Conference Agenda

The European Union's carbon market is characterized by significant fragmentation and overlap: the EU's carbon budget is divided among the EU Emissions Trading System (EU ETS), the Effort Sharing Regulation (ESR) at the national level, and the impending second emissions trading scheme for buildings and road transport (ETS2); emissions covered by the ETS2 also fall completely under the ESR, resulting in double regulation. We develop a multi-country multi-sector general equilibrium model of the EU carbon markets to conduct both positive and normative economic analyses of the current and future architecture of carbon pricing in the EU. We show that the double regulation between the ETS2 and ESR may undermine the effectiveness of the new ETS2 and lead to an implicit upper bound on the equilibrium price of carbon in ETS2. This upper limit is zero if the emission reduction mandates under the ESR are not binding for all countries, which we demonstrate to be the case empirically given the overallocation of emissions budgets for some European countries. In the absence of trading in ESR emission allowances, the double regulation hinders the reduction of carbon price fragmentation, foregoing macroeconomic efficiency gains of 16-22%, reductions in the ETS2 carbon price of 80%, and welfare gains for essentially all Member States. Despite the non-integrated EU ETS and ETS2 systems, an effective ETS2 would achieve 81-98% of the maximum efficiency gains possible with a single carbon price across Europe.

On top of deep decarbonisation, carbon dioxide removal (CDR) is considered instrumental to limit global warming to well below 2 °C. So far, the economic literature on CDR policies has mostly looked at efficiency aspects from both a theoretical and a model-based perspective. Another research strand has discussed the governance of CDR policies, where a central question is time consistency - i.e. whether policymakers can credibly commit to long-term CDR policies. Reconciling these ideas, in the conceptual part of this work, we map out a long-term vision for CDR, then follow the policy backward induction approach to develop a sequencing pathway to get there. In the EU, one option is to integrate Bioenergy Carbon Capture and Storage (BECCS) and Direct Air Carbon Capture and Storage (DACCS) into the emission trading system (EU ETS). With price levels expected under the ETS, removal technologies could play an important role to offset hard-to-abate emissions, effectively creating a ceiling for allowance prices. In addition, the expectation of removal technologies entering the system alone could already affect investment decisions on costly mitigation well before such a ceiling materialises. Given the uncertainties around CDR availability at scale, however, the importance of such effects remains unclear. In the numerical part of this work, we therefore employ an extended version of the linear optimisation model LIMES-EU to assess when and to what extent DACCS and BECCS can be expected to enter the EU's carbon market. We also investigate the resulting impacts on emission allowance prices. We calibrate the model based on recent cost data for three DACCS technologies, using experience curves to project cost reductions with increased deployment. Preliminary results underline that, by 2040, DACCS and BECCS could indeed become an alternative solution for high-cost mitigation options. Removal volumes deployed are large enough to affect EUA prices from then onwards. We discuss policy implications for both the initial steps of the sequencing pathway, as well as the long-term vision for CDR in the EU.

Sectoral and firm-level heterogeneity in behavior and response to carbon pricing is paramount for policy-making, notably as carbon prices are bound to rise. Yet a formal understanding of the drivers of heterogeneous behaviors in intertemporal allowance markets is wanting, largely because models consider a representative firm for tractability. To remedy this, we develop a stochastic allowance market model with firm heterogeneity and intertemporal trading. We analytically study the determinants of firms’ banking decisions as a function of their heterogeneous characteristics (i.e., abatement cost, discount rate, risk aversion degree, emission shock, initial endowment) and the impact of hedging on allowance price formation. This allows us to show how the representative firm assumption is fairly restrictive. We next characterize how the introduction of both futures trading and a market-maker affects banking and hedging choices. This allows us to investigate the partial substitutability between futures trading and banking, and to rationalize a long-standing cost-of-carry puzzle whereby futures are persistently more expensive than spot allowances.

This paper is essentially based on the assumption that policies supporting investment in intermittent renewable technologies cannot be contingent on meteorological events causing this intermittence. This decisionwas taken by most policymakers to avoid overly complex policy prescriptions. But in doing so, the first-best energy mixmay be out of reach. We compare, in a unified second-best setting, the feed-in tariff, renewable premiums and tradable green certificates policy. We consider a “two-period, S-state” model. The S states reflect intermittency. Production decisions for renewable electricity are taken prior to the resolution of the uncertainty while the fossil fuel sector adjusts its decision in each state. Retailers buy electricity on a state dependent wholesale market which they deliver to consumers according to a fixed-tariffor a real-time-pricing contract. All these elements matter in the efficiency assessment of these policies