Putting a Price on Carbon – Econometric Essays on the European Union Emissions Trading Scheme and its Impacts

This dissertation examines the main instrument of the European Union climate policy, the emissions trading scheme (EU ETS) during its first years. Emission trading provides a cost-efficient way to reduce emissions. It creates a price on carbon dioxide and thereby incentives for cleaner production. The four empirical studies in this dissertation provide new information on the price determination in the emissions trading market, market efficiency and market interactions with the electricity markets. This information is useful for many purposes. It benefits the market participants who make choice between trading of emission allowances in the market and abatement of emissions. For the authorities and policy planners the price signal and the efficiency of the markets reveal unique real-time information on marginal abatement costs, impacts of policy decisions and impacts of institutional design of this policy instrument. To be a well-functioning policy instrument the EU ETS should create a credible price signal and efficient markets for trading allowances. The objective of this dissertation is to analyze the EU ETS markets and the price of the European Union emissions allowance, EUA, with econometric time series models. A large data set on market fundamentals is used to analyze the price series. The results of this dissertation reveal that EU ETS is functions well. Carbon has a price that reflects to a large extent the market fundamentals in the study period. The markets are maturing even if not fully informational efficient yet. Interactions with electricity markets are close. The impact of price of carbon on the price of electricity is positive but spatially uneven. In the long run, also climate change affects the electricity bill. The first study of this dissertation investigates the price determination in the market. The empirical results based on years 2005–2011 show that the price of the EUA is largely determined by the market fundamentals. Especially the price of coal, gas, oil and the price of German electricity are reflected in the price of EUA. In the second study we build up forecasting models and use a trading simulation to study the informational efficiency of the market. Results reveal that the market is not fully efficient but maturing. There might have been possibilities to make economic profit during the second period in the EU ETS market. The last two papers focus on the interaction of emissions trading with electricity markets. The third study looks at the impact of EUA price on the integrating European electricity markets. The electricity markets are integrating but the positive impact of carbon price on the electricity price is uneven depending on the fuel mix in regional electricity markets. The last study analyses the impact of increasing mean temperature due to climate change and the EUA price on the electricity bill in the EU. Warming climate affect the electricity bill unevenly: in the southern European countries the bill is expected to increase due to the increased demand for cooling, whereas the northern and central parts of the continent may face decreasing costs as the winters get warmer.