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Impact of the allowance allocation on prices and efficiency

Author

Listed:
  • Neuhoff, K.
  • Grubb, M.
  • Keats, K.

Abstract

Successful cap and trade programs for SO2 and NOx in the US allocate allowances to large emitters based on a historic base line for a period of up to thirty years. National Allocation Plans in Europe allocate CO2 allowances in an iterative approach first for a three then for a five-year period. The potential updating of the base line creates perverse incentives for operation and investment. Some allowances are also reserved for new entrants further distorting the scheme. We use analytic models and numeric simulations for the UK power sector to illustrate and quantify how these effects contribute to an inflation of the allowance price while reducing utilisation and investment in efficient technologies. The inflated allowance prices are likely to increase the European allowance budget and emissions, e.g. through the Linking Directive. As a result opportunity costs of emitting CO2 are reduced relative to an efficient cap and trade program.

Suggested Citation

  • Neuhoff, K. & Grubb, M. & Keats, K., 2005. "Impact of the allowance allocation on prices and efficiency," Cambridge Working Papers in Economics 0552, Faculty of Economics, University of Cambridge.
  • Handle: RePEc:cam:camdae:0552 Note: EPRG, IO
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    File URL: http://www.electricitypolicy.org.uk/pubs/wp/eprg0508.pdf
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    References listed on IDEAS

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    1. Fischer, Carolyn & Toman, Michael & Kerr, Suzi, 1998. "Using Emissions Trading to Regulate U.S. Greenhouse Gas Emissions: An Overview of Policy Design and Implementation Issues," Discussion Papers dp-98-40, Resources For the Future.
    2. Fischer, Carolyn & Kerr, Suzi & Toman, Michael, 1998. "Using Emissions Trading to Regulate U.S. Greenhouse Gas Emissions: An Overview of Policy Design and Implementation Issues," National Tax Journal, National Tax Association, vol. 51(3), pages 453-464, September.
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    Cited by:

    1. Donald N. Dewees, 2008. "Pollution and the Price of Power," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2), pages 81-100.
    2. Philippe Quirion & Damien Demailly, 2008. "Changing the Allocation Rules in the EU ETS: Impact on Competitiveness and Economic Efficiency," Working Papers 2008.89, Fondazione Eni Enrico Mattei.
    3. Harstad, Bård & Eskeland, Gunnar S., 2010. "Trading for the future: Signaling in permit markets," Journal of Public Economics, Elsevier, pages 749-760.

    More about this item

    Keywords

    : Emission Trading; Allowance Allocation; Investment Decision; Operation; Inefficiencies.;

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • Q28 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Government Policy
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General

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