EL AUSPICIO EN LA PRÁCTICA DE LOS CONTRATOS

5.2.1 Rent transfer through CDM limits

The option to use CERs reduces average abatement costs. Schedule 1A of Figure 5.1 shows a stylised marginal abatement cost curve for the EU ETS. The domestic carbon price PD is a function of the demand for emission reductions and the supply of abatement opportunities. The demand for emission reductions is given by the target, denoted by the reduction effort R. The supply curve of abatement MACEU is the aggregation of the individual MAC curves for all ETS emitters in the EU. The costs to fulfil the target domestically are equal to the area B, the area under MACEU up to R on the x-axis.20 To the right of R, denoted verified emissions are the remaining actual emissions that are not abated and for which allowances have been allocated.

Schedule 1B assumes that in a non-Annex B (developing) country, the opportunity to produce abatement in the form of CERs exists at a flat fee of PCER (i.e. the MAC curve in the

non-Annex B country is flat) for a certain volume.21 Hence, the EU faces a new MAC*, a combination of MACEU with the flat rate CER abatement options. This leads to a price of P* and abatement costs equal to the sum of the areas below the new MAC* curve (D + E + F +

G). Abatement conducted within the EU is equal to the sum of A1 and A2. Abatement

conducted externally through the CDM is denoted C1. Total costs (D + E + F + G) in schedule 1B are smaller than total costs (B) in schedule 1A.

In schedule 1C, the supplementarity limit is introduced, which reduces the volume of CERs allowed to be used from C1 (schedule 1B) to C2 and increases the price to PL. Furthermore, the limit increases compliance costs in comparison to schedule 1B, by the amount denoted by area H. Domestic abatement is higher in schedule 1C relative to 1B by the amount A3. External abatement through the CDM is now limited to C2. Actual emissions under all three schedules are the same, as the country has a binding reduction target. Only compliance costs vary with highest costs in schedule 1A (only domestic abatement) and lowest in Schedule 1B (unlimited CDM access).22

20

In mathematical terms, total costs B are equal to the integral of the MAC curve between the origin O and the reduction target R.

21

In practice, CER prices vary in the primary market where projects are conducted, while they are uniform on the secondary market prices. For simplicity, it is assumed that most EU ETS participants buy CERs on the secondary market.

22

If the target R is low, or conversely unlimited, CDM is allowed and only the amount A1 will be abated with the remainder covered through CERs. In this case, the CER price equals the EUA price.

The price PL in schedule 1C will be the EUA price in the EU ETS, which accounts for the increased but limited (due to the supplementarity criterion) supply of abatement opportunities through the CDM. The CER price in the EU ETS will be the flat price PCER. 23

Figure 5.1 Domestic and aggregate marginal abatement curves with and without supplementarity limit for the European Union

The EU’s CDM limit, equal to C2 in Figure 5.1, is transferred through the CDM limit formula to Member States, who translate the country limit to CDM limits for installations. Member States with more stringent targets have a higher CDM limit.

5.2.2 Compliance and abatement strategy

Installations compare their marginal abatement costs of internal measures and allowed external abatement measures (i.e. CERs) with the EUA price PL and abate up to where the marginal abatement costs are equal to the EUA price. Firms whose MAC curve starts above the price PL do not abate internally, because using EUAs and CERs will be cheaper. If installations have surplus allowances, they can sell them on the market. Surplus allowances can be generated through internal abatement, an exchange of EUAs for CERs, or initial free allocation. If after abatement, installations need more allowances they can buy them on the market once internal abatement opportunities below the EUA price have been harvested (see also Gorecki et al., 2010).

23

The discussion assumes an absence of Assigned Amount Units supply at zero marginal cost, which is only the case if ‘hot air’ AAUs are scrapped. In the presence of ‘hot air’, a new marginal abatement cost curve MACAAU is introduced, is horizontal and shifts the MAC in all schedules of Figure 5.2 to the

5.2.3 Effect of CER use on compliance strategies

Figure 5.2 compares two identical installations A and B that face the same internal abatement opportunities (i.e. their MAC curves are equal). The two installations differ only with respect to their CDM limit as the installations are situated in different Member States.

Figure 5.2 Installation specific MAC curves - compliance strategies with and without CDM

Schedules 2A to 2C in Figure 5.2 denote the installation A, and Schedules 2D to 2F denote installation B. Schedules 2A and 2D illustrate the baseline case in which no installation in the EU ETS, thus also neither installations A nor B, can use CERs. Initially, without a carbon price, installation A emits business-as-usual emissions equal to B* units. With a carbon price

PD (the same price as in schedule 1A in Figure 5.1), installation A emits verified emissions equal to V* units and abates A*units. The verified emissions V* are covered through EUAs. The EUAs can either be taken from the free allocation or can be bought on the market if allocation is lower than V*. The total compliance cost for installation A is the sum of the areas I and Q*, equal to the abatement cost and the cost of EUAs to cover remaining emissions (V*).

5.2.4 Impact of CER use

Introducing the possibility of using CERs reduces average compliance costs for installations. The compliance strategy, which uses a limited volume of CERs, is illustrated in schedule 2B for installation A. Using CERs, the MAC curve in schedule 2B is the result of a combination of the installation’s MAC curve, the flat MAC curve for CERs, the flat price PCER and the EUA price PL.24 Installation A now abates the sum of A1* and A2* internally. Installation A abates externally C1* units in a developing country by buying (or conducting the project in a developing country which generates) C1* units of CERs. For the remaining verified emissions

V1*, installation A uses the corresponding amount of EUAs. The total compliance cost is the

sum of internal abatement costs (areas J, L), external abatement costs (areas K1 and K2) and the area Q1 for buying V1* EUAs.

Schedule 2C is a rearrangement of schedule 2B. It illustrates, from left to right, the amount of abatement, the number of CERs used, and the amount of EUAs used. The sum of EUAs (V1*) and CERs (C1*) equals the verified emissions of the installation. Schedule 2C illustrates that abatement (A1*+ A2*) in schedule 2C is lower than A* in schedule 2A. Thus, verified emissions in schedule 2C are also higher than in schedule 2A. This is not surprising as it results from the lower price PL relative to the price PD in schedule 2A.

A lower CER limit, ceteris paribus, leads to higher compliance costs but not to lower verified emissions. Schedules 2D to 2F illustrate the situation for installation B, which has the same internal MAC but a smaller CDM limit relative to installation A.25

When CERs are allowed, the new MAC curve for installation B results from a combination of the installation’s MAC curve, the flat MAC curve for CERs, with the flat price PCER and the EUA price PL. The rearrangement of schedule 2E in schedule 2F illustrates that the difference between installations A and B is the greater reduction in abatement costs created for installation A due to the larger CDM limit.

Interestingly, verified emissions of installation B (C2*+V2*) are the same relative to verified emissions for installation A (C1*+V1*). A larger share of total verified emissions is covered through CERs in installation A (C1*) than in installation B (C2*). Due to the fact that

24

The possibility of using CERs lowers the carbon price from PD to PL as illustrated in Schedule 1A to

Schedule 1C in Figure 5.1.

25

In the situation without the CDM, both installations face the same price PD and thus abate the same

amount A* internally. The compliance costs are equal (areas I and Q*) for both installation without the use of CDM. The rent from internal abatement is equal to the sum of the difference between the price PD and the internal marginal abatement costs, equal to the hatched areas. This rent is the same

for installations A and B and is generated by exploiting internal abatement measures within the installations.

Installation B cannot use as many CERs as installation A, it has to cover this part of emissions with EUAs.

Installation A has an advantage relative to installation B in terms of the reduction in

compliance costs (equal to the area E2 in schedule 2C). The area E2 is equal to the difference in the amount of CERs allowed, multiplied by the difference between the EUA price PL and

the CER price PCER. Depending on the difference in C1*and C2*the analysis in Figure 5.2

shows that installation A can gain a competitive advantage merely by its location in a specific Member State, rather than one based on any emission reduction or innovative effort.26

As the preceding sections have shown, the compliance strategy of installations is determined by their internal and external abatement opportunities. If allocation of allowances is free, as is the case in Phase II of the EU ETS, a profitable arbitrage opportunity exists for some installations. The conditions for arbitrage are illustrated in the next section.