LIFE DICET’s Report “Emissions Trading Systems with different price control mechanisms: implications for linking”

A post by Albert Ferrari


The report “ETSs with different price control mechanisms: implications for linking – Report for the Carbon Market Policy Dialogue“ published in November 2020 is a main output of the project LIFE DICET.

This report was prepared to inform the Carbon Market Policy Dialogue (CMPD) between the European Commission, as the regulator of the EU Emissions Trading System, and the regulatory authorities for the emissions trading systems (ETSs) of California, Québec, China, New Zealand, and Switzerland.

The report offers a conceptual framework to characterise price control mechanisms (PCMs), i.e. the design features of ETSs meant to tackle price uncertainty. It also summarises the relevant scientific literature; it describes the current status of the six ETSs represented in the CMPD and, finally, it offers up a few ideas for discussion.

Most existing Emissions Trading Systems (ETSs) include their own specific Price Control Mechanism (PCM): this feature which steers the allowance price into a desired range has been identified in the project LIFE DICET as a key topic to cover in light of its implications for ETS linking. This report identifies that divergences along five key dimensions of PCMs may impact linking between ETSs in several ways, positive or negative:

  1. its purpose, i.e. to support or contain the allowance price;
  2. the degree of discretion of the regulator;
  3. the nature of the trigger, i.e. a certain price or quantity threshold;
  4. whether it sets a rigid (hard) or flexible (soft) limit on the price;
  5. its effect on the overall emission cap of the ETS.

The literature surveyed in the report finds that depending on the settings and combination of the parameters, PCMs may foster or hinder a linkage between two or more ETSs. On the one hand, PCMs might increase allocative efficiency and reduce price uncertainty in the linked market. On the other hand, PCMs may constitute an obstacle in linkage negotiations, may lead to substantial wealth and abatement effort transfers, and may even create free-riding opportunities among parties in the linkage.

The (in)existence of PCMs can facilitate, but also hinder ETS linking. In the report, the authors remind that, with the creation of a linked ETS, PCMs parameters may need to be recalibrated, and the type of trigger may need to be adjusted.

Concerning the harmonisation process, two alternatives can be identified: a convergence on the most urgent ETS design differences, or rather on the easiest dimension to agree on. Restricted linking, e.g. exchange ratios or import quotas on allowances, could mitigate adverse effects of PCM differences between prospective partners. The authors argue that convergence towards soft and price-based PCMs would be both desirable and likely difficult to accomplish.

In concluding that the most effective way to reduce long term price uncertainty is through the creation of an environmentally ambitious climate policy framework, the authors invite us to dive deeper into the other report “Emissions trading systems with different levels of environmental ambition”.

Read more:

GALDI, Giulio, VERDE, Stefano F., BORGHESI, Simone, FÜSSLER, Jürg, JAMIESON, Ted, WIMBERGER, Emily, ZHOU, Li, Emissions trading systems with different price control mechanisms : implications for linking – Report for the Carbon Market Policy Dialogue, Florence School of Regulation, Climate, LIFE DICET Project, 2020
https://hdl.handle.net/1814/68842

VERDE, Stefano F., GALDI, Giulio, BORGHESI, Simone, FÜSSLER, Jürg, JAMIESON, Ted, WIMBERGER, Emily, ZHOU, Li, Emissions trading systems with different levels of environmental ambition : implications for linking – Report for the Carbon Market Policy Dialogue, Florence School of Regulation, Climate, LIFE DICET Project, 2020
https://hdl.handle.net/1814/68843