An Analysis of carbon emission determinants: Carbon trading and energy prices

Abstract

Climate change seriously impacts environmental quality, social and economic development, and human life. Global warming is one of the forms of climate change that is caused by increased concentrations of greenhouse gases in the atmosphere. Developed countries have completed the process of industrialization and their industry structures mainly focus on the tertiary sector, which is characterized by low emissions of carbon and low consumption of energy. However, developing countries are still in the process of industrialization which is featured by high emissions and high consumption. Thus, when dealing with the issue of greenhouse gas emissions, it is necessary to achieve cooperation between developing and developed countries. At present, carbon emissions reduction efforts have expanded from the technical field to the financial sector. Carbon assets, as an emerging financial derivative, are a tool of carbon emissions reduction and are highly linked with the energy commodity markets, financial markets, and macro-policy. This study firstly analyzes that the impact of energy consumption, economic growth, and foreign direct investment on carbon emissions for developing and developed countries from a macro perspective. In addition, we measure static and dynamic dependence in the relationships amongst the carbon market, fossil energy commodities, renewable energy, and the electricity markets and estimate risk spillover in “one-to-one” and “multivariateto-one” patterns between carbon and energy markets. Firstly, from a micro-perspective, in view of the production path, our results suggest that high carbon costs will trigger electricity producers to switch from cheaper dark fuels to cleaner fuels. Moreover, a substitution effect exists between coal and oil, and coal and renewable energy when the relative prices between the cheaper baseline fuel (coal) and crude oil, and renewable energy increase. This result becomes more pronounced during extreme events. Thus, after taking account carbon costs into the business model, crude oil and renewable energy are more attractive and profitable than coal as input for enterprises and electricity producers. From an investment risk perspective, we suggest investors in the EU carbon market use the weak dependence between the carbon market and other energy commodity markets to reduce investment risk in so far as possible. For instance, coal futures are the optimal choice for diversifying and hedging risks in the EUA market, whilst electricity futures are the least attractive. Secondly, results of “two-to-one” CoVaR indicates that compared with unconditional risk, the conditional risk in EUA market is larger and more aggravated when power and other energy future markets encounter severe distress events. This requires regulators and investors to pay more attention to risk spillovers from multiple markets rather than from a single market. This finding is also helpful for policymakers in regulating the risks of the carbon market. From macro point of view, energy consumption is the crucial impact factor for carbon emissions. The pollution Halo theory and pollution heaven hypothesis are valid for G7 and BRICS countries. The empirical results support the EKC hypothesis that environmental degeneration rises during the first stage in line with increasing economic growth and then turns to decrease at the final stage once the threshold level is reached, given the level of income. Therefore, it is suggested that host countries attempt to assess the impact of environmental pollution on FDI before opening their markets to foreign investors. At the same time, the government should encourage multinational companies to adopt cleaner technologies to avoid the negative impact. In a conclusion, the above study outlines scientific and reliable implications for investors and risk managers to clarify the co-movements mechanism and mitigate risk among the carbon, energy commodity, and electricity markets. Meanwhile, this research also provides reference and policy support to cultivate a stable and healthy carbon trading market. Finally, in terms of the determinants of emissions reduction, we offer more practical suggestions tailored to countries’ different levels of income.