Linking with Uncertainty: The Relationship Between EU ETS Pollution Permits and Kyoto Offsets

Beat Hintermann (Corresponding Author), Marc Gronwald

Research output: Contribution to journalArticle

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Abstract

Carbon offsets from the Kyoto Flexible Mechanisms can be used by firms in the EU Emissions Trading Scheme for compliance in lieu of EU allowances, making these carbon assets interchangeable. We offer an explanation of the price spread using a structural model of the price for Certified Emissions Reductions that combines three features: a limit for the use of Kyoto offsets within the EU ETS; a disconnect between the current price of offsets and their marginal cost of production for institutional reasons; and uncertainty about future supply and demand of offsets. Our model expresses the offset price as an average of the EU allowance price and an offset’s outside value, weighted by the probability of a binding import limit. Using a monthly series of the United Nation’s Clean Development Mechanism and Joint Implementation about offset supply and demand, we provide empirical support for our theory of offset price formation. Counterfactual simulations suggest that the price process is dominated by uncertainty.
Original languageEnglish
Pages (from-to)761-784
Number of pages24
JournalEnvironmental and Resource Economics
Volume74
Issue number2
Early online date9 May 2019
DOIs
Publication statusPublished - Oct 2019

Keywords

  • emissions trading
  • climate change
  • EU ETS
  • Kyoto
  • linking

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