1. The role of carbon pricing Georg Zachmann

2. Key messages  The ETS does largely what it is supposed to do  Credibility is key  Do not start out in a second best-world  More analysis is needed to convince MS that they gain from a “first-best + redistribution” world

3. Agenda 1.Introduction 2.Performance of the ETS 3.Details, Details, Details … 4.EU vs. MS 5.Conclusion

4. Conceptual Framework First best policy adresses individual externalities with optimal solutions

5. Mapping investment barriers to different types of climate investment ExternalitiesPub good Infor prob Behavl failure other barriers Env’t (–) Tech (+) SoS (–) Low- carbon tech PSSPSNP Energy savings SSSNPPN REDDPNNP NNN SequestPSSPSNP P=Barrier of primary importance for the investment at hand. S=Barrier of secondary importance for the investment at hand. N=Barrier of no (little) importance for the investment at hand; or not analyzed in detail. *=Policy failures are potentially very important and, thus, merit a visual representation in the table. However, the grading P, S, and N is not useful for policy failures as it is always important to correct them should they be made. Source: Calthrop, Kolev, Riess, Zachmann (2012)

6. Mapping investment barriers to possible solutions Problems ExternalitiesPub good Infor prob Behavl failure other barriers Env’t ( – ) Tech ( + ) SoS ( – ) Markets Establishing property rights PPNNNNN Creating new marketable goods PNPNSSN Incentives Taxes PNPNNNN Subsidies SPSSSSS Rules Frameworks PPPPPPP* Command & control SNSNPPN Nudge NNNNPPN Enhanced appraisal NNNNPNP* Insurance NNNNPPP** Non-market supply NNSPPNP*** Source: Calthrop, Kolev, Riess, Zachmann (2012)

7. 2. Performance of the ETS 1.Introduction 2.Performance of the ETS 3.Details, Details, Details … 4.EU vs. MS 5.Conclusion

8. ETS emissions by country Crisis year Phase IPhase II Zachmann, Abrell, Faye (2011)

9. ETS constraint emissions Dependant variable Growth rate of emissions (2008- 2007) - Growth rate of emissions (2006-2005) Phase dummy-0.036** changes in turnover0.191*** changes in employment0.0007 Adj R-squared0.17  Emissions dropped more than production  Cap was binding  Not compensated by leakage Zachmann, Abrell, Faye (2011)

10. ETS tightening affected sectors differently Paper and paper products 416 firms Non- metallic minerals 806 firms Basic metals 159 firms Electricty heat 660 firms Phase dummy -0.029-0.087***-0.095*-0.001 Cap-and-trade incentivizes reductions with highest marginal abatement cost -> arguably more efficient than command-and-control Zachmann, Abrell, Faye (2011)

11. But, ETS prices lower than expected 11

12. But, Initial Allocation Matters Dependant variable Growth rate of emissions (2008-2007) - Growth rate of emissions (2006-2005) Total SampleAF 05 <1.15AF 05 >1.15 Phase dummy-0.036**-0.034***0.002 changes in turnover 0.191***0.19***0.21*** changes in employment 0.0007-0.030.07 Adj R-squared0.170.210.23 The tighter cap in Phase II was effective since emissions decrease Under allocated companies in allowances for 2005 reduced their emissions the most Zachmann, Abrell, Faye (2011)

13. Profit Margin 2004-20052004-2008 Impact of EU ETS-0.53-0.51 * Under allocated firms (AF<1) Impact of EU ETS-0.22-1.95 * Over allocated firms (AF>1) Impact of EU ETS2.14*2.32 * But, Huge Windfall Profits  Overallocated firms have benefited significantly from the EU ETS in terms of profitability  Underallocated Firms did lose  Overall effect surprisingly slightly negative Zachmann, Abrell, Faye (2011)

14. 3. Details, Details, Details … 1.Introduction 2.Performance of the ETS 3.Details, Details, Details … 4.EU vs. MS 5.Conclusion

15. Details, Details, Details …  There are a number of details that determine the performance of the EU ETS –Cap –Initial allocation –Coverage –Dealing with leakage –Locking in prices –…  All of them are disputed

16. Detail 1 – Cap  Present –~2 bn allowances –-1.74 %  Future –Keep the path and –Change the path now (e.g., 2020, 30%) –Change the path in the future (e.g., 2030, 40%)

17. Detail 2 – Initial allocation  Grandfathering  Benchmarking  Auctioning

18. Detail 3 – Coverage  Widen: Inclusion of more sectors in the ETS  Deepen: strengthen the long-term price signal in the ETS  Enlarge: link to foreign systems

19. Detail 4 – Leakage  Indirect leakage cannot be tackled  Proposals for direct leakage: –Free allowances –Border adjustment taxes (imports or imports+exports) –Carbon consumption tax –Allowance based system  Risks: –Trade wars (see aviation) –Industrial policy –Overly complex mechanisms (calculating life-cycle emission ?)

20. Detail 5 – Fixing prices Different price targets  Floor price, price Collar, price Ceiling  €0-€100  Fixed or moving limit Methods  Taxes  Managing the annual or period cap  Option contracts

21. 4. EU vs. MS 1.Introduction 2.Performance of the ETS 3.Details, Details, Details … 4.EU vs. MS 5.Conclusion

22. Distributive Effects of European Climate Policy The three main policies (RES, ETS, EE) affect member states differently

23. ETS: Central Europe has the highest potential for reducing emissions but is also most vulnerable 23 Source: Zachmann (2011)

24. ETS: 2013 allocation rules to compensate primary effects 24 Source: Zachmann (2011)

25. RES: Differing competitiveness (RCA) Wind Turbines 2008Solar Cells 2008

26. RES: Differing Support levels 26 RES support levels in a cross-section of EU countries (low,mean,high in €/MWh) Source: CEER 2011

27. RES: Differing Support policies 27 Source: IEA 2012; EcoFys, Fraunhofer ISI, TU Vienna EEG, and Ernst &Young Report: “Financing Renewable Energy in the European Energy Market” Deployment

28. 5. EU vs. MS 1.Introduction 2.Performance of the ETS 3.Details, Details, Details … 4.EU vs. MS 5.Conclusion

29. Conclusion The big horse-trading:  Burden sharing  Effort sharing  Initial allocation  … There are a lot of pretty un-distorting redistribution schemes Do not start out in a second best-world More analysis is needed to convince MS that they gain from a “first-best + redistribution” world

30. Example: De-risking low-carbon investments  Public bank auctions put options to investors  Investor will choose a hedging strategy  Investor get‘s payoff if carbon price is too low  ETS exposure on the balance sheet of public banks increases credibility of the ETS for all mkt participants 30 Strike 20102015202020252030 ETS Price Examples for an Asian option 2020 to 2030 No payoff Average ETS price higher than strike payoff Average ETS price lower than strike