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Incentives and prices in an emissions trading scheme with updating

Listed author(s):
  • Rosendahl, Knut Einar

Emissions trading schemes where allocations are based on updated baseline emissions give firms less incentive to reduce emissions for a given quota (or allowance) price. Nevertheless, according to Böhringer and Lange [On the design of optimal grandfathering schemes for emission allowances, Europ. Econ. Rev. 49 (2005) 2041-2055], such allocation schemes are cost-effective if the system is closed and allocation rules are identical across firms. In this paper, we show that the cost-effective solution may be infeasible if marginal abatement costs grow too fast. Moreover, if a price cap or banking/borrowing is introduced, the abatement profile is no longer the same as in the case with an auction (or lump-sum allocation). In addition, we show that with allocation based on updated emissions, the quota price will always exceed marginal abatement costs, possibly misguiding policy makers and investors about abatement costs. Numerical simulations indicate that the quota price most likely will be several times higher than marginal abatement costs, unless a significant share of allowances is auctioned.

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File URL: http://www.sciencedirect.com/science/article/pii/S0095-0696(08)00024-7
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Article provided by Elsevier in its journal Journal of Environmental Economics and Management.

Volume (Year): 56 (2008)
Issue (Month): 1 (July)
Pages: 69-82

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Handle: RePEc:eee:jeeman:v:56:y:2008:i:1:p:69-82
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622870

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  1. Considine, Timothy J. & Larson, Donald F., 2006. "The environment as a factor of production," Journal of Environmental Economics and Management, Elsevier, vol. 52(3), pages 645-662, November.
  2. Muller, Adrian & Sterner, Thomas, 2009. "Output and Abatement Effects of Allocation Readjustment in Permit Trade," Working Papers in Economics 413, University of Gothenburg, Department of Economics.
  3. Rie Watanabe & Guy Robinson, 2005. "The European Union Emissions Trading Scheme (EU ETS)," Climate Policy, Taylor & Francis Journals, vol. 5(1), pages 10-14, January.
  4. Knut Einar Rosendahl, 2007. "Incentives and quota prices in an emission trading scheme with updating," Discussion Papers 495, Statistics Norway, Research Department.
  5. Burtraw, Dallas & Kahn, Danny & Palmer, Karen, 2006. "CO2 Allowance Allocation in the Regional Greenhouse Gas Initiative and the Effect on Electricity Investors," The Electricity Journal, Elsevier, vol. 19(2), pages 79-90, March.
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  7. Palmer, Karen & Burtraw, Dallas, 2005. "Cost-effectiveness of renewable electricity policies," Energy Economics, Elsevier, vol. 27(6), pages 873-894, November.
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  9. Kuik, Onno & Mulder, Machiel, 2004. "Emissions trading and competitiveness: pros and cons of relative and absolute schemes," Energy Policy, Elsevier, vol. 32(6), pages 737-745, April.
  10. Burtraw, Dallas & Parry, Ian & Goulder, Lawrence & Williams III, Roberton, 1998. "The Cost-Effectiveness of Alternative Instruments for Environmental Protection in a Second-Best Setting," Discussion Papers dp-98-22, Resources For the Future.
  11. 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.
  12. Keats, K. Martinez & Neuhoff, K., 2004. "Allocation of Carbon Emission Certificates in the Power Sector: How generators profit from grandfathered rights," Cambridge Working Papers in Economics 0444, Faculty of Economics, University of Cambridge.
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  14. Burtraw, Dallas & Palmer, Karen & Kahn, Daniel, 2005. "Allocation of CO2 Emissions Allowances in the Regional Greenhouse Gas Cap-and-Trade Program," Discussion Papers dp-05-25, Resources For the Future.
  15. Ahman, Markus & Burtraw, Dallas & Kruger, Joseph & Zetterberg, Lars, 2007. "A Ten-Year Rule to guide the allocation of EU emission allowances," Energy Policy, Elsevier, vol. 35(3), pages 1718-1730, March.
  16. Montgomery, W. David, 1972. "Markets in licenses and efficient pollution control programs," Journal of Economic Theory, Elsevier, vol. 5(3), pages 395-418, December.
  17. Karsten Neuhoff & Markus Åhman & Regina Betz & Johanna Cludius & Federico Ferrario & Kristina Holmgren & Gabriella Pal & Michael Grubb & Felix Matthes & Karoline Rogge & Misato Sato & Joachim Schleich, 2006. "Implications of announced phase II national allocation plans for the EU ETS," Climate Policy, Taylor & Francis Journals, vol. 6(4), pages 411-422, July.
  18. Fischer, Carolyn, 2001. "Rebating Environmental Policy Revenues: Output-Based Allocations and Tradable Performance Standards," Discussion Papers dp-01-22, Resources For the Future.
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