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Emission Permits Allocation, Market Power, and Cost-effectiveness of ETS: A Theoretical Analysis

This paper analyzes the impact of CO2 emission permits allocation methods on the cost-effectiveness of ETS in the presence of market power. The study examines various allocation methods, such as grandfathering, benchmarking, auctioning, and mixed allocation, and discusses their implications on efficiency and fairness.

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Emission Permits Allocation, Market Power, and Cost-effectiveness of ETS: A Theoretical Analysis

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  1. Emission Permits Allocation, Market Power and Cost-effectiveness of ETS - A Theoretical Analysis Mei Wang Advisor Prof. Peng Zhou College of Economics and Management, NUAA Research Centre for Soft Energy Science, NUAA

  2. Introduction Emission trading system (ETS) has become an important policy instrument in response to climate change. ETS

  3. Introduction Many countries/regions have gradually launched their ETS since 2005.

  4. Introduction Market power In EU ETS, carbon price in the first period experienced high fluctuation and fell to 0 at the end of 2007. Over allocation In China pilot ETS, wild fluctuation in the carbon price. (4.2-123 Yuan/ton)

  5. Introduction The presence of market power in the carbon market can lead to efficiency loss in ETS which is dependent on initial allocation of permits. Market power exists only in the carbon market • Hahn (1984) • Westskog (1996) • Malik (2002) • Liski and Montero (2005) • Maeda (2003) • Hintermann (2017) • … • Misiolek and Elder (1989) • Sartzetakis (1997) • Eshel (2005) • Hintermann (2011) • Hatcher (2012) • Tanaka and chen (2012) • … Market power in the carbon market and production market

  6. Introduction Emission allocation is an important part in ETS. Efficiency Fairness • Indicator approach • Optimization approach • Game theoretic approach • Hybrid approach Theoretical study Real-world application • Grandfathering • Benchmarking • Auctioning

  7. Introduction • The main purpose of this paper is • to analyze the impact of CO2 emission permits allocation method on the cost-effectiveness of ETS from the perspective of market power • to choose most suitable allocation method when market power exists in ETS. College of Economics and Management, NUAA Research Centre for Soft Energy Science, NUAA

  8. CO2 emission permit allocation methods Grandfathering Grandfathering Benchmarking Benchmarking Auctioning Auctioning Mixed allocation College of Economics and Management, NUAA Research Centre for Soft Energy Science, NUAA

  9. Stackelberg model in ETS Price takers solve the following optimization problem Minimize (i = 2, …, n) Dominant firm solves the following optimization problem Minimize Subject to College of Economics and Management, NUAA Research Centre for Soft Energy Science, NUAA

  10. Stackelberg model in ETS Grandfathering The carbon price is dependent on initial allocation of emission permits of dominant firm. The inefficiency in abatement relies on the net volume of emission permits traded by firm 1. College of Economics and Management, NUAA Research Centre for Soft Energy Science, NUAA

  11. Stackelberg model in ETS Benchmarking The carbon price is dependent on the value of the benchmark the government sets for the firm with market power. Benchmarking rule can easily result in market distortion when market power exists in carbon market. College of Economics and Management, NUAA Research Centre for Soft Energy Science, NUAA

  12. Stackelberg model in ETS Auctioning 1 Firm 1 has the market power to set carbon price Firm 1 sets the carbon price lower than its marginal abatement cost. The cost-effectiveness of ETS cannot be reached and inefficiency is dependent on the net volume of emission permits traded by firm 1. Auctioning 2 The carbon price is set firstly by the government All the firms are carbon price takers. Under auctioning, the cost-efficiency in carbon market can be achieved, given the proper carbon price set by the government. College of Economics and Management, NUAA Research Centre for Soft Energy Science, NUAA

  13. Stackelberg model in ETS Mixed allocation Grandfathering and Auctioning 1 The carbon price is dependent on initial allocation of emission permits of dominant firm. The inefficiency in abatement relies on the net volume of emission permits traded by firm 1. College of Economics and Management, NUAA Research Centre for Soft Energy Science, NUAA

  14. Discussions and implications 1. Market power and cost-effectiveness of ETS Market power plays an important role in the cost-effectiveness of ETS. The firms with market power in the carbon market can deviate the carbon price from the cost-efficient equilibrium price. 2. Emission permit allocation method and cost-effectiveness of ETS The cost-effectiveness of ETS is highly affected by emission allocation method when there exists market power in carbon market. College of Economics and Management, NUAA Research Centre for Soft Energy Science, NUAA

  15. Policy suggestions College of Economics and Management, NUAA Research Centre for Soft Energy Science, NUAA

  16. Thank You! College of Economics and Management, NUAA Research Centre for Soft Energy Science, NUAA 16

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