Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/41452
Authors: 
Rickels, Wilfried
Görlich, Dennis
Oberst, Gerrit
Year of Publication: 
2010
Series/Report no.: 
Kiel Working Paper 1650
Abstract: 
In 2005, the European Emission Trading Scheme (EU-ETS) established a new commodity: the right to emit a ton of CO2 (EUA). Since its launch, the corresponding price has shown rather turbulent dynamics, including nervous reactions to policy announcements and a price collapse after a visible over-allocation in Phase I. As a consequence, the question whether fundamental factors (fossil fuel prices, economic activity, weather) affect the EUA price remained partially unresolved. Today, being halfway through Phase II (2008-2012) and relying on a more mature market, we use more reliable data to investigate the extent to which allowance price dynamics can be explained by market fundamentals. We empirically test for the influence of fuel prices, economic activity, and weather variations. Fuel prices allow to test for fuel switching from coal to gas, the most important short-term abatement option for most installations in the EU-ETS. The empirical results show a significant influence of gas, coal, and oil prices, of economic activity and of some weather variations. When including the relative price of coal to gas on a forward level, we found evidence of a switching effect. Yet, on a spot level the demand effect seems to dominate. However, when including the absolute coal price the coefficient is positive, contradicting theory with respect to both the switching and the demand effect. The significant weather variations suggest that their influence on EUA prices is less driven by their effect on energy demand but more by their effect on the provision of carbon-free renewable energy. Overall, our results show that the price dynamics are much better explained by a model based on fundamentals than by a purely autoregressive model. However, the results also show that fundamentals alone cannot fully explain price dynamics and that forecasting is improved by the inclusion of time series characteristics.
Subjects: 
Carbon emission trading
EU ETS
Carbon price influence factors
Fuel switching
JEL: 
C22
G14
Q54
Document Type: 
Working Paper

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