Emissions Trading in the Presence of Price-Regulated Polluting Firms: How Costly Are Free Allowances?

Journal Article
Emissions Trading in the Presence of Price-Regulated Polluting Firms: How Costly Are Free Allowances?
Lanz, B. and S. Rausch (2016)
The Energy Journal, 37(1): 195-232

Abstract/Summary:

We study whether to auction or to freely distribute emissions allowances when some firms participating in emissions trading are subject to price regulation. We show that free allowances allocated to price-regulated firms effectively act as a subsidy to output, distort consumer choices, and generally induce higher output and emissions by price-regulated firms. This provides a cost-effectiveness argument for an auction-based allocation of allowances (or equivalently an emissions tax). For real-world economies such as the Unites States, in which about 20 percent of total carbon dioxide emissions are generated by price-regulated electricity producers, our quantitative analysis suggests that free allowances increase economy-wide welfare costs of the policy by 40-80 percent relative to an auction. Given large disparities in regional welfare impacts, we show that the inefficiencies are mainly driven by the emissions intensity of electricity producers in regions with a high degree of price regulation.

Citation:

Lanz, B. and S. Rausch (2016): Emissions Trading in the Presence of Price-Regulated Polluting Firms: How Costly Are Free Allowances?. The Energy Journal, 37(1): 195-232 (http://www.iaee.org/en/publications/ejarticle.aspx?id=2683)
  • Journal Article
Emissions Trading in the Presence of Price-Regulated Polluting Firms: How Costly Are Free Allowances?

Lanz, B. and S. Rausch

37(1): 195-232
2016

Abstract/Summary: 

We study whether to auction or to freely distribute emissions allowances when some firms participating in emissions trading are subject to price regulation. We show that free allowances allocated to price-regulated firms effectively act as a subsidy to output, distort consumer choices, and generally induce higher output and emissions by price-regulated firms. This provides a cost-effectiveness argument for an auction-based allocation of allowances (or equivalently an emissions tax). For real-world economies such as the Unites States, in which about 20 percent of total carbon dioxide emissions are generated by price-regulated electricity producers, our quantitative analysis suggests that free allowances increase economy-wide welfare costs of the policy by 40-80 percent relative to an auction. Given large disparities in regional welfare impacts, we show that the inefficiencies are mainly driven by the emissions intensity of electricity producers in regions with a high degree of price regulation.

Supersedes: 

Cap-and-Trade Climate Policies with Price-Regulated Industries: How Costly are Free Allowances?

Posted to public: 

Wednesday, September 27, 2017 - 11:00