Impact of the Allowance Allocation on Prices and Efficiency

Abstract

CWPE 0552 and EPRG 08 These working papers present preliminary research findings, and you are advised to cite with caution unless you first contact the author regarding possible amendments. The EU CO 2 emissions trading scheme was inspired by successful cap and trade programs for SO 2 and NO x in the US. Most US programs allocated allowances to large emitters based on a historic base line for a period of up to thirty years. The National Allocation Plans in Europe deviate from this principle and allocates allowances in an iterative approach first for a three then for a five-year period. The potential updating of the base line creates perverse incentives for operation and investment. Most National Allocation Plans also reserve allowances for new entrants further distorting the scheme. We use analytic models and a numeric simulation for the UK power sector to illustrate and quantify how these effects contribute to an inflation of the allowance price while reducing utilisation and investment in efficient technologies. The inflated allowance prices are likely to increase the European allowance budget and emissions, e.g. through the Linking Directive. As a result opportunity costs of emitting CO 2 are reduced relative to an efficient cap and trade program.

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Cite this paper

@inproceedings{Neuhoff2000ImpactOT, title={Impact of the Allowance Allocation on Prices and Efficiency}, author={Karsten Neuhoff and Michael Grubb and Kim Keats}, year={2000} }