Several years of experience with the EU ETS and various adaptations of the regulatory framework are accompanied by discussions whether an institutional setting to stabilise carbon markets is needed.
This paper discusses imperfections in market forces contrary to theoretical assumptions especially with respect to the implications of the use of marginal abatement cost curves as well as the role of stable price signals for investment decisions. We argue that the gap between ex ante information when emission caps are set and ex post outcomes might be one of the reasons for price variability in the EU ETS.
This divergence between ex ante and ex post information illustrates that the theoretical assumptions on emissions trading are not matched by a real world setting. We conclude that this weakens the potential role of carbon prices for investment decisions. In order to improve the functioning of the EU ETS we reiterate the arguments for a carbon authority put forward in the literature and extend them by the argument that the concept of abatement curves is only of limited value in the context of CO2 emission reductions where marginal abatement costs often are ambiguous and time variant.