Compliance and Imperfect Intertemporal Carbon Trading

Abstract

This paper examines three compliance mechanisms of the Kyoto Protocol: (i) the restoration rate, (ii) the commitment period reserve rule, and (iii) the suspension mechanism, all potentially constraining greenhouse gas emissions trading across time and space. The joint effect of these mechanisms on prices and costs is studied in a twoperiod model under various assumptions about the competitiveness of the permit market and US participation. The analytical results indicate that the restoration rate can make discounted permit prices decrease over time. With the commitment period reserve, marginal costs may not only be lower, but also higher than the permit prices. The suspension rule will under quite general circumstances not affect prices and costs; only shift non-compliance from future sellers to future buyers. The numerical results suggest that with imperfect permit markets and non-participation of the US in the Kyoto Protocol in 2010, none of the three rules becomes binding.compliance; market power; emissions trading; Kyoto Protocol