System responsiveness and the European Union Emissions Trading System
This paper argues in favour of a reform of the European Union Emissions Trading System (EU ETS) that makes the system more responsive to unexpected price shocks. The paper proposed rules based mechanism for withdrawing and injecting allowances from the market based on price trends.
- Following the 2008 economic recession, the price of European Union Allowances (EUAs) unsurprisingly dropped, following a fall in demand. However the low price has persisted despite mild economic growth within Europe since the beginning of the crisis.
- Policy regulators are currently unable to respond to unforeseen changes in economic circumstances, technology advancement and complementary policies that generate downward price pressure.
- The decision by the European Commission to temporarily withdraw 900 million EUAs from the market will have little impact on the long term market price expectation. Other one-off measures would also leave the system vulnerable, addressing the symptoms but not the cause of structural weakness in the system.
- What is needed is a responsiveness mechanism that enables the European Commission to respond to unanticipated shocks.
- This ‘rules-based reserve management mechanism’ would have a double trigger system in place. A price trend ‘trigger’ to determine when intervention would be needed, and a volume ‘trigger’, that would determine the amount of EUAs to inject or withdraw.
- This would encourage self-adjusting behaviour from market participants, anticipating an intervention by looking at the price trend over the specified period, thus acting in their own interest to buy, sell or banking their EUAs in advance of an intervention. This behaviour would help regulate the supply-demand balance of the market which would effectively limit the need for an intervention to exceptional circumstances.