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Market Power in Emission Permit Markets: Theory and Evidence

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  • Beat Hintermann

Abstract

A well-known result about market power in emission permit markets is that efficiency can be achieved by full free allocation to the dominant firm. I show that this result breaks down when taking the interaction between input and output markets into account, even if the firm perceives market power in the permit market alone. In fact, the dominant firm may have an incentive to inflate the permit price even if it receives no free permits at all. I examine the empirical evidence for price manipulation by large electricity firms during Phase I of the EU ETS. I find that the pattern and extent of firms’ allowance holdings are consistent with strategic price manipulation, and they appear unlikely to be the result of precautionary purchases due to carbon risk.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 4447.

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Date of creation: 2013
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Handle: RePEc:ces:ceswps:_4447

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Related research

Keywords: emission permit market; market power; cost pass-through; price manipulation;

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References

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  1. R. Andrew Muller & Stuart Mestelman, 1998. "What have we learned from emissions trading experiments?," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 19(4-5), pages 225-238.
  2. Bard Harstad & Gunnar S. Eskeland, 2006. "Trading for the Future: Signaling in Permit Markets," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 1429, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Zhao, Jinhua, 2003. "Irreversible abatement investment under cost uncertainties: tradable emission permits and emissions charges," Journal of Public Economics, Elsevier, Elsevier, vol. 87(12), pages 2765-2789, December.
  4. Böhringer, Christoph & Lange, Andreas, 2003. "On the Design of Optimal Grandfathering Schemes for Emission Allowances," ZEW Discussion Papers, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research 03-08, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  5. Matti Liski & Juan-Pablo Montero, 2003. "A Note on Market Power in an Emission Permits Market with Banking," Documentos de Trabajo, Instituto de Economia. Pontificia Universidad Católica de Chile. 236, Instituto de Economia. Pontificia Universidad Católica de Chile..
  6. Seifert, Jan & Uhrig-Homburg, Marliese & Wagner, Michael, 2008. "Dynamic behavior of CO2 spot prices," Journal of Environmental Economics and Management, Elsevier, vol. 56(2), pages 180-194, September.
  7. Dafna Eshel, 2005. "Optimal Allocation of Tradable Pollution Rights and Market Structures," Journal of Regulatory Economics, Springer, Springer, vol. 28(2), pages 205-223, 09.
  8. Sijm, J. & Neuhoff, K. & Chen, Y., 2006. "CO2 cost pass through and windfall profits in the power sector," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 0639, Faculty of Economics, University of Cambridge.
  9. Oberndorfer, Ulrich, 2009. "EU Emission Allowances and the stock market: Evidence from the electricity industry," Ecological Economics, Elsevier, Elsevier, vol. 68(4), pages 1116-1126, February.
  10. Hahn, Robert W., 1982. "Market Power and Transferable Property Rights," Working Papers, California Institute of Technology, Division of the Humanities and Social Sciences 402, California Institute of Technology, Division of the Humanities and Social Sciences.
  11. Neuhoff, K. & Keats, K. & Sato, M., 2006. "Allocation, incentives and distortions: the impact of EU ETS emissions allowance allocations to the electricity sector," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 0642, Faculty of Economics, University of Cambridge.
  12. Robert Godby, 2002. "Market Power in Laboratory Emission Permit Markets," Environmental & Resource Economics, European Association of Environmental and Resource Economists, European Association of Environmental and Resource Economists, vol. 23(3), pages 279-318, November.
  13. Hintermann, Beat, 2010. "Allowance price drivers in the first phase of the EU ETS," Journal of Environmental Economics and Management, Elsevier, vol. 59(1), pages 43-56, January.
  14. Krattenmaker, Thomas G & Salop, Steven C, 1986. "Competition and Cooperation in the Market for Exclusionary Rights," American Economic Review, American Economic Association, American Economic Association, vol. 76(2), pages 109-13, May.
  15. Misiolek, Walter S. & Elder, Harold W., 1989. "Exclusionary manipulation of markets for pollution rights," Journal of Environmental Economics and Management, Elsevier, vol. 16(2), pages 156-166, March.
  16. Frank Convery, 2009. "Origins and Development of the EU ETS," Environmental & Resource Economics, European Association of Environmental and Resource Economists, European Association of Environmental and Resource Economists, vol. 43(3), pages 391-412, July.
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