Emissions Trading with Offset Markets and Free Quota Allocations

36 Pages Posted: 12 Feb 2014

See all articles by Knut Einar Rosendahl

Knut Einar Rosendahl

Norwegian University of Life Sciences; Statistics Norway - Research Department

Jon Strand

World Bank

Date Written: January 31, 2014

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.

Keywords: emissions quotas, offset market, quota allocation

JEL Classification: F640, H230, Q540, Q580

Suggested Citation

Rosendahl, Knut Einar and Strand, Jon, Emissions Trading with Offset Markets and Free Quota Allocations (January 31, 2014). CESifo Working Paper Series No. 4603. Available at SSRN: https://ssrn.com/abstract=2394002

Knut Einar Rosendahl

Norwegian University of Life Sciences ( email )

PO Box 5033
NO-1432 Aas
Norway
+47 64966117 (Phone)

Statistics Norway - Research Department ( email )

Kongens Gt. 6
PO Box 8131 Dep
N-0033 Oslo
Norway
+47 21094954 (Phone)
+47 21094963 (Fax)

Jon Strand (Contact Author)

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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