Soft and Hard Price Collars in a Cap-and-Trade System: A Comparative Analysis

Resources for the Future Discussion Paper 10-27-REV

34 Pages Posted: 19 May 2010 Last revised: 10 Jun 2011

See all articles by Harrison G. Fell

Harrison G. Fell

Resources for the Future

Dallas Burtraw

Resources for the Future

Richard D. Morgenstern

Resources for the Future

Karen L. Palmer

Resources for the Future

Louis Preonas

University of California, Berkeley - Department of Agricultural & Resource Economics

Date Written: May 7, 2010

Abstract

We use a stochastic dynamic framework to compare price collars (price ceilings and floors) in a cap-and-trade system with uncertainty in the level of baseline emissions and costs. We consider soft collars, which provide limited volume of additional emission allowances (a reserve) at the price ceiling, and hard collars, which provide an unlimited supply of additional allowances, thereby preventing allowance prices from exceeding the price ceiling. Conversely, allowances are removed from the market if prices fall to the floor. We find that increasing the size of the reserve strictly lowers expected net present values of compliance costs; however, there is a diminishing effect as the allowance reserve is expanded. Most of the expected cost savings are achieved with a modest reserve. Consequently, a rather limited soft price collar could provide considerable assurance about cost while preventing the possibility that emissions could spiral out of control.

Keywords: climate change, cap-and-trade, price collars, stochastic dynamic programming

JEL Classification: Q54, Q58, C61

Suggested Citation

Fell, Harrison G. and Burtraw, Dallas and Morgenstern, Richard D. and Palmer, Karen and Preonas, Louis, Soft and Hard Price Collars in a Cap-and-Trade System: A Comparative Analysis (May 7, 2010). Resources for the Future Discussion Paper 10-27-REV. Available at SSRN: https://ssrn.com/abstract=1610271 or http://dx.doi.org/10.2139/ssrn.1610271

Harrison G. Fell (Contact Author)

Resources for the Future ( email )

1616 P Street, NW
Washington, DC 20036
United States
202-328-5005 (Phone)

Dallas Burtraw

Resources for the Future ( email )

1616 P Street, NW
Washington, DC 20036
United States
202-328-5087 (Phone)

Richard D. Morgenstern

Resources for the Future ( email )

1616 P Street, NW
Washington, DC 20036
United States

Karen Palmer

Resources for the Future ( email )

1616 P Street, NW
Washington, DC 20036
United States

Louis Preonas

University of California, Berkeley - Department of Agricultural & Resource Economics ( email )

Berkeley, CA 94720
United States

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