Waterbed leakage drives EU ETS emissions: COVID-19, the Green Deal & the recovery plan

Abstract

Because of the EU ETS' cancellation policy, its fixed cap or waterbed is punctured, meaning that shocks and overlapping policies can change cumulative carbon emissions, i.e., waterbed leakage. This paper explains the mechanisms behind waterbed leakage and quantifies the effect of COVID-19, the European Green Deal, and the recovery stimulus package on cumulative EU ETS emissions and allowance prices. We find that the negative demand shock of the pandemic has limited effect on the EU ETS price and is almost completely translated into lower carbon emissions, because of high waterbed leakage. Increasing the 2030 reduction target to -55% increases the price of allowances to 67 euro/ton CO2 today and decreases carbon emissions in the period 2020-2050 by around 16.3 GtCO2 or 42% of the cumulative cap under current policies. These results are robust to significant changes in allowance demand triggered by overlapping policies in the period 2021-2031.

COVID-19, recovery policies and the resilience of EU ETS

“…The impact of the COVID-19 pandemic and recovery policies on climate change issues is undoubtedly accompanied by value changes of climate-related assets (Sartzetakis 2021). Based on previous analysis of the impact of COVID-19 and recovery policies on climate change and carbon emissions, the European Union emissions trading system (EU ETS) might be affected by three direct major shocks: (1) a temporary reduction in the demand for the EU emission allowances (EUA) caused by the COVID-19 pandemic 4 ; (2) the uncertainty in the demand for emission allowances caused by the overlapping of economic stimulus packages under EU economic recovery policies; and (3) permanent reduction in the supply of emission allowances due to the strengthening of Green Deal standards (Bruninx and Ovaere 2021).…”