Emissions trading with nonsignatories in a climate …lessman/slides/wcere2010.pdfKai Lessmann,...
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Kai Lessmann, WCERE 2010 Montreal 1
Emissions trading with nonsignatories in a climate agreement
An analysis of coalition stability
Kai Lessmann*Ottmar Edenhofer*Robert Marschinski*Michael Finus♦
WCERE 2010, Montreal
* Potsdam Institute for Climate Impact Research♦ University of Exeter Business School
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Kai Lessmann, WCERE 2010 Montreal 2
International Environmental Agreements (IEA)
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coalitionpermittrade
CDMcredittrade
non-member
• Coalition formation: two stage game– Stage 1: Membership game
● Players either sign the IEA or do not
● CDM credit supplier remains impartial
● Internal/external stability ( Carraro/Siniscalco 1993)→
– Stage 2: Emission game● Players decide on
investments ( emission trajectories)→and trade ( allowances choice)→
● Partial Agreement Nash Equilibrium ( Chander/Tulkens 1995)→
● Our aim:Design permit trade with nonmembers (“CDM”) to improve the IEA
CDM credit supplier
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Kai Lessmann, WCERE 2010 Montreal 3
Modeling Endogenous Allowance Choices
● Trading allowances: net permit exports = allowances emissions
● Choose
– q > e to sell CDM credits
– q < e to import CDM credits
– q low to reduce global warming, as total allowances cause damages
● Additionality – CDM trader must reduce below “no trade” baseline no “hot air”→
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coalitionpermittrade
CDMcredittrade
non-member
CDM credit supplier
time
allowances,emissions allowance choice q
tradable credits xemissions e
Cf. Helm (2003) JPE, Carbone, Helm and Rutherford (2009) JEEM
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Kai Lessmann, WCERE 2010 Montreal 4
Model of International Climate Agreements (MICA)
welfare
consumption
output
labor capitallaborefficiency
mitigation
emissionintensity
● Model builds on Lessmann et al. 2009, Lessmann/Edenhofer 2010
● Economic dynamics:
– Regions maximize intertemporal welfare(cf. Nordhaus' RICE)
– Trade in one good and emission allowances
– Eight symmetric regions + CDM supplier
● Climate dynamics:
– emissions concentration temperature→ →
– climate change damages
● Data: global aggregates calibrated to common scenarios
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coalitionpermittrade
CDMcredittrade
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Kai Lessmann, WCERE 2010 Montreal 5
Impact on Coalition Stability
● Stability Function: inside payoff – outside payoff
● Largest stable coalition: 2
Stability Functions
No CDMbaseline
Coalition Size
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Kai Lessmann, WCERE 2010 Montreal 6
Impact on Coalition Stability (2)
CDM
No CDM
Stability Functions
● Stability Function: inside payoff – outside payoff
● Largest stable coalition: 2
● Introduction of CDM
– stability decreased
– coalition size 2 remains
● Why?
Coalition Size
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Kai Lessmann, WCERE 2010 Montreal 7
Impact on Coalition Stability (3)
CDM
No CDM
Stability Functions Global Emissions
CDM
No CDM
● More abatement in coalition reduced global emissions→
● Stronger incentive to freeride
Coalition Size Coalition Size
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Kai Lessmann, WCERE 2010 Montreal 8
Improving CDM Design
● Two approaches to (maybe) overcome this negative result:
– Selling targets● Idea: Shift the gains from CDM trade to the coalition● Impose more stringent upper bounds on CDM-trader’s allowance choice
– CEA CDM trade● Idea: Negotiate CDM trade after coalition formation● CDM trade ensure cost effectiveness
(but is not part of the cost/benefit trade-off in the allowance choice)
time
CDM traderallowances
no tradeselling target
allowance choicetradable credits
no trade
time
Coalitionallowances
no trade
“no lower than no trade”
CEA constraint
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Kai Lessmann, WCERE 2010 Montreal 9
Selling targets: Welfare effects
● No selling targets:
– welfare gains from CDMtrade for● CDM-trader (––) ● Non-member (––)
● Selling targets
– shift welfare gains from CDM trader to Members, leaving Nonmembers unaffected
– freeriding incentive remains high
● CDMtrader gain < 0:not profitable no trade→
● Tradeoff: profitability vs. stability
fixed coalition size of 6
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Kai Lessmann, WCERE 2010 Montreal 10
Selling targets: Stability vs. Profitability
Coalition Size
Selling Target
profitable CDM trade
stable coalitions
→ Selling targets work in principle, but are restricted by non-profitability
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Kai Lessmann, WCERE 2010 Montreal 11
CEA CDM: Coalition Stability
Stability Functions
● Stability is improved, but the effect remains small
● This may be due to relatively small volume of CDM trade
→ Boost CDM trade by introducing some heterogeneity
CDM No CDM
CEA CDM
Coalition Size
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Kai Lessmann, WCERE 2010 Montreal 12
CEA CDM: Introducing Heterogeneity
Abatement
Coalition (all members) CDM-trader
MCi
MBC
MBi
Abatement
MCi
MBi
SY
MM
ET
RIC
SY
MM
ET
RIC
CDMContributionto Abatement
17%
AN O – T R A D E for a 5 playercoalition
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Kai Lessmann, WCERE 2010 Montreal 13
CEA CDM: Introducing Heterogeneity
Abatement
Coalition (all members) CDM-trader
MCi
MBC
MBi
Abatement
MCi
MBi
Abatement
MCi
MBC
MBi
Abatement
MCi
MBi
SY
MM
ET
RIC
SY
MM
ET
RIC
HE
TE
RO
GE
NE
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CDMContributionto Abatement
17%
67%
for a 5 playercoalition
AN O – T R A D E
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Kai Lessmann, WCERE 2010 Montreal 14
CEA CDM: Results from heterogeneous players
Stability Functions Stability and profitability of trade
profitable CDM trade
stable coalitions
Coalition SizeCoalition Size
Sel
ling
targ
etCDM
No CDMbaseline
CEA CDM
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Kai Lessmann, WCERE 2010 Montreal 15
CEA CDM: Welfare implication of hot air
● Positive effect of CDM trade on treaty participation increases with traded volume (heterogeneity)
● Neteffect of “hot air” ambiguous:
– dillutes the agreement and thus causes welfare loss
– improves participation – which may outweigh the welfare loss
with additionalitywith “hot air”
Degree of Heterogeneity
% o
f soc
ial o
ptim
um
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Kai Lessmann, WCERE 2010 Montreal 16
Summary
1. Depending on its design,
– CDM may discourage participation (CBA) or
– CDM may foster participation (CEA)
2. Selling targets may help the agreement in two ways:
– by shifting welfare gains of CDM trade to coalition members (CBA)
– by stabilizing a dilluted agreement by allowing “hot air” (CEA)
3. Large enough differential, large credit trade volume necessary
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Kai Lessmann, WCERE 2010 Montreal 17
Thank your for your time.