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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. Jinhua Zhao, 2000. "Irreversible Abatement Investment Under Cost Uncertainties: Tradable Emission Permits and Emissions Charges," Center for Agricultural and Rural Development (CARD) Publications 00-wp252, Center for Agricultural and Rural Development (CARD) at Iowa State University.
  2. Matti Liski & Juan-Pablo Montero, 2004. "A Note on Market Power in an Emission Permits Market with Banking," Working Papers 0405, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
  3. 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.
  4. 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.
  5. 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.
  6. Frank Convery, 2009. "Origins and Development of the EU ETS," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 43(3), pages 391-412, July.
  7. Hahn, Robert W, 1984. "Market Power and Transferable Property Rights," The Quarterly Journal of Economics, MIT Press, vol. 99(4), pages 753-65, November.
  8. Robert Godby, 2002. "Market Power in Laboratory Emission Permit Markets," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 23(3), pages 279-318, November.
  9. Krattenmaker, Thomas G & Salop, Steven C, 1986. "Competition and Cooperation in the Market for Exclusionary Rights," American Economic Review, American Economic Association, vol. 76(2), pages 109-13, May.
  10. Oberndorfer, Ulrich, 2009. "EU Emission Allowances and the stock market: Evidence from the electricity industry," Ecological Economics, Elsevier, vol. 68(4), pages 1116-1126, February.
  11. Harstad, Bård & Eskeland, Gunnar S., 2010. "Trading for the Future: Signaling in Permit Markets," Discussion Papers 2010/2, Department of Business and Management Science, Norwegian School of Economics.
  12. 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 0642, Faculty of Economics, University of Cambridge.
  13. Böhringer, Christoph & Lange, Andreas, 2003. "On the Design of Optimal Grandfathering Schemes for Emission Allowances," ZEW Discussion Papers 03-08, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  14. Dafna Eshel, 2005. "Optimal Allocation of Tradable Pollution Rights and Market Structures," Journal of Regulatory Economics, Springer, vol. 28(2), pages 205-223, 09.
  15. Sijm, J. & Neuhoff, K. & Chen, Y., 2006. "CO2 cost pass through and windfall profits in the power sector," Cambridge Working Papers in Economics 0639, Faculty of Economics, University of Cambridge.
  16. 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.
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