Long-Run Equilibrium Modeling of Alternative Emissions Allowance Allocation Systems in Electric Power Markets

Jinye Z. Schulkin, Benjamin Hobbs (bhobbs@jhu.edu) and Jong-Shi Pang

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: A question in the design of carbon dioxide trading systems is how allowances are to be initially allocated: by auction, by giving away fixed amounts, or by allocating based on output, fuel, or other decisions. The latter system can bias investment, operations, and pricing decisions, and increase costs relative to other systems. A nonlinear complementarity model is used to investigate long-run equilibria that would result under alternative systems for power markets characterized by time varying demand and multiple generation technologies. Existence of equilibria is shown under mild conditions. Solutions show that allocating allowances to new capacity based on fuel use or generator type can distort generation mixes, invert the operating order of power plants, and inflate consumer costs. The distortions can be smaller for tighter CO2 restrictions, and are somewhat mitigated if there are also electricity capacity markets or minimum-run restrictions on coal plants.

Keywords: Emissions trading; allowance allocations; electricity; air pollution; auction; grandfathering; cost-effectiveness; greenhouse gases; climate change; global warming; carbon dioxide; generation investment. (search for similar items in EconPapers)
JEL-codes: C61 L94 Q4 Q53 (search for similar items in EconPapers)
Pages: 24
Date: 2007-09
New Economics Papers: this item is included in nep-ene and nep-env
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