Properly designed Emission Trading do work!

Properly designed emissions trading schemes do work!

Properly designed emissions trading schemes dowork!

Ilnaz Asadzadeh

The University of Calgary

October 9, 2013

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Emission Trading

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Emission Trading

DESCRIPTION

I Emission Trading or Cap and Trade is a market-basedapproach used to control pollution by providing economicincentives for achieving reductions in the emissions ofpollutants

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How Does It Work?

I A control authority sets a limit or Cap on the amount ofpollutant.

I The Cap is allocated or sold to firms in the form of emissionspermit.

I The total number of permits can not exceed the cap.

I The transfer of permits is referred to as Trade.

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Examples of Existing Cap and Trade Systems

Examples of Existing Cap and Trade Systems

I European Union Emission Trading Scheme (EU-ETS)

I US REgional Clean Air Incentives(RECLAIM)

I Regional Greenhouse Gas Incentives(RGGI)

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Standard Cap and Trade Scheme

I The regulator sets the initial allocation which is the number ofpermits that each firm can emit.

I Sets the level of the Penalty for each emission unit not offsetby an allowance certificate at the end of the complianceperiod.

I Because of too generous an allocation of pollution permits andlow level of penalty this scheme did not meet emission targets.

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Did Cap and Trade System fail?

Windfall Profits for Power Producers

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What is the Objective?

Objective

The objective is to design and implement cap and trade schemescapable of

I Controlling the incentives to promote changes in theproduction portfolio towards cleaner technologies.

I Reaching reasonable pollution targets at low reduction costsand windfall profits.

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Equilibrium Model

For each specific good(electricity) at any given time t the effectiveproduction cost

˜C jt = C j

t + e jAt

I C jt = Cost without regulation

I At = Allowance price at time t

I e j = Emission per unit of produced good when usingtechnology j

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Describing the Model

I The price of the good at time t is given by the classical meritorder relation.

I If allowance is expensive then the pollution intensivetechnology can appear costly and be scheduled last forproduction. This effect creates cleaner production

I The producer has the chance to sell allowances on the marketinstead of using technology j .

I The allowance price enters the price of the good with thefactor e j so the consumer’s cost increase by e jAt for each unitproduced at time t.

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Costs Of a Standard Cap and Trade Scheme

Whether or not a cap and trade scheme can be considered asuccess depends upon the overall costs incurred to reach theemission target.

I Penalty Payments

I Consumer Costs

I Reduction Costs

I Windfall Profits

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Penalty Payments

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Producer and Consumer Costsand Consumer Costs.pdf

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Alternative Cap and Trade Schemes


I Proportional Scheme(Relative Scheme)

I Auctioning Scheme

I Emission Tax Scheme

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Proportional Allocation Scheme

I A big part of allowances being distributed over timeproportionally to the product of goods

I Since allowances have a financial value, allocating allowancesproportionally reduces the marginal costs of production

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Auctioning

I Replace free allocation of allowances by an auction likeprocurement

I Producers pay for allowances

I Regulator can return revenues to consumers or invest them inother emission reduction projects

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Tax Scheme

I The static tax that is paid for emission of each ton ofCo2-equivalent.

I Here the good is electricity which is inelastic so tax has tomake coal more expensive than gas. However both coal andgas prices are stochastic so the emission reductions are nearlyimpossible to control with tax.

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Comparison of the various Cap and trade Schemes

I The case study: Japanese Electricity Market

I The market is totally deregulated

I The goal is to reduce emissions by 20% at the end of 2012

I The emission target of less than or equal 300 Mega-ton ofcarbon dioxide

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Controls available to the regulator

I Standard Scheme: size of the penalty, and total number ofallocated allowances.

I Relative Scheme: size of the penalty, total number ofallowances allocated upfront, and factor of proportionalallocation.

I Tax Scheme: tax levied to discourage dirty production.

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In order to have a meaningful and fair comparison we chooseparameters as follows:

I For Standard Scheme: Penalty = 100 USD,Initial allocation = 300Mega− ton

I For Relative Scheme: Penalty = 100 USD,Upfront allocation = 63Mega− ton,Proportionality factor = 45%

I For Tax Scheme: Coal taxation = 39.5 USD per ton Co2

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Yearly Emissions

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Windfall Profits

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Abatement Costs

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Conclusion

So properly designed cap and trade schemes can work if

I They are given the right emissions targets and penalty

I The appropriate tools are used to allocate emissions credit

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References

References

I Rene Carmona, Max Fehr, Juri Hinz (2010). Properlydesigned emissions trading schemes do work!, OperationsResearch.

I Rene Carmona, Max Fehr, Juri Hinz (2010), Market Designfor Emission Trading SchemesSociety for Industrial andApplied Mathematics.

I Wikipedia

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Properly designed Emission Trading do work!

Education

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