Does the EU ETS Bite? The Impact of Allowance Over-Allocation on Share Prices

Abstract

The aim of this paper is to find out whether shareholders consider the EU Emission Trading Scheme (EU ETS) as value relevant for polluting firms. An analysis is conducted of changes in share prices, caused by the first publication of annual compliance data. In April 2006, it turned out that there was an over-allocation of emission allowances, causing a large drop in allowance prices. Through an event study, the impact of this drop on share prices of firms under the EU ETS is analyzed. It is considered to what extent these share price impacts have been determined by (1) their carbon-intensity of production, (2) the pass-through of carbon-related production costs (carbon leakage), (3) their allowance holdings, and (4) their involvement in allowance trade. The results are, respectively, that the carbon-intensity of production has a negative value impact on firms, that larger allowances holdings are positively valued, and that the trade activity of firms has no significant impact. Due to measurement problems, carbon leakage cannot be reliably specified in the regressions. The conclusion is that the EU ETS does ‘bite’. The main impact on the share prices of firms arises from their carbon-intensity of production. The EU ETS is thus valued as a restriction on pollution.