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Long-Run Equilibrium Modeling of Emissions Allowance Allocation Systems in Electric Power Markets

Author

Listed:
  • Jinye Zhao

    (ISO-New England, Holyoke, Massachusetts 01040)

  • Benjamin F. Hobbs

    (Department of Geography and Environmental Engineering and Department of Applied Mathematics and Statistics, The Johns Hopkins University, Baltimore, Maryland 21218, and ECN, Policy Studies Unit, Amsterdam, The Netherlands)

  • Jong-Shi Pang

    (Department of Industrial and Enterprise Systems Engineering, University of Illinois at Urbana--Champaign, Urbana, Illinois 61801)

Abstract

Carbon dioxide allowance trading systems for electricity generators are in place in the European Union and in several U.S. states. An important question in the design of such systems is how allowances are to be initially allocated: by auction, by giving away fixed amounts (grandfathering), or by allocating based on present or recent output, investment, or other decisions. The latter system can bias investment, operations, and product pricing decisions and increase costs relative to the other systems. A nonlinear complementarity model is proposed for investigating the long-run equilibria that would result under alternative systems for power markets characterized by time-varying demand and multiple technology types. Existence of equilibria is shown under mild conditions. Solutions for simple systems show that allocating allowances to new capacity based on fuel use or generator type can yield large distortions in capacity investment, invert the operating order of power plants, and inflate consumer costs. The distortions can be smaller for tighter CO 2 restrictions and are somewhat mitigated if there is also a market for electricity capacity or minimum-run restrictions on coal plants. Distortions are also less if allowances are allocated to plants in proportion to sales rather than capacity.

Suggested Citation

  • Jinye Zhao & Benjamin F. Hobbs & Jong-Shi Pang, 2010. "Long-Run Equilibrium Modeling of Emissions Allowance Allocation Systems in Electric Power Markets," Operations Research, INFORMS, vol. 58(3), pages 529-548, June.
    • Handle: RePEc:inm:oropre:v:58:y:2010:i:3:p:529-548
    DOI: 10.1287/opre.1090.0771
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    References listed on IDEAS

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