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Prices In Emissions Permit Markets: The Role Of Investor Foresight And Capital Durability

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  • Bryan K. Mignone

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    Abstract

    Of the many regulatory responses to climate change, cap-and-trade is the only one currently endorsed by large segments of the scientific, economic and political establishments. Under this type of system, regulators set the overall path of carbon dioxide (CO2) reductions, allocate or auction the appropriate number of emissions allowances to regulated entities and – through trading – allow the market to converge upon the least expensive set of abatement opportunities. As a result, the trading price of allowances is not set by the regulator as it would be under a tax system, but instead evolves over time to reflect the underlying supply and demand for allowances. In this paper, I develop a simple theory that relates the initial clearing price of CO2 allowances to the marginal cost premium of carbon-free technology, the maximum rate of energy capital replacement and the market interest rate. This theory suggests that the initial clearing price may be lower than the canonical range of CO2 prices found in static technology assessments. Consequently, these results have broad implications for the design of a comprehensive regulatory solution to the climate problem, providing, for example, some intuition about the proper value of a possible CO2 price trigger in a future cap-and-trade system.

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    Bibliographic Info

    Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2008-31.

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    Length: 20 pages
    Date of creation: Oct 2008
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    Handle: RePEc:een:camaaa:2008-31

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    1. McKibbin, Warwick J. & Wilcoxen, Peter J., 2004. "Estimates of the costs of Kyoto: Marrakesh versus the McKibbin-Wilcoxen blueprint," Energy Policy, Elsevier, vol. 32(4), pages 467-479, March.
    2. Richard Newell & William Pizer & Jiangfeng Zhang, 2005. "Managing Permit Markets to Stabilize Prices," Environmental & Resource Economics, European Association of Environmental and Resource Economists, European Association of Environmental and Resource Economists, vol. 31(2), pages 133-157, 06.
    3. Curtis Carlson & Dallas Burtraw & Maureen Cropper & Karen L. Palmer, 2000. "Sulfur Dioxide Control by Electric Utilities: What Are the Gains from Trade?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 108(6), pages 1292-1326, December.
    4. van Vuuren, Detlef P. & Weyant, John & de la Chesnaye, Francisco, 2006. "Multi-gas scenarios to stabilize radiative forcing," Energy Economics, Elsevier, Elsevier, vol. 28(1), pages 102-120, January.
    5. Baumol, William J, 1972. "On Taxation and the Control of Externalities," American Economic Review, American Economic Association, American Economic Association, vol. 62(3), pages 307-22, June.
    6. Roberts, Marc J. & Spence, Michael, 1976. "Effluent charges and licenses under uncertainty," Journal of Public Economics, Elsevier, vol. 5(3-4), pages 193-208.
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