Investment Incentives Under Emission Trading: An Experimental Study

This paper presents the results of an experimental investigation on incentives to adopt advanced abatement technology under emissions trading. Our experimental design mimics an industry with small asymmetric polluting firms regulated by different schemes of tradable permits. We consider three allocation/auction policies: auctioning off (costly) permits through an ascending clock auction, grandfathering permits with re-allocation through a single-unit double auction, and grandfathering with re-allocation through an ascending clock auction. Our results confirm both dynamic and static theoretical equivalence of auctioning and grandfathering. We nevertheless find that although the market institution used to reallocate permits does not impact the dynamic efficiency from investment, it affects the static efficiency from permit trading

‘Sub-Prime’ Water, Low-Security Entitlements and Policy Challenges in Over-Allocated River Basins: the Case of the Murray–Darling Basin

Environmental policy is often implemented using market instruments. In some cases, including carbon taxing, the links between financial products and the environmental objectives, are transparent. In other cases, including water markets, the links are less transparent. In Australia’s Murray–Darling Basin (MDB), financial water products are known as ‘entitlements’, and are similar to traditional financial products, such as shares. The Australian water market includes ‘Low Security’ entitlements, which are similar to ‘sub-prime’ mortgage bonds because they are unlikely to yield an amount equal to their financial worth. Nearly half the water purchased under the Murray–Darling Basin Plan for environmental purposes is ‘Low Security’. We suggest that the current portfolio of water held by the Australian Government for environmental purposes reflects the mortgage market in the lead-up to the global financial crisis. Banks assumed that the future value of the mortgage market would reflect past trends. Similarly, it is assumed that the future value of water products will reflect past trends, without considering climate change. Historic records of allocations to ‘Low Security’ entitlements in the MDB suggest that, in the context of climate change, the Basin Plan water portfolio may fall short of the target annual average yield of 2075 GL by 511 GL. We recommend adopting finance sector methods including ‘hedging’ ‘Low Security’ entitlements by purchasing an additional 322–2755 GL of ‘Low Security’, or 160–511 GL of ‘High Security’ entitlements. Securing reliable environmental water is a global problem. Finance economics present opportunities for increasing the reliability of environmental flows