3. Carbon price floors and ceilings

Managing prices under an ETS 

This page looks at how carbon price floors and ceilings can be implemented in an emissions trading system (ETS) to limit the range which prices can take.  Such measures are also sometimes referred to as price containment mechanisms, or, if there is both a price floor and price ceiling, price corridors.

This page includes examples of:

  • carbon price floors set by an auction reserve price for the sale of allowances
  • carbon price floors implemented by a tax, most commonly a top-up tax, which imposes a floor by adding a tax to “top-up” the price to the level of the floor when the allowance price is below the floor price
  • carbon price ceilings implemented by increasing supply of allowances above a specified price threshold, and variants of this approach.

A third approach is for the government or other entity to buy back permits from the market at a specified price.  However this would risk imposing large costs on government. It has been little used in practice, with the only example being some provisions under the Beijing ETS.   It was also discussed but never implemented in New Zealand.  It is not reviewed  further here.

The examples considered here are from the following jurisdictions.

Mechanisms to manage auctions

  • The California system.   Quebec has very similar arrangements.
  • The Regional Greenhouse Gas Initiative (RGGI) in the northeastern USA.
  • Carbon pricing in Germany for sectors not covered by the EUETS
  • Price containment mechanisms in New Zealand
  • The UKETS auction reserve price
  • The Nova Scotia cap and trade system
  • The previous Australian system
  • The previous Alberta system

Use of Carbon Taxes to create price floors

  • UK carbon price support
  • The Netherlands carbon taxes in industry and power generation.
  • The Norwegian carbon tax

This page does not review the EUETS market Stability Reserve (MSR), which manages supply according to rules based on the number of allowances in circulation, without direct reference to price.

Price Floors – an overview

An effective price floor can easily be introduced into an ETS by setting a reserve price in allowance auctions.  This automatically leads to a reduced quantity of allowances being made available in the market if the market price is below the reserve price, because some allowances remain unsold, and there is thus a smaller supply of allowances.  Correspondingly there is a greater reduction in emissions compared with the original cap.

A further design choice needs to be made as to whether any unsold allowances are retained for future use, or permanently removed, for example immediately or at the end of each phase of the system.  Unsold allowances may be retained by holding them in a reserve for release in future if needed.  This may result in a smoothing of total allowance supply or a reduction, depending on whether all allowances are returned to the market.

The reserve price is not an absolute floor, in that the price in the market can dip below the reserve price for a while.  But if prices remain there the reduction in supply from unsold allowances at auction is likely to restore the price quickly, assuming that a significant proportion of allowances are auctioned, as they are in each of the systems with reserve prices.

An alternative approach to implementing a price floor is a tax that in effect tops up the carbon price when it’s below the floor.  This may be done by adding the difference between the floor and allowances prices.  The Netherlands and Norway have recently introduced  this type of approach (see below). This was the original intention of the UK’s carbon price support mechanisms, although this has now become a  fixed price, which is simply added to the ETS price (originally the EUETS, now the UKETS price). A top-up mechanism was also envisaged for international offsets under the Australian system, though not implemented.

Taxes  are most commonly used where the floor applies to only a proportion of emissions covered by an ETS.  In particular, in Norway and the Netherlands have independently introduced a tax to set a floor price for sectors covered by the EUETS.  In these cases an auction reserve price would have a minimal effect on the wider EUETS, so would not be effective in setting a floor price.

Mechanisms to establish price floors could be extended to create a stepped floor, by setting different reserve prices for different tranches of allowances.  This would in effect offer a supply schedule into the market, representing different prices and quantities of abatement.  Indeed something like this already exists in the California system where the effect of the price floor is supplemented by a ceiling in the form of a price containment reserve which is allocated in stages at successive price thresholds, and in this way seeks to limit the price of allowances.

Reserve prices in ETSs resemble similar features in many types of auctions for different sorts of products, whether they are there to prevent, for example, your favourite Rembrandt selling for a few pounds, or your latest e-Bay offering selling for a few pence.

Price ceilings – an overview

Price ceilings for an emissions trading scheme operate by making additional allowance supply available when prices reach specified levels.  Ceilings can be absolute, or “hard” with unlimited additional supply available, or they can be “soft”, with limited amounts of additional supply available, so the price can rise above the ceiling if the demand for allowances is sufficiently strong.

Price ceilings are intended to limit the risks of economic damage due to unexpectedly damagingly high allowance prices.  It is important that they do not prevent prices rising to levels necessary to stimulate adequate low carbon investment.  At present ceilings in existing systems are generally below levels appropriate for enabling necessary abatement.

Examples of mechanisms based on managing auctions

Example 1: California – floors and ceilings

The California system has both a price floor and a price ceiling.

1.1 The auction reserve price sets the price floor.

Under the California ETS (Quebec has very similar arrangements) there is an auction reserve price set at $10/tonne in 2012, rising at 5% p.a. plus an inflation adjustment, reaching $19.70/tonne in 2022.  Any allowances that are not sold at auction are retained by the regulator, the Air Resources Board (ARB), in an Auction Holding Account. The holding account allowances are not made available again through the auction until the price has exceeded the floor price for two consecutive quarterly auctions, and return is subject to a limit of 25% of the total allowances available at each regular quarterly auction. As a result, a surplus in the Auction Holding Account may take time to be drawn down.

The price in the California system has stayed above the auction reserve apart from a period in 2016 where there was political and legal uncertainty about the future of the system (see chart), and in early 2020 at the onset of the global covid-19 pandemic.

Market prices and auction reserve prices in theCalifornia ETS (September 2013 to March 2018)

Source:  http://calcarbondash.org/ and CARB (http://ww2.arb.ca.gov)

1.2 Allowance reserves to set a price ceiling

In California there is also an Allowance Price Containment Reserve (APCR) from which successive additional tranches of allowances are released if the auction price rises above specified schedules.  Before 2021 this was at three price tiers of $40, $45, and $50/tonne in 2013, rising at 5% p.a. plus inflation thereafter. From 2021, allowances in the reserve were released at two price tiers with thresholds set at $41.40 and $53.20, and a price ceiling set at $65/tonne, all rising at 5% p.a. plus inflation. In 2022, these prices were $46.05 and $59.17, with a price ceiling of $72.29/tonne.

This is entirely separate from the account used to maintain the price floor.  Allowances are sold from the APCR on a quarterly basis if there is demand.  The sale is held six weeks after the regular quarterly auction of allowances, allowing buyers to make up a shortfall after the auction. Buyers specify the number of allowances they want at any of the three fixed prices.

When the scheme began in 2013, 122 million allowances were scheduled put into the APCR for the period to 2020, equal to 4.5% of the overall cap across all years (including the maximum allowed offsets), and relative to a single year (2015) is 29% of the cap including the maximum allowed offsets.  The APCR allowances were taken from within each year’s capped total.  The reserve was divided equally among the three price tiers.

1.3 The change from a soft to a hard ceiling

Price ceiling arrangements changed from 2021. Two price containment points triggered at increasing price levels are filled with remaining APCR allowances. A third price level is a price ceiling. At this level, allowances (or if no allowances remain, price ceiling units) can be bought in unlimited quantities, with the revenues having to be invested in additional emissions reductions of at least equal amount.

The ceiling has thus moved from being a soft ceiling with prices able to increase indefinitely, to a harder ceiling which prices should not exceed. This provision potentially somewhat weakens the environmental integrity of the cap but the provision to increase offsets to match helps maintain emissions reductions at an equivalent level.

Example 2: The Regional Greenhouse Gas Initiative (RGGI) – floors and ceilings but at price levels which are too low

The design of RGGI has both a price floor and a price ceiling.  However prices for both are below levels likely to signal enough abatement.

2.1 Auction reserve price to set a floor

RGGI, which covers power sector emissions from several states in the north eastern USA, also includes an auction reserve price.  However, the reserve price is much lower than in California, at $2.44/short ton in 2022 rising at 2.5% p.a..  Allowances unsold at auction prior to 2014 are retained by the authorities and can be auctioned again, but allowances unsold at the end of each 3 year control period (the scheme is currently in its fifth control period which lasts from 2021-2023) may be retired permanently at the discretion of individual states.  This gives a mechanism for tightening the cap if there is a surplus of allowances at the floor price over an extended period.

2.2 An allowance reserve to set a price ceiling

RGGI also has a costs containment reserve (CCR) of additional allowances that can be released into the auction when the auction clearing price rises above a certain threshold.  The prices at which allowances are released are much lower than in California, being $4/short ton in 2014 rising at $2/short ton p.a. to reach $10/short ton in 2017, escalating at 2.5% p.a. thereafter. The CCR allowances are in addition to the cap, and balances are re-set annually to 10 million tons (which is just over 10 percent of the 2014 cap of 91 million tons plus allowable offsets of 3% of the total) if allowances are drawn down from the CCR. The CCR trigger price is $13.91/tCO2 in 2022 rising at 7% p.a..

An Emissions Containment Reserve (ECR) was introduced for RGGI from 2021. The trigger price at which allowances would be withheld from auction was set at $6, increasing by 7% p.a. thereafter.  10% of allowances are auctioned only if the price rises above this threshold  (which rose to $6.42/tCO2 in 2022.  This has given RGGI, like California, a stepped supply curve.

Example 3: Germany – fixed price followed by price floor and ceiling

In 2021 Germany introduced a national ETS for transport and buildings, which are sectors outside the current scope of the EUETS .  Allowances are sold at a fixed price, increasing annually from €25/t in 2021 to €55/t in 2026.  In 2026 the system will transition to an auction based ETS, with a floor  set at €55/t and the ceiling at €65/t.  The floor and ceiling are imposed in the form of minimum and maximum auction prices.   A decision on floors and ceiling from 2027 onwards will be taken in 2025, and may depend in practice on developments at EU level.

This type of system is broadly similar to the previous Australian system (see below).

Example 4: New Zealand ETS  – price floor and ceiling

With the start of auctioning in 2021, New Zealand’s Government introduced an auction reserve price of NZD 20 ($14.15), increasing at 2% p.a. This was revised to NZD 30 ($21.22) for 2022 and will increase to c. NZD 39 ($27.59) by 2026.

New Zealand has also introduced a cost containment reserve that triggers the release of allowances if the unit price reaches NZD 50 ($35.37) in 2021, increasing at 2% p.a.. For 2022 the CCR trigger price was updated to NZD 70 ($49.51) following advice from the Climate Change Commission. The total volume in the reserve is approximately 7 million tonnes per annum, implying that this is a soft ceiling. The reserve volume will remain at 7 million tonnes per year until 2024 and will subsequently fall to 6.7 million by 2026.

Example 5: UKETS auction reserve price – price floor

The UKETS began operation in 2021. It replaced the EUETS following the UK’s departure from the EU.  It has a reserve price for auctions of £22/tonne.

Example 6:  Nova Scotia – price floor and ceiling

The Nova Scotia cap and trade system has both a floor, in the form of an auction reserver price, and a ceiling, in the form of a cost containment reserve.

The reserve price was set at $20 for 2000.  For auctions held in 2022, the reserve price is $22.92.  The reserve price increases annually by 5% plus inflation, similar to the arrangements in the California and Quebec systems.

There is also a cost-containment reserve.  The price at which allowances are released was $50 per tCO2e in 2020, rising annually by 5% plus inflation.

Since May 2018, Nova Scotia has been a member of the Western Climate Initiative (WCI), which provides technical services and support for the provinceʼs cap-and-trade program. However it is not linked to any jurisdictions.

Example 7: Former Australian system fixed price with a subsequent floor

The former Australian system introduced in mid-2012 had a fixed price, at an initial level of AU$23/tCO2, escalated at 5% p.a. nominal.  It was intended to run for the first three years of the scheme.  The fixed price was set by selling an unlimited number of allowances at that price.  In practice it ran for approximately two years, until the scheme was abolished.

The system also had a planned price floor of $15/tCO2, and a planned a price ceiling set at $20/tCO2 above the prevailing international credit price. The floor and ceiling were both due to apply from the start of the floating price phase of the scheme, which was due to follow the fixed price phase in mid-2015.  The floor was due to be implemented by way of a reserve price at permit auctions, coupled with a fee on imported emissions units to bring their cost up to the floor price. It was thus intended to use a combination of auction reserve prices and top-up payments.

However, although these were legislated for they were not implemented as the scheme was repealed before this phase began.

Example 8: Former Alberta system – a ceiling based on payment into a fund

The Alberta Specified Gas Emitters Regulation (SGER), which ran for approximately ten years until the start of 2018, was a baseline and credit system.  It imposed a hard ceiling of $15/tCO2 by allowing emitters to pay into a fund at that price rather than surrender allowances.  This is broadly equivalent to issuing unlimited additional allowances at the ceiling price.

Use of carbon taxes to give a price floor

The following are examples of using taxes to set price floors.

Example 9:  UK carbon price support – price floor in the power sector

The carbon price for fuels used in power generation in the UK consists of two components.  The first is the price of allowances under the UKETS (and previously the EUETS).  The second is the UK’s own carbon tax for the power sector, known as Carbon Price Support (CPS).  The Chart below shows how the level of CPS (green bars on the chart) increased over the period 2013 to 2017[i].  These increases led to a total price – that is the CPS plus the price of EUAs under the EUETS (grey bars on the chart) – increasing, despite the price of EUAs remaining low over this period.  The price floor is set by the level of the tax, as this would remain even if the EUA price fell to zero.

This increase had a dramatic effect on emissions from coal burning power generators, which reduced by more than 80%, over 100 million tonnes p.a., over the period (black line on chart).   Various factors contributed to this reduction, including the planned closure of some plants and the effects of regulation of other pollutants.  Nevertheless, the increase in the carbon price from 2014 played a crucial role.  Analysis has shown the increase in the carbon price accounted for three quarters of the total reduction in emissions due to generation from coal achieved by 2016[ii].  This was achieved by a price which remains moderate against a range of markers, including other carbon taxes.  The trend continued in 2018 and 2019 (not shown on the chart).  In 2018 generation from coal fell a further 25% in 2018, while total carbon prices were higher as the EUA price rose strongly, a trend which continued in 2019.

The net fall in emissions over the period (shown as the dashed blue line on chart) was smaller, at around 62 million tonnes p.a. [iii] This is because generation from coal was largely displaced by generation from gas. The attribution of three quarters of this 62 million tonnes as due to carbon price support implies nearly 47 million tonnes p.a. of net emission reductions due to the carbon price.  This was equivalent to a reduction of more than 10% of total UK GHGs.  Other analysis has shown even larger effects, closer to the black line shown here.

The UK tax thus proved highly effective in reducing emissions substantially and quickly.

Carbon prices and emissions in the UK power sector 2012-2017

The tax was then set at a fixed level of £18/tonne.  It was previously set around two years in advance, targeting a total price comprising the tax plus the EUA price.  There was no guarantee that it would set a true floor price, as EUA prices could and did change a good deal in the interim.  Indeed, in 2013 support was set at £4.94/tCO2, reflecting previous expectations of higher EUA prices, leading to prices well below the original target for the year of £16/tCO2 in 2009 prices (around £17.70 in 2013 prices).

Original intention of a top-up taxes

The original UK proposal was for a top-up tax (or rebateable tax), as now adopted by the Netherlands.  The tax would have been charged on the difference between the floor and the EUA price whenever the EUA price was below the floor. (Or similarly, the tax could have been charged at the level of the floor price but the out-turn EUA price for the year could have been used to set a rebate on the tax.)  This seems a superior design to that adopted because it would have given a more certain and stable floor.  The mechanism adopted was nevertheless highly effective, as shown.

Example 10: The Netherlands Carbon Taxes – separate floors in industry and power generation

Something much closer to the original intention of the UK tax is found in the Netherlands, which has introduced top-up taxes to give price floors.  In January 2021 the Dutch Government introduced a carbon tax on industrial emitters covered by the EUETS.  A similar type of tax on power generation was introduced a year previously.

The taxes act as a top-up to the EUA price, effectively putting a floor on the carbon price.  If the EUA price is less than the tax, the amount of tax paid is the difference between the tax and the annual average EUA price for the year. For example, if the carbon price is set at €125/tCO2 in 2030, as it is for industry, and the average annual EUA price in 2030 is €50/tCO2 a tax of €75/tCO2 is payable.  If the EUA price is above the level of the tax no tax is paid.

The tax is set at a much higher level than other floor prices. The price rises linearly from €30/tCO2 in 2021 to €125/tCO2 in 2030.  (For power generation the level is much lower, rising linearly from €12.30/tCO2 in 2021 to €31.90/tCO2 by 2030.)

Example 11:  Norway’s carbon tax

Norway has modified its carbon tax to achieve a target price which is the total of the tax and the EUA price.  The target price is even higher than the Dutch tax, at NOK2000/tCO2 (€200/tCO2).   However the tax is set in advance, so the total remains uncertain, and ultimately the floor is set by the tax itself in the unlikely event of EUA prices falling to zero.  In this respect it is closer to UK carbon price support than to the Dutch tax.

This page was updated on 30th August 2022

i] UK carbon price support reached at £18/tCO2 (€20/tCO2) in the fiscal year 2015/6 and was retained at this level in 2016/7.  In 2013/4 and 2014/5 levels were £4.94 and £9.55 respectively.  This reflected defined escalation rates and lags in incorporating changes in EUA prices. https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/293849/TIIN_6002_7047_carbon_price_floor_and_other_technical_amendments.pdf and www.parliament.uk/briefing-papers/sn05927.pdf

[ii] hhttps://www.auroraer.com/insight/carbon-price-thaw-post-freeze-future-gb-carbon-price-2/

[iii] Based on UK coal generation estimated weighted average emissions intensity of 880gCO2/kWh, and 350gCO2/kWh for gas generation.

2 thoughts on “3. Carbon price floors and ceilings

  1. Pingback: ETS price floors and ceilings | On Climate Change Policy

  2. Pingback: Europe’s phase out of coal | On Climate Change Policy

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