The protracted process to get EU ETS backloading reforms passed over 2012-2014 failed to build expectations amongst participants for higher carbon prices, according to a study by four academics in Germany and Austria published Wednesday.
“Our results unequivocally support the view that political attempts to anchor higher price expectations by temporarily withdrawing allowances have failed,” said the paper, published on the Social Science Research Network website.
“Although backloading was suggested as a measure to stabilize prices, we provide strong evidence that the backloading decision process caused substantial price declines,” the paper said.
The researchers studied the price impacts following some 29 EU ETS regulatory announcements relating to allowance supplies between 2008 and 2014, in the first comprehensive investigation into whether and how prices respond to such information in the world’s largest cap-and-trade system.
They found that announcements about longer-term measures had very little market impact.
SUPPLY GLUT
The European Commission published its backloading proposal in 2012 in response to a drastic slide in EU carbon prices from their peak above €30 in 2008. The scheme’s rigid rules prevented adjustment in the supply of allowances as demand crashed due to the bloc’s economic downturn.
Backloading was only introduced after various other ideas, such as deepening the EU’s overall emissions cut target or cancelling allowances, were dismissed as political unfeasible amid concerns they could hamper the bloc’s fragile economy.
Despite the build-up of a massive allowance that still stands at more than 2 billion units – or more than a year’s worth of supply – prices did not fall to zero as traders anticipated lawmakers would step in to revive the market.
The Commission maintained that backloading was introduced as a stopgap measure to curb new supply coming into the already-inundated market, and was not an explicit attempt to raise EUA prices or price expectations.
WILD PRICE SWINGS
“In such a situation, expectations about the future supply-demand balance are the only driver of price formation and news about the supply schedule are a pivotal element of expectation formation,” the paper said.
As a result, EUA prices experienced daily fluctuations ranging from -43% to +18%, as market participants scrambled to interpret legislative developments and a seemingly wavering appetite for reforming the market, the study found.
Prices for the benchmark front-year futures were trading above €6 when the backloading strategy was revealed in early 2012, but despite the wild volatility they were trading below that level when the measure was finally approved by EU lawmakers in Feb. 2014.
The paper titled ‘Regulatory Events as Catalysts for Price Formation Under Cap-and-Trade’ was written by Nicolas Koch of the University of Hamburg, Godefroy Grosjean and Ottmar Edenhofer of the Potsdam Institute for Climate Impact Research, and Sabine Fuss of the International Institute for Applied Systems Analysis in Austria.
Front-year EUA price (€) and backloading-related news.
By Ben Garside – ben@carbon-pulse.com
