In 2016, the price of emission allowances under the EU Emissions Trading System was about 5 euro per ton CO2, which is much lower than previously expected. Introducing a price component to the ETS will structurally support the carbon price and hence provide incentives for investments in low-carbon technologies.
We analysed the effects of various options to support allowance prices in the EU Emissions Trading System (ETS), such as adjusting the cap, setting an auction reserve price, and introducing fixed and variable carbon taxes in addition to the EU ETS.
Adjusting the cap
Tightening the cap, as proposed by the European Commission in 2015, will cause carbon prices to increase, but would not make the EU ETS more robust to, for instance, future recessions. The effect of the market stability reserve, that was adopted in 2015, on the allowance price is also uncertain.
Introducing a price component to the ETS would structurally support carbon prices within the EU ETS. Setting a price floor, either by an auction reserve price or by a (variable) tax complementary to the EU ETS, directly addresses price certainty. Such price-based policies still benefit from the intertemporal flexibility through the banking provision in the EU ETS by re-allocating emissions over time with stronger emission reductions in early years and emission increases in later years.
We conclude that options that guarantee an effective minimum price for CO2 would provide incentives for early investments in low-carbon technologies, which would be required from the perspective of the EU long-term objectives of a low-carbon economy. Moreover, a minimum price for EU emission allowances reduces uncertainty about the future carbon price trajectory, which is particularly helpful for investors in low-carbon technologies involving long-term time horizons, even when the minimum price is never binding.
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