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Emissions Trading with Offset Markets and Free Quota Allocations

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  • Knut Einar Rosendahl
  • Jon Strand

Abstract

We study optimal climate policy for a “policy bloc” of countries facing a market where emissions offsets can be purchased from a non-policy “fringe” of countries (such as for the CDM). Policy-bloc firms benefit from free quota allocations whose quantity is updated according to firms’ past emissions, or their outputs. We show that the resulting abatement and its allocation between policy bloc and fringe are both inefficient. When firms buy offsets directly from the fringe and all quotas are traded at a single price, the policy bloc chooses to either not constrain the offset market, or ban offsets completely. The former (latter) case occurs when free allocation of quotas is not (very) generous, and the offset market is large (small). It is preferable for policy-bloc countries’ governments to instead buy offsets directly from the fringe at a quota price below marginal damage cost of emissions, while the policy-bloc quota price will be above this cost. With maximization of global welfare and a unified quota price, this price is higher, and offsets constrained in fewer cases, but the solution still inefficient. Full efficiency then requires a higher quota price in the policy bloc than in the fringe.

Suggested Citation

  • Knut Einar Rosendahl & Jon Strand, 2014. "Emissions Trading with Offset Markets and Free Quota Allocations," CESifo Working Paper Series 4603, CESifo.
  • Handle: RePEc:ces:ceswps:_4603
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    Cited by:

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    3. Strand, Jon, 2016. "Mitigation incentives with climate finance and treaty options," Energy Economics, Elsevier, vol. 57(C), pages 166-174.
    4. Strand,Jon & Siddiqui,Sauleh, 2015. "Value of improved information about forest protection values, with application to rainforest valuation," Policy Research Working Paper Series 7423, The World Bank.

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    More about this item

    Keywords

    emissions quotas; offset market; quota allocation;
    All these keywords.

    JEL classification:

    • F64 - International Economics - - Economic Impacts of Globalization - - - Environment
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy

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