Price determinants in the EU emissions trading scheme

Emissions trading is the key policy instrument for dealing with increasing greenhouse gas emission levels. Through the establishment of a market for trading of emission allowances, companies in the EU must implement carbon management strategies, as their emissions will become either an asset or a liability. The emerging carbon market shows evidence of increasing activity levels and a number of new players will enter the market in the near future. What parameters must the players in the market consider when trying to assess the impact of future carbon prices? This article analyses a number of key factors that will influence the price of emission allowances in the EU emissions trading system in the 2005-2007 period, including: policy and regulatory issues; market fundamentals, including weather and production levels; together with technical indicators. While overall allocation sets the starting point for the market, it is shown that other factors, such as the impact of weather on power demand and relative fuel prices, will be driving prices in the short- to medium-term. The article provides a starting point for understanding the dynamics of emissions trading.