The Effects of Penalty Design on Market Performance: Experimental Evidence from an Emissions Trading Scheme with Auctioned Permits

This paper investigates the behavioural implications of penalty designs on market performance using an experimental method. Three penalty types and two penalty levels are enforced in a laboratory permit market with auctioning, including the Australian Carbon Pollution Reduction Scheme proposed design of tying the penalty rate to the auction price. Compliance strategies are limited to undertaking irreversible abatement investment decisions or buying permits. We aim to assess how penalty design under the presence of subjects‟ risk preferences might affect compliance incentives, permit price discovery, and efficiency. In contrast to theory, we find that penalty levels serve as a focal point that indicates compliance costs and affects compliance strategies. The make-good provision penalty provides stronger compliance incentives than the other penalty types. However, the theory holds with regard to permit price discovery, as we find no evidence of the effect of penalty design on auction price. Interestingly, risk preference does not directly affect compliance decision, but it does influence price discovery, which evidently is a significant factor in compliance decisions as well as efficiency. Most importantly, a trade-off between investment incentives and efficiency is observed.emissions trading, penalty design, experiment, auction, irreversible investment, abatement, compliance, Environmental Economics and Policy, Resource /Energy Economics and Policy,

A Theoretical Model of Optimal Compliance Decisions under Different Penalty Designs in Emissions Trading Markets

This paper employs a theoretical model to examine compliance incentives and market efficiency under three penalty types: the fixed penalty rate, which uses a constant marginal financial penalty; the make-good provision (quantity penalty), where each missing permit in the current period is to be offset with a ratio (restoration rate) in the following period; and a mixed penalty, which combines the two penalty types. Using a simple two-period model of firm's profit maximisation, we analyse compliance decisions and the efficient penalty level under each penalty type. Firms‟ compliance strategies are modelled as an irreversible investment in abatement measures and permit buying in the market. Our findings indicate that the penalty type does not affect compliance decisions provided that the efficient penalty level is applied. Market efficiency is retained regardless of penalty types. Nevertheless, the mixed penalty design provides the strongest compliance incentives. Hence this finding supports the practice in which this penalty design is widely used in the existing and the proposed trading schemes. Furthermore, we discuss the policy implications of the findings with regard to permit price discovery process and the Australian proposal of tying the penalty level to the permit priceemissions trading, penalty design, compliance, Environmental Economics and Policy, Resource /Energy Economics and Policy,

An early assessment of national allocation plans for phase 2 of EU emission trading

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EU Emission trading – better job second time around?

The EU Emission Trading Scheme (EU ETS) for CO2-emissions from energy and industry installations reflects a paradigm shift towards market-based instruments for environmental policy in the EU. The centerpieces of the EU ETS are National Allocation Plans (NAPs), which individual Member States (MS) design for each phase. NAPs state the total quantity of allowances available in each period (ET-budget) and determine how MS allocate allowances to individual installations. The NAPs thus govern investments and innovation in energy efficient technologies and the energy sector. In terms of distribution, they predetermine winners and losers. In this paper we analyze and evaluate 25 NAPs submitted to the European Commission (EC) for phase 2 (2008-2012) of the EU ETS. At the macro level,we assess whether the submitted ET-budgets are stringent, and whether they imply a cost-efficient split of the required emission reductions between the EU ETS sectors (energy and industry) and the remaining sectors (transportation, tertiary and households). Comparing the submitted ET-budgets with those already approved by the EC suggests that the EC’s decisions significantly improved the effectiveness and economic efficiency of the EU ETS. But given the high share of Kyoto Mechanisms companies are allowed to use, the EU ETS is unlikely to require substantial emission reductions within the EU. At the micro level, we assess (across countries and phases) the allocation methods for existing and new installations, for closures and for clean technologies. A comparison of the NAPs for the second phase and the first phase (2005-2007) provides insights into the (limited) adaptability and flexibility of the scheme. The findings provide guidance for the future design of the EU ETS and applications to other sectors and regions

Klima im Wandel - Emissionsrechte im Handel

Der Klimawandel findet nicht in ferner Zukunft, sondern bereits jetzt statt. Um ihn für Mensch und Umwelt auf einem erträglichen Niveau zu stabilisieren, müssen die Treibhausgasemissionen reduziert werden. Der Emissionshandel soll dazu beitragen, sie dort zu mindern, wo die geringsten Kosten anfallen. So kann das gesetzte Mengenziel ökonomisch effizient erreicht werden

Optimal Coverage of Installations in a Carbon Emissions Trading Scheme (ETS)

Trading schemes for emission allowances have become a panacea for nations aspiring to reduce their aggregate emissions of greenhouse gases from industry in a cost-effective manner. The contention of this paper is that an emissions trading scheme (ETS) should not be based on blanket coverage of installations on a downstream level, but should rather be designed to include some installations, and from some industrial sectors. In the case of an ETS there are high costs of administration, monitoring and transacting imposed on the installations covered. These costs are supposed to be more than offset by the cost savings realised through trading in the market for emission allowances. However, the paper shows that not all installations can fully offset administrative costs, and are therefore exposed to higher cost compared to a situation under an alternative instrument (e.g. standard). The paper formulates a conceptual framework for analysing overall cost and benefits from an ETS in the light of administration and transactions costs. It theoretically establishes a threshold point for optimal coverage of installations on a downstream level. The paper uses data from EU ETS to empirically determine optimal coverage for selected sectors. The results indicate that blanket coverage is more costly than the determined optimum coverage plan.Climate Change, Emissions Trading Scheme, European Union, Marginal Abatement Costs, Environmental Policy, Environmental Economics and Policy, International Relations/Trade,

Making GHG Emissions Trading Work - Crucial Issues in Designing National and International Emissions Trading Systems

Art. 17 of the Kyoto Protocol defines International Emissions Trading exclusively on country level, sub-national entities like industrial installations or households are not included initially. However, there are some arguments for such an expansion, of which the most important ones are a significant increase of the overall efficiency of the trading system as well as an increase of market liquidity. In the first part of this paper, the options for an inclusion of sub-national entities are analysed, concluding that AAUs should not be allocated to participants directly. Instead, there are several options how those entities can be included in International Emissions Trading as defined in the Kyoto-Protocol in an indirect way. The second part of the paper elaborates on the design options of national trading systems. All governments planning to introduce a domestic emissions trading scheme covering entities need to consider several design parameters, e.g. the characteristics of emission targets, participants of the trading scheme, participation mode, covered gases, non-compliance provisions, etc. We analyse and evaluate the options for each of those aspects, having in mind that the design of a trading system must assure its environmental integrity and keep transaction costs low at the same time. Der "Internationale Emissionshandel (IET)" wird nach Artikel 17 des Kyoto-Protokolls zunächst ausschließlich auf Staatenebene definiert. Es sprechen jedoch einige Gründe dafür, den Emissionshandel auch auf nicht staatliche Einheiten, wie z.B. industrielle und/oder private Emittenten auszudehnen. Die wesentlichen Vorteile sind die zu erwartende deutliche Erhöhung der Effizienz des Handelssystems sowie der Marktliquidität. Wir analysieren die verschiedenen Möglichkeiten einer derartigen Ausweitung des Emissionshandels. Eine direkte Einbeziehung subnationaler Einheiten durch die Zuteilung von Emissionsrechten nach dem Kyoto-Protokoll (AAUs) in den IET erscheint nicht empfehlenswert. Statt dessen bestehen verschiedene Möglichkeiten der indirekten Einbeziehung, bei der nationale "Währungen" für Emissionsrechte ausgegeben werden. Zudem werden die verschiedenen Ausgestaltungsparameter analysiert, die bei der Einrichtung eines (inter-)nationalen Emissionshandelssystems berücksichtigt werden müssen. Dies sind u.a. die Definition von Teilnehmerkreis, Teilnahmemodus, Art der Emissionsziele, Einbeziehung von Gasen, Einbeziehung der projektbasierten Mechanismen sowie Strafregelungen. Die einzelnen Ausgestaltungsoptionen werden evaluiert, insbesondere hinsichtlich der grundlegenden Ziele des Emissionshandels: Sicherung der ökologischen Integrität bei Minimierung der entstehenden Kosten.Environmental Economics and Policy,

Initial Allocation Effects in Permit Markets with Bertrand Output Oligopoly

We analyse the efficiency effects of the initial permit allocation given to firms with market power in both permit and output market. We examine two models: a long- run model with endogenous technology and capacity choice, and a short-run model with fixed technology and capacity. In the long run, quantity pre-commitment with Bertrand competition can yield Cournot outcomes also under emissions trading. In the short run, Bertrand output competition reproduces the effects derived under Cournot competition, but displays higher pass-through profits. In a second-best setting of overallocation, a tighter emissions target tends to improve permit-market efficiency in the short run.Emissions trading, Initial permit allocation, Bertrand competition, EU ETS, Endogenous technology choice, Kreps and Scheinkman, Resource /Energy Economics and Policy, L13, Q28, D43,

An early assessment of national allocation plans for phase 2 of EU emission trading

Based on 18 National Allocation Plans (NAP) for phase 2 (2008-2012) of the EU Emission Trading Scheme (EU ETS), we explore to which extent individual Member States (MS) intend to use the ETS effectively and efficiently to reduce CO2 emissions. Our analyses at the macro level of these NAPs show that on average the ET-budgets in phase 2 are only about 3 % lower than the budgets in phase 1 (2005-2007), historical emissions in 2005 and projected emissions in 2010. While on average, the old MS intend to reduce emissions by about 10 %, compared to projected emissions, the im-plied excess allocation in the new MS is more than 20 %. When compared with a cost-efficient split of the required emission reductions, the ET-budgets in the EU-15 MS are generally too large. Thus, the burden for non-trading sectors (households, tertiary and transport) will be too high. Noteworthy are also the high shares of governments' intended and companies' possible use of Kyoto Mechanisms, which challenge the traditional position held by the EU on supplementarity. In general, our analyses at the micro level of the allocation methods (across countries and phases) suggest that MS tend to stick with the oncepts and methodologies developed in phase 1, unless these actually contradict rulings by the European Commission. Thus the progress made towards more efficient and more harmonized allocation rules is generally small. With some variation, all NAPs include persistent inefficient rules for closures and new installations which distort dynamic innovation incentives and tend to preserve existing production structures. Observed improvements include a (rather small) increase in auctioning and the use of benchmarking for existing and new installations. Also, the NAPs of a few old MS have simplified special provisions for process-related emissions or combined heat and power. In contrast, new MS have often introduced such provisions in phase 2. We conclude that potentials to improve environmental effectiveness and economic efficiency are far from being tapped. Improvements crucially hinge on the outcome of the European Commission's review process. --

Incentives for energy efficiency in the EU Emissions Trading Scheme

This paper explores the incentives for energy efficiency induced by the European Union Emissions Trading Scheme (EU ETS) for installations in the energy and industry sectors. Our analysis of the National Allocation Plans for 27 EU Member States for phase 2 of the EU ETS (2008-2012) suggests that the price and cost effects for improvements in carbon and energy efficiency in the energy and industry sectors will be stronger than in phase 1 (2005-2007), but only because the European Commission has substantially reduced the number of allowances to be allocated by the Member States. To the extent that companies from these sectors (notably power producers) pass through the extra costs for carbon, higher prices for allowances translate into stronger incentives for demand- side energy efficiency. With the cuts in allocation to energy and industry sectors these will be forced to greater reductions, thus the non-ET sectors like household, tertiary and transport will have to reduce less, which is more in line with the cost-efficient share of emission reductions. The findings also imply that domestic efficiency improvements in the energy and industry sectors may remain limited since companies can make substantial use of credits from the Kyoto Mechanisms. The analysis of the rules for existing installations, new projects and closures suggests that incentives for energy efficiency are higher in phase 2 than in phase 1 because of the increased application of benchmarking to new and existing installations and because a lower share of allowances will be allocated for free. Nevertheless, there is still ample scope to further improve the EU ETS so that the full potential for energy efficiency can be realized. --Climate policy,emission trading,energy efficiency,innovation