Designing emissions trading schemes for a price-regulated and concentrated industry: Insights from China’s power sector

This paper proposes a framework for designing an emissions trading system (ETS) for the highly concentrated and regulated Chinese electricity forward markets. We present an economic model where a few generation firms maximize profits by choosing output levels under a price set below equilibrium and engage in trading carbon permits under either tradable performance standards (TPS) or cap-and-trade (C&T) systems. The regulated price causes underproduction across all firms. Compared to a scenario with no ETS, both ETS depress permit buyers’ production, and C&T typically decreases sellers’ production unless initial allocations are excessively high. However, TPS encourages permit sellers’ production if a seller cannot drastically shift the permit market equilibrium. From a Guangdong dataset, we uncover model parameters, such as firm-specific cost functions, and use them to evaluate policy scenarios. We find TPS achieves higher welfare with lower emissions than C&T under the regulated price. If the price is jointly selected with the ETS to maximize welfare, both achieve almost identical welfare and emission levels, but TPS has more consumer surplus than C&T. Moreover, TPS under the regulated price approximates this maximized welfare, counteracting the underproduction by reallocating generation to low-emission-intensity firms, whereas C&T requires substantially higher power and permit prices.