Unintended consequences of price controls: An application to allowance markets

Price controls established in a cap-and-trade allowance market are intended to reduce cost uncertainty by constraining allowance prices between a ceiling and floor; however, they could provide opportunities for strategic actions by firms that would lower government revenue and increase emissions. In particular, when the ceiling price is supported by introducing new allowances into the market, firms could choose to buy allowances at the ceiling price, regardless of the prevailing market price, in order to lower the equilibrium price of all allowances. Those purchases could either be transacted by firms intending to manipulate the market price or be induced through the introduction of inaccurate information about the cost of emissions abatement. Theory and simulations using allowance elasticity estimates for U.S. firms suggest that the manipulation could be profitable under the stylized setting and assumptions evaluated in the paper, although in practice many other conditions will determine its use.     

The environment as a factor of production

This paper uses firm-level data about electric utilities to develop an empirical model of how electric utilities use and bank SO₂ pollution permits under the Acid Rain Program. The empirical model considers emissions, fuels, and labor as variable inputs with quasi-fixed stocks of permits and capital. Consequently, substitution possibilities between the environment and other production factors can be measured and tested. The results reveal substantial substitution between emissions, permit stocks, capital, fuel, and labor. The empirical findings also indicate that firms bank permits primarily as a hedge against uncertainty and for other firm-specific reasons. Overall, the results suggest that cap-and-trade approaches can reduce the cost of meeting environmental goals by providing a mechanism for addressing regulatory and market risks and by signaling an appropriate price for factor use, especially irreversible capital investments.     

The environment as a factor of production

This paper uses firm-level data about electric utilities to develop an empirical model of how electric utilities use and bank SO₂ pollution permits under the Acid Rain Program. The empirical model considers emissions, fuels, and labor as variable inputs with quasi-fixed stocks of permits and capital. Consequently, substitution possibilities between the environment and other production factors can be measured and tested. The results reveal substantial substitution between emissions, permit stocks, capital, fuel, and labor. The empirical findings also indicate that firms bank permits primarily as a hedge against uncertainty and for other firm-specific reasons. Overall, the results suggest that cap-and-trade approaches can reduce the cost of meeting environmental goals by providing a mechanism for addressing regulatory and market risks and by signaling an appropriate price for factor use, especially irreversible capital investments.     

Procrastinating reform: The impact of the market stability reserve on the EU ETS

We study the impact of the market stability reserve (MSR) on price and emission paths of the EU ETS. From 2019 onwards, the MSR will adjust the number of allowances auctioned as a function of the size of the surplus, i.e. in times of a large surplus it shifts the issue date of allowances into the future. In a perfectly competitive allowance market the MSR only affects price and emission paths if the baseline equilibrium becomes unfeasible. If the MSR is binding, prices increase in the short run but drop in the medium run relative to the baseline. The MSR increases price variability if uncertainty over future allowance demand is resolved while there is a surplus. The long run cap is unaffected by both the MSR and overlapping climate policies. This contrasts the EU׳s objectives of improving the resilience of the EU ETS and increasing synergies with overlapping climate policies.     

Incentives and prices in an emissions trading scheme with updating

Emissions trading schemes where allocations are based on updated baseline emissions give firms less incentive to reduce emissions for a given quota (or allowance) price. Nevertheless, according to Böhringer and Lange [On the design of optimal grandfathering schemes for emission allowances, Europ. Econ. Rev. 49 (2005) 2041–2055], such allocation schemes are cost-effective if the system is closed and allocation rules are identical across firms. In this paper, we show that the cost-effective solution may be infeasible if marginal abatement costs grow too fast. Moreover, if a price cap or banking/borrowing is introduced, the abatement profile is no longer the same as in the case with an auction (or lump-sum allocation). In addition, we show that with allocation based on updated emissions, the quota price will always exceed marginal abatement costs, possibly misguiding policy makers and investors about abatement costs. Numerical simulations indicate that the quota price most likely will be several times higher than marginal abatement costs, unless a significant share of allowances is auctioned.     

Heterogeneous firms and the environment: a cap-and-trade program

Currently, cap-and-trade programs are a cornerstone of many countries' climate change policies and proposals. This paper investigates the economic and environmental effects of different climate change policy designs in a general equilibrium setting with heterogeneous firms and monopolistic competition. The analysis predicts that the cap on emissions perfectly defines the environmental quality but has no effect on firms' profits, or decisions to enter or exit the market. In contrast, increasing the share of free allocations of emission allowances, as opposed to auctions, has no effect on environmental quality but reallocates resources among firms toward the most productive ones which has an impact on firms' entry and exit decisions, the mass of firms, and the composition of the market. Firm heterogeneity magnifies these economic effects of changes in the initial allocation of allowances. The paper provides a decomposition of the change in aggregate emissions which takes account of the changes at sector level, across the firms within a sector, and at the firm level.     

Emission reduction and profit-neutral permit allocations

The present paper addresses two policy objectives: to implement a market for pollution permits and to make regulation acceptable for businesses. Profit-neutral permit allocations are defined as the number of permits that the regulator should give for free so that post-regulation profits (i.e. a firm's profits in the products market plus the value of the allowances granted for free) are equal to pre-regulation profits. The proposed model is developed by assuming that firms use polluting technologies and compete “à la Cournot”. The paper demonstrates that a low number of free allowances is sufficient to meet these two goals. Moreover, the regulator can fully offset losses, even when the reduction in emissions is high, provided that the sectors concerned are not monopolies, both for isoelastic and linear demand functions.     

When do environmental regulations backfire? Onsite industrial electricity generation,energy efficiency and policy instruments

More than half of all energy produced by electric utilities is lost in the form of waste heat. However, when manufacturing facilities choose to produce their own electricity, this waste heat is captured by Combined Heating and Power (CHP) technologies and used in the production process. As a result, manufacturers' pollution footprint can be dramatically reduced by choosing to produce electricity onsite rather than purchasing it from a utility. This paper uses Census microdata to study manufacturers’ decision to produce electricity onsite and examines how plants adjust onsite generation when they are subject to environmental regulations. Environmental regulations will backfire if they cause manufacturers to produce less electricity onsite and shift to electricity from less efficient, offsite electric utilities. We find that manufacturing plants subject to NOx command-and-control regulations decrease onsite electricity generation, increase electricity purchases from off-site utilities and see declines in their energy efficiency. However, manufacturers subject to cap-and-trade see no decline in onsite generation and experience improvements in energy efficiency. These findings demonstrate the importance of instrument selection and identify a new pathway through which emissions leakage may occur.     

Political influence on non-cooperative international climate policy

We analyze non-cooperative international climate policy in a setting of political competition by national interest groups. In the first stage, countries decide whether to link their domestic emission permit markets to an international market, which only forms if it is supported by all countries. In the second stage, countries non-cooperatively decide on the number of tradable emission allowances. In both stages, special interest groups try to sway the government in their favor. We find that (i) both the choice of regime and the levels of domestic and global emissions only depend on the aggregate levels of organized stakes in all countries and not on their distribution among individual interest groups and (ii) an increase in lobbying influence by a particular lobby group may backfire by inducing a change towards the lobby group's less preferred regime.     

Carbon leakage and capacity-based allocations: Is the EU right?

Competitiveness and carbon leakage are major concerns for the design of CO₂ emissions permits markets. In the absence of a global carbon tax and of border carbon adjustments, output-based allocation is a third-best solution and is actually implemented (Australia, California, New Zealand). The EU has followed a different route; free allowances are allocated to existing or new capacities in proportion to a benchmark, independent of actual production. This paper compares these two schemes in a formal setting and shows that the optimal one is in fact a combination of both schemes, or output-based allocation alone if uncertainty is limited. A key assumption of our analysis is that the short-term import pressure depends both on the existing capacities and the level of demand, which is typical in capital intensive and internationally traded sectors. A calibration of the model is used to discuss the EU scheme for the cement sector in the third phase of the EU-ETS (2013–2020). This allows for a quantification of various policies in terms of welfare, investment, production, company profits, public revenues and leakage.     

The private and social economics of bulk electricity storage

The ability to store excess intermittent renewable electricity is increasingly being seen as a key option for integrating large quantities of renewable capacity. However, intermittent energy sources currently account for very small amounts of total generation. Despite this fact, policymakers have begun implementing requirements that will dramatically increase the amount of bulk storage capacity. This paper examines the social benefits provided by bulk storage in the Texas electricity market, which has a large amount of renewable capacity relative to other states, but still quite limited renewable penetration. We focus on the impact of arbitraging electricity across time—a major service of bulk storage. Using current storage technologies, we demonstrate that electricity arbitrage will increase daily CO₂ emissions by an average of 0.19 tons for each MWh stored. In addition, daily SO₂ emissions will increase by an average of 1.89 pounds/MWh while NO_X emissions will fall by an average of 0.15 pounds/MWh.     

Cost-effective unilateral climate policy design: Size matters

Given the bleak prospects for a global agreement on mitigating climate change, pressure for unilateral abatement is increasing. A major challenge is emissions leakage. Border carbon adjustments and output-based allocation of emissions allowances can increase effectiveness of unilateral action but introduce distortions of their own. We assess antileakage measures as a function of abatement coalition size. We first develop a partial equilibrium analytical framework to see how these instruments affect emissions within and outside the coalition. We then employ a computable general equilibrium model of international trade and energy use to assess the strategies as the coalition grows. We find that full border adjustments rank first in global cost-effectiveness, followed by import tariffs and output-based rebates. The differences across measures and their overall appeal decline as the abatement coalition grows. In terms of cost, the coalition countries prefer border carbon adjustments; countries outside the coalition prefer output-based rebates.     

Integrierte Treibhausgasbewertung der Prozessketten von Erdgas und industriellem Biomethan in Deutschland

Background The use of natural gas has increased in the last years. In the future, its import supply and transport structure will diversify (longer distances, higher share of LNG (liquefied natural gas), new pipelines). Thus the process chain and GHG emissions of the production, processing, transport and distribution might change. Simultaneously, the injection of bio methane into the natural gas grid is becoming more important. Although its combustion is regarded as climate neutral, during the production processes of bio methane GHG emissions are caused. The GHG emissions occurring during the process chain of energy fuels are relevant for the discussion on climate policy and decision making processes. They are becoming even more important, considering the new Fuel Quality Directive of the EU (Dec. 2008), which aims at controlling emissions of the fuel process chains. Aim In the context of the aspects outlined above the aim is to determine the future development of gas supply for Germany and the resulting changes in GHG emissions of the whole process chain of natural gas and bio methane. With the help of two gas consumption scenarios and an LCA of bio methane, the amount of future emissions and emission paths until 2030 can be assessed and used to guide decision processes in energy policy. Results and discussion The process chain of bio methane and its future technical development are outlined and the related emissions calculated. The analysis is based on an accompanying research study on the injection of bio methane to the German gas grid. Two types of biogas plants have been considered whereof the “optimised technology” is assumed to dominate the future market. This is the one which widely exploits the potential of process optimisation of the current “state of the art” plant. The specific GHG emissions of the process chain can thus be nearly halved from currently 27.8?t CO₂-eq./TJ to 14.8?t CO₂-eq./TJ in 2030. GHG emissions of the natural gas process chain have been analysed in detail in a previous article. Significant modifications and a decrease of specific emissions is possible, depending on the level of investment in the modernisation of the gas infrastructure and the process improvements. These mitigation options might neutralise the emission increase resulting from longer distances and energy intensive processes. In the last section two scenarios (low and high consumption) illustrate the possible development of the German gas supply until 2030, given an overall share of 8–12?% of bio methane. Considering the dynamic emission factors calculated in the former sections, the overall gas emissions and average specific emissions of German gas supply can be given. The current emissions of 215.4 million t CO₂-eq. are reduced by 25?% in the low-consumption scenario (162 million t CO₂-eq.), where consumption is reduced by 17?%. Assuming a consumption which is increased by 17?% in 2030, emissions are around 7?% higher (230.9 million t CO₂-eq.) than today. Conclusions Gaseous fuels will still play a significant role for the German energy supply in the next two decades. The GHG emissions mainly depend on the amount of gas used. Thus, energy efficiency will be a key issue in the climate and energy related policy discussion. A higher share of bio methane and high investments in mitigation and best available technologies can significantly reduce the emissions of the process chain. The combustion of bio methane is climate neutral compared to 56?t CO₂/TJ caused by the direct combustion of natural gas (or 111?t CO₂/TJ emitted by lignite). The advantage of gaseous energy carriers with the lowest levels of GHG emissions compared to other fossil fuels still remains. This holds true for fossil natural gas alone as well as for the expected future blend with bio-methane.     

Risk aversion and CO2 regulatory uncertainty in power generation investment: Policy and modeling implications

We consider a simulation of risk-averse producers when making investment decisions in a competitive energy market, who face uncertainty about future regulation of carbon dioxide emissions. Investments are made under regulatory uncertainty; then the regulatory state is revealed and producers realize returns. We consider anticipated taxes, grandfathered permits and auctioned permits and show that some anticipated policies increase investment in the relatively dirty technology. Beliefs about the policy instrument that will be used to price carbon may be as important as certainty that carbon will be priced. More generally, a failure to consider risk aversion may bias policy analysis for the power sector.     

Modeling the impact of uncertainty in emissions trading markets with bankable permits

The various forms of uncertainty that firms may face in bankable emission permit trading markets will affect firms’ decision making as well as their market performance. This research explores the effect of increased uncertainty over future input costs and output prices on the temporal distribution of emission. In a dynamic programming setting, the permit price is a convex function of stochastic prices of coal and electricity. Increased uncertainty about future market conditions increases the expected permit price and causes a risk neutral firm to reduce ex ante emissions in order to smooth out marginal abatement costs over time. Finally, safety valves, both low-side and high-side, are suggested to reduce the impact of uncertainty in bankable emission trading markets.     

Is there really a green paradox?

In the absence of a CO₂ tax, the anticipation of a cheaper renewable backstop increases current emissions of CO₂. Since the date at which renewables are phased in is brought forward and more generally future emissions of CO₂ will decrease, the effect on global warming is unclear. Green welfare falls if the backstop is relatively expensive and full exhaustion of fossil fuels is optimal, but may increase if the backstop is sufficiently cheap relative to the cost of extracting the last drop of fossil fuels plus marginal global warming damages as then it is attractive to leave more fossil fuels unexploited and thus limit CO₂ emissions. We establish these results by analyzing depletion of non-renewable fossil fuels followed by a switch to a clean renewable backstop, paying attention to timing of the switch and the amount of fossil fuels remaining unexploited. We also discuss the potential for limit pricing when the non-renewable resource is owned by a monopolist. Finally, we show that if backstops are already used and more backstops become economically viable as the price of fossil fuels rises, a lower cost of the backstop will either postpone fossil fuel exhaustion or leave more fossil fuel in situ, thus boosting green welfare. However, if a market economy does not internalize global warming externalities and renewables have not kicked in yet, full exhaustion of fossil fuel will occur in finite time and a backstop subsidy always curbs green welfare.     

Is there really a green paradox?

In the absence of a CO₂ tax, the anticipation of a cheaper renewable backstop increases current emissions of CO₂. Since the date at which renewables are phased in is brought forward and more generally future emissions of CO₂ will decrease, the effect on global warming is unclear. Green welfare falls if the backstop is relatively expensive and full exhaustion of fossil fuels is optimal, but may increase if the backstop is sufficiently cheap relative to the cost of extracting the last drop of fossil fuels plus marginal global warming damages as then it is attractive to leave more fossil fuels unexploited and thus limit CO₂ emissions. We establish these results by analyzing depletion of non-renewable fossil fuels followed by a switch to a clean renewable backstop, paying attention to timing of the switch and the amount of fossil fuels remaining unexploited. We also discuss the potential for limit pricing when the non-renewable resource is owned by a monopolist. Finally, we show that if backstops are already used and more backstops become economically viable as the price of fossil fuels rises, a lower cost of the backstop will either postpone fossil fuel exhaustion or leave more fossil fuel in situ, thus boosting green welfare. However, if a market economy does not internalize global warming externalities and renewables have not kicked in yet, full exhaustion of fossil fuel will occur in finite time and a backstop subsidy always curbs green welfare.     

Bewertung der Umwelteffizienz moderner Autoantriebe – auf dem Weg vom Diesel-Pkw-Boom zu Elektroautos

Motorized traffic is among the biggest CO₂-emitting sources and is additionally dominating NO_x emission. Engine technology shifts are approaching, while automobiles developed in Germany and Europe are exported worldwide together with the European emission thresholds for cars. The Diesel car boom induced by EU commission, national EU governments and car industry is accordingly analyzed for sustainability and its effects on environment. German CO₂ emission reduction numbers by motorized traffic, as claimed by the government, are questioned. Radiative forcing by soot (black carbon) Diesel car emissions is added on the CO₂ emissions by fuel combustion. Diesel cars without particle filters are found to cause an atmospheric warming. Modelled and measured NO_x emission data are assessed to mismatch considerably. In spite of an ambitious national NO_x reduction plan there is excess NO_x emission by the German and European Diesel car boom. In this context environmental sustainability of battery electric vehicles (BEV) is investigated. Direct (by car) und indirect (by power plant) emissions (CO₂, NO_x, PM₁₀, SO₂) of cars with internal combustion engines (ICE) and BEVs, respectively, are calculated and compared. CO₂-ecoanalysis revealed advantages for BEVs even operated with current German electricity mix based on around 15?% renewable sources.     

Assessment of hydrocarbon emissions from diesel invert mud residues treated in a bioreactor

Hydrocarbon emissions from a diesel invert mud residue (DIMR) were monitored while the hydrocarbons were being biodegraded in a solid‐phase bioreactor. Five to twenty percent of the reduction in diesel hydrocarbons was attributed to evaporation depending on the treatment, i.e. homogenization, cultivation, and aeration. Most of these volatile hydrocarbons were linear C₈ — C₁₂ alkanes and one‐ring aromatics. Of the treatments aeration had the largest effect on emissions; forced air through the bottom of the bioreactor cells increased emissions by three times over that of the non‐aerated cells. Cultivation increased hydrocarbon emission concentration as much as twofold over the pre‐cultivation value, however, emissions returned to the original levels within 12 hours. Homogenization had the least effect of all treatments. Diurnally, the emission rate was 40% higher in late afternoon than at midnight; the cause of which was probably atmospheric fluctuations such as temperature and solar radiation. The effects of daily atmospheric fluctuations were empirically modeled and taken into account for determining the total volume of emissions.     

Sellers' Hedging Incentives at EPA's Emission Trading Auction

Cason (1993, J. Environ. Econom. Management25, 177–195, doi:10.1006/jeem 1993.1041) argued that the auction which the EPA used in order to start the market for sulfur allowances may reduce the efficiency of the market since it gives sellers an incentive to understate their valuation. In this paper we show that the sellers' incentives are even more perverse than Cason suggested when we take into account that sellers can also submit a bid. We show that sellers have an incentive to set their asking price equal to 0 while simultaneously hedging their bets by submitting a positive bid.