Detecting speculation in the market for EU emission allowances

This paper investigates whether the price spikes observed in the European Union Emissions Trading System (EU ETS) from 2017 to 2022 – a period characterised by rapid price increases and heightened volatility – were driven by speculative episodes, price bubbles, and abnormal trading activity. We apply, for the first time to our knowledge, the bubble detection procedure developed by Phillips and Shi (2020) to futures prices of emission allowances. The approach integrates a right-sided recursive testing algorithm with a bootstrap approach that accounts for heteroscedasticity, as is common in most EU ETS studies, and for family-wise size errors, which can significantly reduce detection power. Additionally, we use an abnormal trading detection method to identify unusual patterns in both futures and options markets. Our findings reveal seven speculative bubbles, spanning 154 out of 1,521 trading days, or approximately 10% of the sample period. We also identify ten instances of abnormal trading in futures and twelve in options, with four aligning with detected speculative bubbles. By examining 69 regulatory events related to the EU ETS during the period studied, we observe that six of the seven bubbles correspond with regulatory announcements. These results demonstrate that speculative activity has substantially influenced emission allowances prices, causing significant deviations from their fundamental values. This highlights the importance of continuously monitoring speculative impacts within the EU ETS and underscores the need for careful timing and communication of regulatory interventions.