: in this category, we will find the early work by Alberola et al (2008Alberola et al ( , 2009, as well as a series of new studies.…”

Carbon Price Drivers: An Updated Literature Review

“…Based on the characteristics of the global economic context and changes in industrial production in EU ETS sectors during 2005, Alberola et al (2008b) provide the first rigorous econometric exercises aimed at disentangling the potential impacts ranging from production to environmental conditions on carbon prices. This relationship may be understood intuitively: as industrial production increases, associated CO 2 emissions increase, and therefore more CO 2 allowances are needed by operators to cover their emissions.…”