Profiting from Regulation: An Event Study of the European Carbon Market

Tradable permit regulations have recently been implemented for climate change
policy in many countries. One of the rst mandatory markets was the EU Emission
Trading System, whose rst phase ran from 2005-07. Unlike taxes, permits expose
rms to volatility in regulatory costs, but are typically accompanied by property
rights in the form of grandfathered permits. In this paper, we examine the e ect
of this type of environmental regulation on pro ts. In particular, changes in permit
prices a ect: (1) the direct and indirect input costs, (2) output revenue, and (3) the
carbon permit asset value. Depending on abatement costs, output price sensitivity,
and permit allocation, these e ects may vary considerably across industries and rms.
We run an event study of the carbon price crash on April 25, 2006 by examining the
daily stock returns for 90 stocks from carbon intensive industries and approximately
600 stocks in the broad EUROSTOXX index. In general, rms in industries that
tended to be either carbon intensive, or electricity intensive, but not involved in
international trade, were hurt by the decline in permit prices. In industries that
were known to be net short of permits, the cleanest rms saw the largest declines
in share value. In industries known to be long in permits, rms granted the largest
allocations were most harmed.


Energy Institute at Haas

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  Climate Change     environmental regulation