📄💡 New paper published in Nature Energy showing that the ten-fold surge of carbon prices in the EU emissions trading system (EU-ETS) over the last five years were not only due to tighter emission caps, but also due to increased political commitment, which made firms more farsighted.
in short: *Policy credibility is a key component for an effective and efficient EU emissions trading system!*
💡 The EU-ETS is one of the central policy instruments to reduce GHG emissions in the EU. Over the course of two large reforms over the last five years, prices surged ten-fold.
❓📈 Why did carbon prices in the EU-ETS increase so strongly?
❓🔭 Does it matter for carbon prices whether firms only care about the current trading period, or whether they also consider the future certificate scarcity after 2030?
❓⚙ Can we use the unique opportunity of the two major ETS reforms and the resulting price increases to test how farsighted firms were in the past?
🛠💻⚙ We used the power sector/EU-ETS model LIMES-EU to model carbon prices emerging from the pre- and post-reform emission caps under two different model settings. One setting assumed that firms were farsighted and considered future scarcities; the other setting assumed that actors focused on the short-term.
💡⚡ We find that the price change following the EU ETS/MSR reform in 2018 is *not* mainly due the change of the emission cap as widely assumed. The full price increase can only be explained if the reform also has made actors more farsighted.
🔭 In general, if actors do not consider the long-term cap on emissions to be credible, they will minimize their costs to achieve the short-term cap only, missing intertemporally efficient emission reductions and potentially creating stranded assets from misinvestments.
💲💲 The price effect of policy credibility is substantial, as near-term price levels in a farsighted market (high credibility) are about *three times higher* than in a short-sighted market (low credibility).
👍💪 The Fit-for-55 package tightened the emission cap a lot, elevating prices to a level of around 80 €/tCO2, consistent with what model results suggest is dynamically cost-effective.
Going beyond the paper itself:
⚠ 📜 Policymakers should take precautions to sustain high credibility and strengthen commitment if prices drop again to levels that signal low credibility – as happened in the last months 📉
🔥 Better refrain from actions that undermine policy credibility, such as trying to raise funds by auctioning additional allowances (REPowerEU 👀) - this can undermine market actor's trust in long-term stable caps. If this damages policy credibility, the strong drop in carbon prices could lead to *lower* total auction revenues!
Check out the paper (open access): https://lnkd.in/emJ52Gm8
#EUETS
Many thanks for the great collaboration Joanna Sitarz, Gunnar Luderer, Sebastian Osorio and Michael Pahle !
PIK - Potsdam Institute for Climate Impact Research
