CO2 Allowance Price Dynamics and Stock Markets in EU Countries: Empirical Findings and Global CO2-Perspectives

The European Union uses an emissions certificate trading system (the EU ETS) with coverage of both industry and the energy sector CO2 emissions which is based on an EU-wide emissions cap that declines over time. Firms that have an excess stock of CO2 emission permits can sell surplus certificates at the current market price and have to record the value of the excess emission permits as an asset on the balance sheet of the respective company so that the stock market price of companies with an excess supply of certificates should increase while that of firms which have to purchase a considerable amount of additional emissions permits - beyond any initial free allocation by the EU emission trading system - could face a decline in the value of their respective stock market price. An AR-GARCH approach shows the behaviour of the EU stock market oil and gas subindex (STOXX Europe 600 Oil & Gas Producers (SEOG) index) and of the overall stock market index - with somewhat lower empirical impact findings - with regard to positive and negative shocks in terms of the allowance price dynamics. Results indicate that the oil and gas stock index responds asymmetrically to positive and negative price shocks from the CO2 allowance market: The coefficient of the shock dummy is negative and significant, while that of a positive shock dummy is not significant. There is no Granger causality in the direction from CO2 allowance price dynamics to stock market price dynamics, there is, however, a significant Granger causality running from stock markets to CO2 allowance markets in the EU - with a negative sign. The analysis has wide-ranging implications for climate policy and financial market dynamics in the EU, the US and Asia in the long run.