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Drawing lessons from the unwieldy reforms of EU-ETS:
Combining price and quantity management
Christian de Perthuis
Professor at Paris-Dauphine University
European University Institute
Florence School of Regulation - Climate, Tuesday 9 May 2017

2
Outline
 Do we need a carbon price signal ?
– Short term: A comparison between the UK and Germany
– Long term: “Carbon rent” versus Oil rent
 Lessons from past experience
– A brief history of EU-ETS
– The three main drivers of EU-ETS shortcomings
– Challenges of the reform
 Combining Price and Quantity-based Management
– Limits of the current reform
– Restoring the carbon price signal through a price-corridor
– Political feasibility ?
– Medium term possible co-benefits

Do we need a carbon price signal ?
– Short term: A comparison between the UK and Germany
– Long term: “Carbon rent” versus Oil rent

4
EU ETS emissions since 2005 : Germany vs. UK
50
60
70
80
90
100
110
120
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
ETSemissions(aviationexcl.)-Base100=2005
Germany UK
Impact of UK carbon price floor (introduced in 2013)
Source: Climate Economics Chair, EUTL data

5
The economics of oil rent
Oil price ($/bbl)
investments
20
200
Conventional
Deposits
Offshore &
Oil Shales
Extreme
Conditions (Ex : Arctic)
Source : Climate Economics Chair

6
The economics of « Carbon Rent »
Carbon price (€/tCO2)
investments
20
200
Coal phase-out
Oil phase-out
Natural gas
pase-out
Possible impacts
of CCS ?
Conventional
Unconventional
Source : Climate Economics Chair

Lessons from past experience
– A brief history of EU-ETS
– The three main drivers of the EU-ETS shortcomings
– Challenges of the reform

8
A brief history of EU-ETS
Source: Climate Economics Chair
? (UK?)

9
A brief history of EU-ETS : three main results
 More Complexity
– Ex: Rules for free allocations
– Ex: Rules for the use of auction revenues
– Ex: Rules for the projected « stability reserve »
– Complexity is costly!
 Less flexibility
– Impossibility of adjusting the cap within a phase
– A major governance issue: How to manage unexpected shocks?
 Less predictability
– Ex : Uncertainty on the cap
– Ex : how to anticipate future carbon prices?

10
What is your carbon price anticipation ?
0
5
10
15
20
25
30
35
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
€/tCO2
EUA Phase 1 (Spot) EUA Phase 2 et 3 (Futures Dec. Year+2)
Climate
Energy
Package
2020
Economic
crisis
Proposal for a
Directive on Energy
Efficiency
Climate Energy
Package 2030
and Market
stability reserveBackloading
debateSurplus
Phase 1
EUAs
cannot be
used in
Phase 2
Brexit
Source: Climate Economics Chair from Bluenext and ICE ECX Futures

11
Three main drivers of the current shortcomings
 An over-estimation of the baseline emissions
– Uncertainty over the economic environment and technical change
– A frequent situation (Ex : Rggi, Chinese pilots, Korea, …)
– A major problem of asymmetric information !
 The uncontrolled entry of Kyoto certificates (2009-2012)
– An increasing gap between the “official cap” and the actual cap
– A general issue: does market linkage reduce ambition?
 A lack of coordination with other policy tools
– Most of the EU abatement results from other policies
– An overlap of instruments: a frequent situation (Cal., SO2,…)
– A major issue of governance, especially in a 28 member states EU

12
The challenges of the reform
 Providing:
– More simplicity
– Less rigidity
– More predictability
 Curing the illness, not the symptoms :
- How to face uncertainty over the baseline ?
- Coordination with the rest of the world
- Coordination with other policy instruments

Combining Price and Quantity-based
Management
– Limits of the current reform
– Restoring the carbon price signal through a price-corridor
– Political feasibility ?
– Medium term possible co-benefits

14
Limits of the current reform
 The « Reform » under discussion:
– Introduction of a Market Stability Reserve (MSR)
– With a bias towards a “pure” quantity-based management:
• No explicit carbon price targets or price triggers ;
• The “Surplus” as a threshold triggering quota withdrawal ;
• An “automatic” adjustment of the cap.
 The ZEPHYR model simulations : risks of more instability
 Can a pure quantity-based management be implemented?
– Short term: action thresholds should be carbon prices
– Medium and long term: A quantity-based management requires
a new governance with the equivalent of a “Carbon Central
Bank”.

15
Restoring the carbon price signal through a price-corridor
 Substituting the “quantity” corridor by a “price” corridor
– Already existing and working (Cal, Rggi, …)
– Technically easy to implement
– Between the thresholds: a quantity-based mechanism
– At the threshold: a price-based mechanism
 What would happen with a price floor at 30 €/tCO2?
– A quasi-tax mechanism (price at the floor) that could last
– Limited adverse effects of an overlap with other policies
– EU-ETS could be compared to other schemes sending an actual
carbon price reference

16
Carbon pricing worldwide, in 2016
Source : World Bank, Carbon Pricing State and Trends

17
Political feasibility?
 Transforming C&T into a quasi-tax scheme involves costs:
– Legal risk
– Huge distribution effects between countries
– Impacts on the cost of energy
– Possible international carbon leakage for covered sectors?
 A major issue: the level of the price-corridor
– Using the social cost of carbon?
– Empirical cost-efficiency approach?
– No perfect formula and the need for pedagogy and specific
governance

18
Social cost of carbon (Computed by US Government Agencies)

19
Coal-to-gas switching price zone (2008-2017)
-20
-10
0
10
20
30
40
50
60
70
80
90
100
110
120
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
€/tCO2
Siwtching price zone CO2 Allowance price
Carbon price
Source: Climate Economics Chair from ICE data

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Possible medium term co-benefits
 1990: first attempt to price carbon through taxes
 Since 2005, three situations coexist for EU CO2 emissions:
– Energy & Industry: EU ETS (~50 %)
– Other sectors: domestic carbon taxes (~20%)
– Other sectors: no cost associated to emissions (~30%)
 A robust carbon price corridor could help moving towards a more
unified system

Références
 Bennear, L.S., Stavins, R.N. (2007). Second-best theory and the use of multiple policy
instruments. Environmental and Resource Economics 37, 111-129.
 De Perthuis, C., Trotignon R. (2014). Governance of CO2 markets: Lessons from the EU
ETS, Energy Policy, 75, 100-106.
 De Perthuis, C., Solier, B., Trotignon R. (2016). How should the EU ETS be reformed
following the Paris agreement and Brexit?, Climate Economics Chair Policy Brief, July
2016.
 Goulder, L.H. (2013). Markets for tradable pollution allowances: what are the (new)
lessons ? Journal of Economic Perspectives 27 (1), 87-102.
 Murray, B.C., Newell, R.G., Pizer, W.A. (2008). Balancing Cost and Emissions Certainty: An
Allowance Reserve for Cap-and-Trade, Review of Environmental Economics and Policy
3(1), 84-103, Winter.
 Pizer, W.A. (2002). Combining price and quantity controls to mitigate global climate
change. Journal of Public Economics 85, 409–434.
 Solier, B., R. Trotignon (2016). The impacts of introducing a CO2 floor price in the
electricity sector. Climate Economics Chair, Informations et Débats, June 2016.
21

Thank you for your attention
For more information,
please visit the Climate Economics Chair website:
http://www.chaireeconomieduclimat.org

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Drawing lessons from the unwieldy reforms of EU-ETS: Combining price and quantity management

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Drawing lessons from the unwieldy reforms of EU-ETS: Combining price and quantity management