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What overallocation at the system level are we facing and what are the perspectives to reform the EU ETS to avoid overallocation in the future? Anne Schopp and Karsten Neuhoff German Institute for Economic Research (DIW Berlin)

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slide1
What overallocation at the system level are we facing and what are the perspectives to reform the EU ETS to avoid overallocation in the future?
  • Anne Schopp and Karsten Neuhoff
  • German Institute for Economic Research (DIW Berlin)
  • Overallocation– a scourge of emission trading systems, Zurich CMA
  • Zurich, 12 March 2014
outline
Outline

Surplus in the EU ETS

Actorsbankingsurplusallowances

Reformingthe EU ETS

slide3

EU ETS surplus

  • 1

Cumulativesurplus

High RenewableEmissions Scenario

3.0

CurrentPolicy Initiative Emissions Scenario

2.0

Reference Emissions Scenario

International CDM / JI creditslinkedtoEU

CO2 surplus allowances in billion tonnes

Time profileofauctions

1.0

Cap minus Emissions

0.0

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Source: Neuhoff, Schopp, Boyd, Stelmakh, andVasa (2012)

actors banking surplus allowances
Actors banking surplus allowances
  • Power sector: sells power on forward contracts up to three years in advance and buy in parallel fuel inputs and CO2 to hedge
  • Industry sector: banks free allowances that are not needed to cover annual emissions
  • Banks: bank allowances and sell forward contracts at 3-5% to cover cost of capital
  • Speculative investors: bank allowances if they can realise their required rate of return 10-15%

Emitter/ Hedger

Arbitrageur/ Speculator

Source: Neuhoff, Schopp, Boyd, Stelmakh, andVasa (2012)

hedging strategies by power generators

100%

Power hedged with non-fossil generation

Power hedged with fossil generation

50%

0%

3 years ahead

2 years ahead

1 year ahead

Hedging strategies by power generators

84%

Percentageofpower hedged

46%

20%

Source: Annual reports 2011, Eureelectric 2010

aggregate hedging corridor
Aggregate hedging corridor

2.0

7.5 € /tCO2

1.6

1.2

CO2 hedgingvolume in billiontonnes

0.8

0.4

0.0

-

5%

0%

5%

10%

15%

Expectedgrowth rate ofcarbonprice

< market rate of 5%

= market rate of 5%

> market rate of 5%

Source: Schopp andNeuhoff(2013)

eu ets surplus vs hedging corridor
EU ETS surplus vs hedging corridor

3

Cumulative

surplus

in EU ETS

Speculative

investment

2

CO2 surplusallowances in billiontonnes

1

Hedging volumeby power sector

0

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Source: Schopp andNeuhoff(2013)

gap between today s price and price expectations
Gap between today's price and price expectations

35

Price in period 2

Speculators

30

entermarketat

15% discount rate

25

Price in period 2

20

Price equilibriums in Euro/tonne

15

Price in period 1

with unlimited banking at 5%

10

5

Price in period 1

withmarketdemandforhedgingandbanking

-

1.0

1.2

1.5

1.7

2.1

2.2

Cumulativesurplusallowances in billiontonnes CO2

Source: Schopp andNeuhoff(2013)

eu ets reform options
EU ETS reform options

3

Cumulativesurplus

Billion tonnes CO2

Backloading 0.9 bn

2

30% CO2 reduction

Reserve price

1

Set aside 1.4 bn

Hedging volumeby power sector

0

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Source: Neuhoff, Schopp, Boyd, Stelmakh, andVasa (2012)

market stability reserve
Market stability reserve

3

Cumulativesurplus

Billion tonnes CO2

2

Hedging volumeby power sector

1

0

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

conclusion
Conclusion
  • Surplus in EU ETS accumulated in Phase II and is estimated to grow
  • CO2 hedging by power sector can absorb surplus some allowances
  • With increasing surplus the discrepancy between today's price and price expectations widens
  • Surplus of allowances in the EU ETS needs to be reduced to a level corresponding to hedging demand