Does Non Ratification of the Kyoto Protocol by the US Increase the Likelihood of Monopolistic Behavior by Russia in the Market of Tradable Permits?

After the decision by the US not to ratify the Kyoto Protocol, the prospects on the actual working of the world carbon market change dramatically. While in the case of US participation, according to most evaluations, the equilibrium price in 2010 was expected to be in the range of 50 to 100 US$, after the recent US decision it would be considerably smaller, even close to zero in some scenarios. This reflects the fact that the emission credits allocated in excess to Russia and other CIS countries (Hot Air) will be approximately enough to satisfy the potential demand by Annex B countries, even if the latter implement a very modest –and a fortiori none- domestic abatement policy. In such a context, it is very likely that Russia and its Former Soviet Union partners adopt a concerted monopolistic behavior, and sell only a share of available excess permits, in order to maximize receipts. Such a behavior is not, under any circumstance, inconsistent with the Kyoto Protocol considering its provisions on banking, and the possible transfer of unused permits to later periods. The aim of the paper is to simulate the working of the world carbon emissions market under the assumption of monopolistic behavior by FSU. Successively are assessed two profit-maximization schemes, a static one and an inter-temporal. The latter requires to consider a long term horizon (2040), in order to assess the potential gains for FSU of an expected steady increase over time of carbon price. Simulations are implemented through an inter-temporal mathematical program of optimization calibrated on an Applied General Equilibrium model (GEMINI-E3). Beside the working of the carbon market – including the competition from other flexibility mechanisms, in particular the CDM- the optimization program simulates the behavior of all other countries, taken together, and the macro-economic effects in particular changes in the prices of international markets and the associated Gains from Terms of Trade. Over such a long period, many uncertainties affect the strategy of FSU. Most important are the potential of the CDM mechanism and the future of the Kyoto Protocol, which is critical in determining the value of carbon in the long run. Notwithstanding, some robust results are obtained. The first is that the market price of carbon in the short run is nearly insensitive to FSU long run strategy, but very sensitive to the potential of CDM. According to a realistic range for this potential, the market price would be in the interval of 45 to 90 US$90 in 2010. The second result concerns the macro-economic effects of US withdrawal. If, as it could be easily expected, emissions abatement at the world level is significantly reduced (nearly dropped to zero in the short run, more than halved in the long run), the welfare cost for other Annex B countries (except FSU) remains approximately unchanged. Effectively, the monopolistic power of FSU allows to sustain a high price of permits, implying a high cost of compliance of the commitments taken by Annex B countries in Kyoto, while a higher demand for fossil fuels limits the price decrease and the associated Gains from Terms of Trade for remaining Annex B countries.