1. Does the spread between coal and gas prices affect the price of EU emissions allowances? IAFA Conference NUI Galway, May 2012 Peter Deeney

2. IAFA 2012 NUI Galway2 Contents What’s an Emission Allowance? What Changes Price? Data Regression Analysis Conclusion

3. IAFA 2012 NUI Galway3 Emission Allowances Permission to emit one tonne of CO 2.

4. IAFA 2012 NUI Galway4 Emission Allowances Permission to emit one tonne of CO 2.........How much should this cost?

5. IAFA 2012 NUI Galway5 Emission Allowances  European Emission Allowances - EUAs  Certified Emission Redutions - CERs.  Emission Reduction Units – ERUs.

6. IAFA 2012 NUI Galway6 Emission Allowances  European Union Emission Allowances EUAs  Issued by EU ETS, soon to be auctioned rather than given out for free.  Quantity capped and agreed years in advance.

7. IAFA 2012 NUI Galway7 Emission Allowances  Certified Emission Reductions CERs  Issued by UN to non Annex countries so that CO 2 reductions can be achieved in developing countries.  Problem with additionality.  Presently flooding market and dropping EUA prices.

8. IAFA 2012 NUI Galway8 Emission Allowances  Emission Reduction Unit ERU  Created in the Annex countries. Less worry about delivery.

9. IAFA 2012 NUI Galway9 Emission Allowances  Cap puts a limit on the amount of GHG from regulated emitters in EU.  Trade allows free trading of these allowances so that emitters can reduce their own GHG emissions and sell their allowances, or not reduce their own and buy emission allowances from elsewhere.

10. IAFA 2012 NUI Galway10 What changes the price?  Scarcity

11. IAFA 2012 NUI Galway11 What changes the price?  Scarcity  (Perception of high activity or cheap fuel)

12. IAFA 2012 NUI Galway12 What changes the price?  Scarcity  Abundance

13. IAFA 2012 NUI Galway13 What changes the price?  Scarcity  Abundance  (Perception of low activity or over allocation.)

14. IAFA 2012 NUI Galway14 Contents Emission Allowances Changes in Price Literature Data Methods Conclusion

15. Chevallier, J. (2009) Carbon Futures and Macroeconomic Risk Factors: a view from the EU ETS  Fuel switching is more important for EUA prices than macro-economic variables. IAFA 2012 NUI Galway15

16. Chevallier, J. (2011) A Model of Carbon Price Interactions with Macroeconomic and Energy Dynamics  Returns on carbon futures are influenced by  equity dividend yields and  junk bond premiums IAFA 2012 NUI Galway16

17. Delarue et al. (2008) ‘Fuel Switching in the Electricity Sector under the EU ETS: Review and Prospective’  Focuses on abatement in European electricity generation and finds that the spread between gas and coal and the load required are larger influences than EUA prices on the level of reduction of CO 2. IAFA 2012 NUI Galway17

18.  Increasing Gas – Coal spread should decrease use of gas increase use of coal, increase GHG,  Increase EUA price.  Increasing Stoxx should increase expected GHG and increase EUA price.  Increasing Brent should reduce oil used as fuel, reduce GHG output and reduce EUA. IAFA 2012 NUI Galway18

19.  Increase Consumer Goods indicates increased use and purchase, hence increased GHG, increased EUA IAFA 2012 NUI Galway19

20.  Brent  Consumer  Spread  Stoxx IAFA 2012 NUI Galway20

21. IAFA 2012 NUI Galway21 Data 13 th March 2010 to 14 th March 2012 DataStream Brent Crude Futures, US$, Stoxx, NBP Gas, European Consumer Goods Price Index, ICE 3Month Futures prices for AP12 coal Rotterdam. All prices were converted to Euro, futures were discounted at Euribor rate

22.  EUA are not physically needed,  Required in March by regulated emitters.

23.  https://www.theice.com/marketdata/reports/ ReportCenter.shtml#report/10 https://www.theice.com/marketdata/reports/ ReportCenter.shtml#report/10

24. IAFA 2012 NUI Galway24

25.  The quoted marginal costs are in Delarue and D’haesseleer (2007) in the International Journal of Energy Research, and state that the marginal cost of electricity using coal is 0.67 that of electricity using gas.  The two time series of coal and gas prices were adjusted to have the ratio of their means equal to 0.67. IAFA 2012 NUI Galway25

26.  Check for spurious regression. The usual method is to avoid spurious regression is to check the first differences of the data. A more sophisticated method is to check for non- stationarity (ADF) and then check for co- integration (Johansen).  Multiple Comparison Problem a test with a significance of 5% will be wrong 5% of the time. IAFA 2012 NUI Galway26

27.  The p value is the probability of observing the data with the hypothesis that the time series is not stationary. IAFA 2012 NUI Galway27

28.  Two Years  EUA, non-stationaryp= 0.92  ChEUA, stationaryp= 10 -7  Brent,non-stationaryp=0.90  ChBrent, stationaryp= 10 -26  Stoxx,non-stationaryp= 0.53  ChStoxx, stationaryp= 10 -36 IAFA 2012 NUI Galway28

29.  Two Years  Consumer,non-stationary p= 0.61  ChConsumer, stationary p= 10 -9  Spread, non-stationary p = 0.7777, ChSpread, stationary p= 10 -15 IAFA 2012 NUI Galway29

30.  The p value is the probability of observing the data with the hypothesis that there are the rank number of co-integrating vectors. IAFA 2012 NUI Galway30

31.  Two Year EUA, Brent, Consumer, Stoxx and Spread for co-integration as they are all I (1).  Result: Inconclusive  Rank 0p = 0.4270  Rank 1 p = 0.9017  Rank 2 p = 0.9580  Rank 3 p = 0.9246  Rank 4 p = 0.9909 IAFA 2012 NUI Galway31

32. EUA, Consumer, Stoxx and Spread (Brent)  Result: Positive  Rank 0p = 0.075  Rank 1 p = 0.560  Rank 2 p = 0.919  Rank 3 p = 0.828 IAFA 2012 NUI Galway32

33.  Two Year  EUA = 5.54 *** - 0.000976 Brent ***  - 0.00809 Consumer - 0.0143 Spread *+ 0.0715 Stoxx ***  R 2 = 69% IAFA 2012 NUI Galway33

34.  Brent  Consumer  Spread  Stoxx IAFA 2012 NUI Galway34

35. IAFA 2012 NUI Galway35

36.  There seems to be a two phase behaviour in EUA prices. Up to 16 th June 2011 there is reasonably stable prices and after this there is a steady decline. IAFA 2012 NUI Galway36

37.  First Period  EUA, non-stationaryp= 0.82  ChEUA, stationaryp= 10 -6  Brent,non-stationaryp= 0.90  ChBrent, stationaryp= 10 -5  Stoxx,non-stationaryp= 0.61  ChStoxx, stationaryp= 10 -31 IAFA 2012 NUI Galway37

38.  First Period  Consumer,non-stationary p= 0.93  ChConsumer, stationary p= 10 -7  Spread, non-stationary p = 0.77 ChSpread, stationary p= 10 -8 IAFA 2012 NUI Galway38

39.  First Period EUA, Brent, Consumer, Stoxx and Spread for co-integration as they are all I (1).  Result: Positive  Rank 0p = 0.011  Rank 1 p = 0.252  Rank 2 p = 0.540  Rank 3 p = 0.512  Rank 4 p = 0.130 IAFA 2012 NUI Galway39

40.  First Period  EUA = 16.35*** + 0.000827 Brent ***  + 0.0228 Consumer*** - 0.0287 Spread *** - 0.0501 Stoxx ***   R 2 = 40% IAFA 2012 NUI Galway40

41.  Brent  Consumer  Spread  Stoxx IAFA 2012 NUI Galway41

42.  Second Period  EUA, curious p= 0.025  ChEUA, stationaryp= 10 -25  Brent,non-stationaryp= 0.96  ChBrent, stationaryp= 10 -7  Stoxx,non-stationaryp= 0.49  ChStoxx, stationaryp= 0.0069 IAFA 2012 NUI Galway42

43. IAFA 2012 NUI Galway43

44.  Second Period  Consumer,non-stationary p= 0.75  ChConsumer, stationary p= 0.0001  Spread, non-stationary p = 0.63 ChSpread, stationary p= 10 -12 IAFA 2012 NUI Galway44

45.  Second Period EUA, Brent, Consumer, Stoxx and Spread for co-integration as they are all I (1).  Result: Positive  Rank 0p = 0.066  Rank 1 p = 0.228  Rank 2 p = 0.401  Rank 3 p = 0.541  Rank 4 p = 0.882 IAFA 2012 NUI Galway45

46.  Second Period  EUA = 19.34*** - 0.00218 Brent ***  + 0.00592 Consumer - 0.0186 Spread ** + 0.0345 Stoxx *   R 2 = 70% IAFA 2012 NUI Galway46

47.  Brent  Consumer  Spread  Stoxx IAFA 2012 NUI Galway47

48.  The regime modelling displays co-integration  The affect of Brent crude, consumer prices and the Stoxx seem unclear  The affect of the spread Gas – 0.67Coal is to decrease the EUA price. This is consistent across time periods.  Results from Diff and Ch vvvvvvvvvvvvvvvvv IAFA 2012 NUI Galway48

49.  Brent ?  Stoxx ?  Consumer ?  Spread IAFA 2012 NUI Galway49

50. Residuals against Date should not show an interesting pattern.... IAFA 2012 NUI Galway50

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54.  7 peaks over 2 years?  This also happens in the Regime models.  Seasonal  Buy EUA for March  Data – discounting from futures and forwards IAFA 2012 NUI Galway54