Energy Prices and Emissions Trading: Windfall Profits from Grandfathering?

Abstract

The greenhouse gas emissions trading scheme in the European Union primarily uses grandfathering until 2012, which means that polluters get emission rights free of charge based on their historical emissions. Energy consumers accuse energy producers of making windfall profits by incorporating the market value of those free rights into the energy prices. However, we develop a numerical example to illustrate that the reasoning of the producers is correct. We also explain why this market value is only partly passed on to consumers. We consider various measures and conclude that only auctioning the rights after 2012 nullifies the additional profits.

Keywords: emissions trading, energy prices, windfall profits, opportunity costs, grandfathering, auctioning

JEL Classification: D21, D62, K32, Q48, Q54