Climate Policy Design with Correlated Uncertainties in Offset Supply and Abatement Cost

Harrison Fell, Dallas Burtraw, Richard Morgenstern () and Karen Palmer
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Richard Morgenstern: Resources for the Future

RFF Working Paper Series from Resources for the Future

Abstract: Current and proposed greenhouse gas cap-and-trade systems allow regulated entities to offset abatement requirements by paying unregulated entities to abate. These offsets from unregulated entities are believed to contain system costs and stabilize allowance prices. However, the supply of offsets is highly uncertain and may be correlated with other sources of uncertainty in emissions trading systems. This paper presents a model that incorporates both uncertainties in the supply of offsets and in abatement costs. We numerically solve a dynamic stochastic model, with parameters relevant to the U.S. climate debate, under a variety of parameter settings, including a system that includes allowance price controls, risk aversion, and competitive offset purchasing. We find that as uncertainty in offsets and uncertainty in abatement costs become more negatively correlated, expected abatement plus offset purchase costs increase, as does the variability in allowance prices and emissions from the regulated sector. These results are amplified with risk sensitivity, larger annual offset limits, and competitive offset purchasing. Imposing an allowance price collar substantially mitigates cost increases as well as the variability in prices, while roughly maintaining expected environmental outcomes. In contrast with previous literature we find a collar may also mitigate emissions variability.

Keywords: climate change; offsets; cap-and-trade; price collars; stochastic dynamic programming (search for similar items in EconPapers)
JEL-codes: C61 Q54 Q58 (search for similar items in EconPapers)
Date: 2011-06-09
New Economics Papers: this item is included in nep-cmp, nep-ene, nep-env and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Journal Article: Climate Policy Design with Correlated Uncertainties in Offset Supply and Abatement Cost (2012)
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