This article critically examines the impact of industrial production for sectors covered by the EU Emissions Trading Scheme (EU ETS) on emissions allowance spot prices during Phase I (2005-2007). Using sector production indices and CO2 emissions compliance positions dened by a ratio of allowance allocation relative to baseline emissions, we show that the eect of industrial activity on EU carbon price changes shall be analysed in conjunction with production peaks and compliance net short/long positions at the sector level. The results extend previous literature by showing that carbon price changes react not only to energy prices forecast errors and extreme temperatures events, but also to industrial production in three sectors covered by the EU ETS: combustion, paper and iron.

The price of European Union Allowances (EUAs) has been declining at far lower levels than expected during Phase I (2005-2007). Previous literature identifies among its main explanations over-allocation concerns, early abatement efforts in 2005 and possibly decreasing abatement costs in 2006. We advocate low allowance prices may also be explained by banking restrictions between 2007 and 2008 which undermine the ability of the EU ETS to provide an efficient price signal. Based on a Hotelling-type analysis, our results suggest EUA prices do not reflect adequately abatement costs. We also give evidence that the French ban on banking and the expected allowance scarcity at the end of Phase I computed by the Ellerman-Parsons ratio contribute to the explanation of low EUA prices. This situation may be interpreted as a sacrifice of the temporal flexibility offered to industrials in Phase I to give a chance to correct design inefficiencies and achieve an efficient price pattern leading to effective abatement efforts in Phase II.

No abstract