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Climate Policy Design with Correlated Uncertainties in Offset Supply and Abatement Cost

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  • Fell, Harrison

    ()
    (Resources for the Future)

  • Burtraw, Dallas

    ()
    (Resources for the Future)

  • Morgenstern, Richard

    ()
    (Resources for the Future)

  • Palmer, Karen

    ()
    (Resources for the Future)

Abstract

Current and proposed greenhouse gas cap-and-trade systems allow regulated entities to offset abatement requirements by paying unregulated entities to abate. These offsets from unregulated entities are believed to contain system costs and stabilize allowance prices. However, the supply of offsets is highly uncertain and may be correlated with other sources of uncertainty in emissions trading systems. This paper presents a model that incorporates both uncertainties in the supply of offsets and in abatement costs. We numerically solve a dynamic stochastic model, with parameters relevant to the U.S. climate debate, under a variety of parameter settings, including a system that includes allowance price controls, risk aversion, and competitive offset purchasing. We find that as uncertainty in offsets and uncertainty in abatement costs become more negatively correlated, expected abatement plus offset purchase costs increase, as does the variability in allowance prices and emissions from the regulated sector. These results are amplified with risk sensitivity, larger annual offset limits, and competitive offset purchasing. Imposing an allowance price collar substantially mitigates cost increases as well as the variability in prices, while roughly maintaining expected environmental outcomes. In contrast with previous literature we find a collar may also mitigate emissions variability.

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Bibliographic Info

Paper provided by Resources For the Future in its series Discussion Papers with number dp-10-01-rev.

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Date of creation: 09 Jun 2011
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Handle: RePEc:rff:dpaper:dp-10-01-rev

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Related research

Keywords: climate change; offsets; cap-and-trade; price collars; stochastic dynamic programming;

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  1. Shaul Ben-David & David Brookshire & Stuart Burness & Michael McKee & Christian Schmidt, 2000. "Attitudes toward Risk and Compliance in Emission Permit Markets," Land Economics, University of Wisconsin Press, vol. 76(4), pages 590-600.
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Cited by:
  1. Suzi Kerr & Adam Millard-Ball, 2012. "Cooperation To Reduce Developing Country Emissions," Climate Change Economics (CCE), World Scientific Publishing Co. Pte. Ltd., vol. 3(04), pages 1250023-1-1.
  2. Gonzalex-Ramirez, Jimena & Kling, Catherine Louise & valcu, adriana, 2012. "An Overview of Carbon Offsets from Agriculture," Staff General Research Papers 35575, Iowa State University, Department of Economics.
  3. Heather Klemick, 2012. "What is the Optimal Offsets Discount under a Second-Best Cap & Trade Policy?," NCEE Working Paper Series 201204, National Center for Environmental Economics, U.S. Environmental Protection Agency, revised Jul 2012.
  4. Stocking, Andrew, 2010. "Unintended Consequences of Price Controls: An Application to Allowance Markets," MPRA Paper 25559, University Library of Munich, Germany.
  5. Andrew Yates, 2012. "On a Fundamental Advantage of Permits Over Taxes for the Control of Pollution," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 51(4), pages 583-598, April.
  6. Horowitz, John & Ueda, Kohei, 2013. "Paying Farmers to Reduce Nitrogen Application on Corn: The Baseline Approach," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C. 150561, Agricultural and Applied Economics Association.

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