Managing prices under an ETS
This page gives an overview of some of the issues around price floors and ceilings and their implementation. Another look at some of the arguments for and against price floors can be found at this link.
Mechanisms to manage price are a common feature of emissions trading schemes. Measures that have been introduced are summarised in the table below. The notable omissions are the EUETS, which has no price management, and the schemes in China and South Korea, which are illiquid with little trading, and any price management is more implicit.
In addition to those shown in the table the UK has its own mechanism, carbon price support, which is essentially a tax on power generators to top up the EUETS price to a floor, which is reviewed further below.
Table: Examples of price floors and ceilings in Emissions Trading Systems
|Scheme||Price floor||Price Ceiling||Notes|
|California,||$10 in 2012 + 5% p.a. real escalation auction floor ($13.57 in 2017)||$40/45/50 in 2013 + 5% p.a. real. Reserve tranche volume increasing over time.||The floor has been effectively binding on occassions|
|Quebec||CAN$10 in 2012 + 5% p.a. real escalation, auction floor ($13.56 in 2017)||c$40/45/50 + 5% p.a. real||Linked to California as part of the WCI|
|RGGI||c. $2.1 in 2016 escalting at 2.5% p.a.||Increased offsets at price thresholds. Moving to Cost Containment Reserve, at $4 in 2014 rising to $10 by 2017, 2.5% p.a. nominal increase thereafter||The floor has been effective in sustaining prices despite chronic oversupply|
|Alberta||No||CAN$30/tonne buyout price||A hybrid baseline and credit scheme and tax|
|British Columbia||Carbon tax fixed at C$30||Planned introduction of a separate ETS with effective ceiling price of $25/tonne|
|Australia (trading phase of scheme legislated but not implemented before repeal)||A$15 + escalation||$20 above EU price, rising annually||Fixed price of A$23 rising at 5% nominal p.a. for first three years|
|New Zealand||No||Price ceiling at NZ$25||Effective ceiling lower due to 2 for 1 surrender provisions|
As above the table shows, floor prices are part of the design of a number of schemes. An effective floor price 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 price is below the reserve, because some allowances remain unsold, and there is thus a greater reduction in emissions compared with the original cap in the event of excess supply. Unsold allowances are typically held in a reserve for release in future. (A further design choice then needs to be made as to whether any unsold allowances are permanently removed after a time, for example at the end of each phase of the scheme.) The reserve price is not an absolute floor, in that the price in the market can dip below it for a while, but if they remain there the reduction in supply from unsold allowances at auction is likely quickly to restore the price assuming that a significant proportion of allowances are auctioned, as they are in each of the schemes 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, as is done in the UK under the carbon price support mechanisms, and was envisaged for international offsets under the Australian scheme, though not implemented – see below for further details on this.
A price floor can create greater certainty for investors in low carbon technology, and greater stability for the scheme itself. Floor prices can also make for more stable government revenue, and for this reason alone they are likely to attract continuing attention from governments. However there is a risk with a reserve price allowances will be unsold, and so reduce revenue, as has happened in California. In this respect the use of a tax mechanism may enable more robust revenue streams.
In the Regional Greenhouse Gas Initiative (RGGI) the auction reserve price, which is currently around $2.10/tCO2 escalating at 2.5% p.a.. The California scheme has a reserve price at the much higher level of $10/tCO2 escalated at inflation plus 5%, reaching $13,57 in 2017, and the Quebec scheme has similar arrangements. The auction reserve price has been binding in practice on a number of occasions.
The Australian scheme also had a planned floor price, due to apply from the start of the floating price phase of the scheme in mid-2015, but although this was legislated it was not implemented as the scheme was repealed before this phase began. However it retained a fixed price until it was abolished, at an initial level of $23/tCO2, escalated at 5% p.a. nominal for the first three years of the scheme).
Such provisions 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 scheme for the price containment reserve, which seeks to limit the price of allowances, where successive additional tranches of allowances are available at prices of $40/tCO2, $45/tCO2 and $50/tCO2, which like the floor price are indexed to increase over time.
Reserve prices resemble similar features in many types of auctions for different sorts of products, whether they are there to prevent your favourite Rembrandt selling for a few pounds, or your latest e-bay offering selling for a few pence.
How auction reserve prices work in practice – examples from North America
Under the California ETS (Quebec has very similar arrangements) there is an auction reserve price of $10/tonne in 2012, which rises at 5% p.a. plus an inflation adjustment, and is currently $13.57/tonne. 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.
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 $2.1/short ton in 2014 rising at 2.5% p.a., approximately in line with inflation. 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 current control period is 2015-2017) may be retired permanently at the discretion of individual states. This gives a possible mechanism for automatically tightening the cap if there is a surplus allowances at the floor price over an extended period.
Price ceilings for an emissions trading scheme operate by making additional supply available. Ceilings can be absolute, 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 is sufficiently strong.
Similar arrangement are found in the South Korean scheme, where the regulator can release additional allowances if the price reaches 33,500 won/ tonne (around $29/t). However the market is highly illiquid so the effect of this is unclear.
Alberta provides an example of a hard ceiling, which any unmet obligation met by payment into a fund used for investment in clean technology and other measures for decarbonisation. California offers an example of a “soft” ceiling with a limited number of allowances made available at defined price thresholds.
How Price Ceilings work in practice – examples from North America
In California there is an Allowance Price Containment Reserve (APCR) from which allowances are released at prices of $40, $45, and $50/tonne in 2013, rising at 5% p.a. plus inflation thereafter. This is entirely separate from the Auction Holding Account used for the 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 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 are taken from within each year’s capped total. The reserve is divided equally among the three price tiers.
RGGI also has a costs containment reserve (CCR) of additional allowances that can be released into the auction when the auction clearing price crosses a certain threshold. As with the floor 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.
National floor prices – the role of taxes
Some national governments have sought to impose a floor price in their own jurisdictions. Putting in place a national auction price floor would not be effective in the EUETS as it would not do enough to restrict total EU supply. However, as noted above, there is another possibility in the form of a tax that in effect tops up the EUA price, and such a mechanism has applies to the power sector in the UK. A similar scheme was proposed in Australia for putting a floor on the price of international allowances by charging a surrender fee, but this was never introduced as the scheme was repealed before implementation
The UK tax has proved highly effective in reducing emissions, producing a substantial environmental benefit. This has been achieved by a price that, while set at a more adequate level than prevails in the EU ETS, remains moderate or low against a range of other markers, including other carbon taxes.
The chart below shows how the level of the UK carbon tax in the power sector rose over the period 2013 to 2016. This was accompanied by a nearly 80% reduction in emissions from coal generation, which fell by 100 million tonnes over the period. Various factors contributed to this reduction in coal generation, including the closure of some plant and the effect of regulation of other pollutants. Nevertheless the increase in the carbon price in 2015 and 2016 played a crucial role in stimulating this reduction in emissions by making coal generation more expensive than gas. According to a report by independent analysts Aurora, the increase in carbon price support accounted for three quarters of the total reduction in coal generation over the period.
The decrease in emissions of 100 million tonnes from reduced coal burn resulted in a net fall in emissions over the period around 60 million tonnes p.a. taking account increased emissions from burning additional gas. The attribution of three quarters of this reduction as attributable to carbon price support implies around 45 million tonnes p.a. of net emission reductions is attributable to carbon price support. This is equivalent to about 10% of total UK GHG’s.
The tax has now set at a fixed level of £18/tonne. It was previously set around two years in advance (the 2015/16 value has recently been announced, with indicative values for the subsequent two years[ii]), targeting a total price comprising the tax plus the EUA price. There was no guarantee that it will 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).
In this respect the original proposal for a rebateable tax seems a superior design. The tax would 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, thus creating a floor at the level of the tax irrespective of where the EUA price ended up. This would have made it much closer to a true hybrid of a tax and trading than the measure that has been introduced, which to some extent is simply two separate carbon prices added together, albeit with expectation of one influencing the other[iii].
There is a standard objection to a floor in one country is that it does not change of the overall cap at an EU level so does not decrease emissions. However this does not hold under the present conditions of the EUETs, and is unlikely to do so in any case. A review of the reasons that emissions reductions from national measures such as the UK carbon price floor do reduce total cumulative emissions over time is provided here:
This page was updated on 24th November 2017