The Price Determinants of the EU Allowance in the EU Emissions Trading Scheme

The Kyoto Protocol came into effect in 1997 to curb greenhouse gas (GHG) emissions and to address the problem of climate change. The Protocol includes a market-based mechanism designed to offset GHG emissions, called the emissions trading scheme (ETS), allowing companies to “trade” their shortage or surplus allowance. This study examines the determinants of the EU allowance (EUA) price in Phase 3 of the EU ETS (2013–2017). First, the causality between the EUA price and other variables is determined using a Granger causality test. Second, the correlation between the EUA price and each variable is measured using a VECM estimation and an impulse response function. Finally, the relative effect of each variable on the EUA price is determined using a forecast error variance decomposition. The results show that the EUA price has a causal effect on the prices of electricity and natural gas. Second, all variables, except the minimum temperature, show a positive relationship with the EUA price. Furthermore, when unexpected shocks occur, the EUA price shows the highest response to its past price, followed by the electricity price. Third, the past EUA price has the most influence on the EUA price, followed by the coal price.