Faculty & Research -Carbon emissions pricing – more than just politics?

Carbon emissions pricing – more than just politics?

The ever-growing importance of keeping carbon emissions to a minimum has made clean and efficient energy consumption a political and financial issue as well as an environmental one. There is an increasingly fine line between pushing a green agenda, managing the markets in order to drive institutions to more eco-friendly energy sources, and keeping the electorate happy. However, the buck does not stop there. Market sentiment and media exposure of greener fuels must be factored into the equation, as the way the impact of the European Parliament’s handling of emissions prices illustrates.

In these increasingly eco-conscious times, it is in the best interests of policy makers to keep the price of dirty energy sources such as coal high in order to encourage investment in cleaner options such as gas. In the case of the European Parliament, this is achieved via the EU Emissions Trading Scheme. The scheme revolves around the timing of decisions to issue emissions allowances onto the market, allowances which permit regulated institutions to emit up to one tonne of CO². However, this involves a considerable balancing act for the European Parliament, which has to weigh up political versus non-political issues, the need to encourage green investment and reduce emissions. However, these are not the only factors to effect prices and resultant energy consumption.

The price of politics

In April 2013 the European Parliament’s attempt to push up the price of dirty fuels via the Emissions Trading Scheme failed due to a negative vote against its proposals. As a result, prices actually dropped due to regulatory actions, in part impacted by the political wrangling between the European Parliament committees, the European Commission, the European Council and MEPs. However, it is a widely accepted fact that political decisions are generally taken in reaction to the nature of the market rather than in anticipation. This begs the question – what market conditions could be impacting EU policy decisions and the resulting influence they have on emissions prices? A body such as the EU does not enjoy the licence that an institution such as a bank has, so when not only the politics of emissions pricing are complicating matters but also market conditions, how best to proceed? A recent study has sought to delve further into this issue by assessing the impact of market sentiment and media coverage of carbon emissions on pricing policy.

Testing the temperature outside

If an institution such as the European Parliament ultimately responds to the market rather than shaping it, then market sentiment has a fundamental role to play. Low confidence will dissuade traders from investing in energy sources. In turn, market attention to the issue of carbon emissions and their desire to invest may be impacted by the amount of coverage given to the issue of carbon emissions in the media. It is therefore through these two lenses that a recent study into 29 European Parliament policy decisions regarding coal and gas was conducted. The political or non-political origin of each decision was taken into account and matrices established to gauge market sentiment via the volume of trading and level of volatility and market attention via the level of media coverage. The results suggest that the issue of emissions pricing goes beyond just politics.

No such thing as bad news?

Three key findings emerged from the study. Firstly, it was the non-political decisions (as opposed to political ones) taken by the European Parliament that had a negative effect on prices. Such decisions included a general commitment to meet certain climate change targets, assessing the risks of carbon leakage, and the implementation of greenhouse gas allowance trading. Secondly, the political decisions were linked to establishing greenhouse gas targets and the inclusion of air transport in the Emissions Trading Scheme. In terms of market sentiment and attention, in both cases the lower the level the greater were the chances of a drop in prices and therefore a rise in market volatility. Thirdly, the issue of media coverage is an especially revealing one as it underlines the chain reaction effect that good or bad news on busy or quiet news days can have on traders’ intentions to invest or not, which then have a knock-on effect when the European Parliament decides how to proceed at policy level.

The need for guidance

Given these findings, plus the fact that emissions pricing decisions are known to have a negative effect for a decent period of time even post-announcement, communication emerges as the key to better preparing the market for the implications of emissions pricing policies. Decision-making bodies need to plan and communicate over a longer term than they currently do so that potential investors are better informed further in advance. This would go a long way towards reducing market uncertainty in times of bad news and low market sentiment. For as long as a dirty fuel such as coal remains cheaper than the cleaner gas alternative, policy makers and investors need to try to work hand-in-hand as far as possible in order to keep the market buoyant and keep the planet clean. Guidance and communication are crucial to this process, as well as the politics of responsible energy production.

This article draws inspiration from the paper Influences from the European Parliament on EU emissions prices written by Peter Deeney, Mark Cummins, Michael Dowling and Alan F. Smeaton and published in Energy Policy 88 (2016).

Michael Dowling is an Assistant Professor of Finance and Accounting at Rennes School of Business, France. His research interests include Asset Pricing, SME Financing, Behavioural Corporate Finance, Investor Psychology, and Energy Finance.