The EU emission trading system (EU-ETS) set in 2005 is still, by far, the widest emissions trading scheme in the world. It is designed as a classical cap-and-trade system specifying a maximum amount of cumulated greenhouse gas emissions and allocating tradable allowances to firms covered by the scheme. Allowing trade in these permits results in a market price for allowances. The price provides an economic signal of which mitigation measures are worthwhile. A cap-and-trade system is by design effective in keeping the emissions of the participating installations below the cap.
The EU ETS is considered central to achieving the EU¿s climate policy goal of at least an 80 percent reduction in GHG emissions (relative to1990 levels) by 2050.
Unlike traditional commodities, which at some point during their market exchange must be physically delivered to someone, carbon credits do not represent a physical commodity but instead have been described as a legal fiction that is poorly understood by many sellers, buyers and traders. This lack of understanding makes carbon trading particularly vulnerable to fraud and other illegal activities. Carbon markets, like other financial markets, are also at risk of exploitation by criminals due to the large amount of money invested, the immaturity of the regulations and the lack of oversight and transparency.
In this vein, the contribution of this research project is twofold. On the one hand, we intend to shed some light on the effects of the EU ETS at firm level by studying the effectiveness of the ETS during its three evolution phases, and the impact that it is has exerted on companies performance. On the other hand, we aim to devise some tools to measure the degree of vulnerability present in the carbon market. Finally, suggestions will be provided on potential involvement of or interventions by the EU or single Member States in building up new regulation frameworks and allowing for a more effective compliance.
The research will be able to provide interesting insights for several reasons: (i) Italy is one of the main emitters of greenhouse gases, ranked third in Europe (UNFCC, 2014), (ii) its industrial structure is mainly based on small - medium-sized companies (SMEs) that, in recent years, have been actively involved in environmental innovation, and (iii) it allows for comparison with other European case studies already examined in the literature (Pontoglio, 2010; Tomas et al., 2010; Rogge et al., 2011; Horbach et al., 2012). The results achieved will facilitate the analysis of the national and European context both in terms of controlling climate change and improving the environmental and production performance of companies. While there are numerous theoretical studies in the literature that examine the mechanisms related to the exchange of tradable permits, empirical studies dealing with the impact of these permits both in environmental terms and in terms of productive performance are scarse and uncoordinated, especially in the case of Italy. This research wants to be a contribution in this sense. The novelty of the project relies in the following four major areas.
First, exploiting micro level data, through a dynamic panel approach, we evaluate the effectiveness of the EU ETS in reducing CO2 emissions in Italy. In particular, the long run nature of the dataset (2005-2016) allows us to test to what extent the structural break between the EU ETS phases (Phase 1-2005-2007, Phase 2- 2008-2012, Phase 3- 2013-2016) led to a change in abatement behaviour. Evidence about the impact of the ETS in Italy and a thorough understanding of how it affects firm¿s behaviour will be crucial for policymakers, given the new carbon markets rise around the world. An important aspect that the project proposal aims to disentangle is related to the investigation of the interaction between the effectiveness of ETS in presence of exogenous shocks on the demand side and possible new regulatory remedies.
Second, estimating the effect of initial endowment allocation on emissions¿ reduction behaviour, we test empirically if carbon markets deviate from the hypothetical market conditions assumed under the Coase theorem set up. If we find that the initial allocation matters for reduction behaviour, this would have significant implications for the design of emissions trading schemes, as compensation through initial allocation would no longer be emissions neutral.
Third, exploiting micro level data, the project intends to empirically evaluate how changes in environmental policies affect firms¿ performance in terms of value added, employment, profitability. This will provide useful insights on the benefit or losses for the operating performance of enterprises, in particular their competitiveness and creativeness. These elements are bound to be crucial for the mechanism design of the EU ETS and deserve further investigation. In order to be dynamically efficient, the EU ETS must provide incentives not only for emissions abatement in the short run but also for innovation in clean technologies. This aim is important as climate change is a long-run problem that will require efforts to curb GHG emissions over a prolonged time period.
Fourth, applying anomaly detection techniques to the analysis of the carbon market¿ dynamics in Italy, the project will provide knowledge on the likelihood of illegal or opportunistic firms¿ behaviours. This approach allows us to test (i) the impact of the missing trader fraud involving carbon emissions allowances (the so-called carousel¿ Value Added Tax fraud) (ii) to what extent some firms might exploit their dominant positions in order to alter the market price of carbon emissions allowances. Questions regarding the nature and extent of fraud in these contexts and their relationship to the quite unique institutional arrangements of carbon markets are both unanswered and undeveloped.