Regulation, Allocation, and Leakage in Cap-and-Trade Markets for CO2

35 Pages Posted: 17 Nov 2009

See all articles by James Bushnell

James Bushnell

University of California - Energy Institute; University of California, Berkeley - Department of Industrial Engineering & Operations Research (IEOR)

Yihsu Chen

University of California, Merced

Date Written: November 2009

Abstract

The allocation of emissions allowances is among the most contentious elements of the design of cap-and-trade systems. In this paper we develop a detailed representation of the US western electricity market to assess the potential impacts of various allocation proposals. Several proposals involve the updating of permit allocation, where the allocation is tied to the ongoing output, or input use, of plants. These allocation proposals are designed with the goals of limiting the pass-through of carbon costs to product prices, mitigating leakage, and of mitigating costs to high-emissions firms. However, some forms of updating can also inflate permit prices, thereby limiting the benefits of such schemes to high emissions firms. Rather than mitigating the impact on high carbon producers, the net operating profit of such firms can actually be lower under input-based updating than under auctioning. This is due to the fact that product prices (and therefore revenues) are lower under input-based updating, but overall compliance costs are relatively comparable between auctioning and input-based updating. In this way, the anticipated benefits from allocation updating are reduced and further distortions are introduced into the trading system.

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JEL Classification: L9, Q50

Suggested Citation

Bushnell, James B. and Chen, Yihsu, Regulation, Allocation, and Leakage in Cap-and-Trade Markets for CO2 (November 2009). NBER Working Paper No. w15495, Available at SSRN: https://ssrn.com/abstract=1505799

James B. Bushnell

University of California - Energy Institute ( email )

Berkeley, CA 94720
United States

University of California, Berkeley - Department of Industrial Engineering & Operations Research (IEOR)

IEOR Department
4135 Etcheverry Hall
Berkeley, CA 94720
United States

Yihsu Chen

University of California, Merced ( email )

P.O. Box 2039
Merced, CA 95344
United States

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