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An Analysis of Allowance Banking in the EU ETS

Author

Listed:
  • Denny Ellerman
  • Vanessa Valero
  • Aleksandar Zaklan

Abstract

The existence of some 2 billion unused EU Allowances (EUAs) at the end of Phase II of the EU's Emissions Trading System (EU ETS) has sparked considerable debate about structural shortcomings of the EU ETS. At the same time, there has been a surprising lack of interest in one possible explanation of this accumulation of EUAs: the theory of intertemporal permit trading, i.e. allowance banking. In this paper we adapt basic banking theory to the case of a smoothly declining cap such as that in the EU ETS. We show that it is rational for agents to decrease emissions beyond the constraint imposed by the cap initially, accumulating an allowance bank and then drawing it down in the interest of minimizing abatement cost over time. Having laid out the theory, we carry out a set of simulations for a reasonable range of key parameters, calibrated to the EU ETS, to illustrate the e_ects of intertemporal optimization of abatement decisions on optimal time paths of emissions and allowance prices. We also explore the e_ect of an unexpected change in counterfactual emissions. We conclude that bank accumulation as the result of intertemporal abatement cost optimization should be considered at least a partial explanation when evaluating the current discrepancy between the cap and observed emissions in the EU ETS.

Suggested Citation

  • Denny Ellerman & Vanessa Valero & Aleksandar Zaklan, 2015. "An Analysis of Allowance Banking in the EU ETS," RSCAS Working Papers 2015/29, European University Institute.
  • Handle: RePEc:rsc:rsceui:2015/29
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    References listed on IDEAS

    as
    1. Kling, Catherine & Rubin, Jonathan, 1997. "Bankable permits for the control of environmental pollution," Journal of Public Economics, Elsevier, vol. 64(1), pages 101-115, April.
    2. Rubin Jonathan & Kling Catherine, 1993. "An Emission Saved Is an Emission Earned: An Empirical Study of Emission Banking for Light-Duty Vehicle Manufacturers," Journal of Environmental Economics and Management, Elsevier, vol. 25(3), pages 257-274, November.
    3. Yates, Andrew J. & Cronshaw, Mark B., 2001. "Pollution Permit Markets with Intertemporal Trading and Asymmetric Information," Journal of Environmental Economics and Management, Elsevier, vol. 42(1), pages 104-118, July.
    4. Cronshaw, Mark B & Brown-Kruse, Jamie, 1996. "Regulated Firms in Pollution Permit Markets with Banking," Journal of Regulatory Economics, Springer, vol. 9(2), pages 179-189, March.
    5. Stevens, Brandt & Rose, Adam, 2002. "A Dynamic Analysis of the Marketable Permits Approach to Global Warming Policy: A Comparison of Spatial and Temporal Flexibility," Journal of Environmental Economics and Management, Elsevier, vol. 44(1), pages 45-69, July.
    6. A. Denny Ellerman & Juan-Pablo Montero, 2007. "The Efficiency and Robustness of Allowance Banking in the U.S. Acid Rain Program," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4), pages 47-72.
    7. Paul Leiby & Jonathan Rubin, 2001. "Intertemporal Permit Trading for the Control of Greenhouse Gas Emissions," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 19(3), pages 229-256, July.
    8. repec:dau:papers:123456789/10174 is not listed on IDEAS
    9. Rubin, Jonathan D., 1996. "A Model of Intertemporal Emission Trading, Banking, and Borrowing," Journal of Environmental Economics and Management, Elsevier, vol. 31(3), pages 269-286, November.
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    Citations

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    Cited by:

    1. Abrell, Jan & Rausch, Sebastian, 2017. "Combining price and quantity controls under partitioned environmental regulation," Journal of Public Economics, Elsevier, vol. 145(C), pages 226-242.
    2. Kollenberg, Sascha & Taschini, Luca, 2016. "Emissions trading systems with cap adjustments," Journal of Environmental Economics and Management, Elsevier, vol. 80(C), pages 20-36.
    3. Clemens Gerbaulet & Casimir Lorenz, 2017. "dynELMOD: A Dynamic Investment and Dispatch Model for the Future European Electricity Market," Data Documentation 88, DIW Berlin, German Institute for Economic Research.
    4. repec:gam:jeners:v:11:y:2018:i:4:p:706-:d:137313 is not listed on IDEAS
    5. Stefan Trück & Rafał Weron, 2016. "Convenience Yields and Risk Premiums in the EU‐ETS—Evidence from the Kyoto Commitment Period," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 36(6), pages 587-611, June.
    6. Joltreau, Eugénie & Sommerfeld, Katrin, 2016. "Why does emissions trading under the EU ETS not affect firms' competitiveness? Empirical findings from the literature," ZEW Discussion Papers 16-062, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    7. Kim Collins & Roman Mendelevitch, 2015. "Leaving Coal Unburned: Options for Demand-Side and Supply-Side Policies," DIW Roundup: Politik im Fokus 87, DIW Berlin, German Institute for Economic Research.

    More about this item

    Keywords

    Cap and Trade System; EU ETS; Intertemporal Trading.;

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • F18 - International Economics - - Trade - - - Trade and Environment
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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