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Impact of the allowance allocation on prices and efficiency

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

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.

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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0552.

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Length: 23
Date of creation: Nov 2005
Date of revision:
Handle: RePEc:cam:camdae:0552
Note: EPRG, IO
Contact details of provider: Web page: http://www.econ.cam.ac.uk/index.htm

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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.
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