Market Power in Emission Permit Markets: Theory and Evidence from the EU ETS

A well-known result about market power in emission permit markets is that efficiency can be achieved by full free allocation to the dominant firm. I show that this result breaks down when taking the interaction between input and output markets into account, even if the dominant firm perceives market power in the permit market alone. I then examine the empirical evidence for price manipulation by the ten largest electricity firms during phase I of the EU ETS. I find that some firms’ excess allowance holdings are consistent with strategic price manipulation, and that they cannot be explained by price speculation or by precautionary purchases to insure against uncertain future emissions. My results suggest that market power is likely to be an empirically relevant concern during the early years of emission permit markets.     

Bilateral Oligopoly,Private Information,and Pollution Permit Markets

We analyze the effects of strategic behavior and private information in pollution permit markets in which all firms have market power. The market is characterized by supply-function equilibria. Firms submit net supplies for permits and a market maker determines the market-clearing price. Net supplies depend on abatement cost functions, which in turn depend on private information parameters. We calculate the increase in aggregate abatement costs due to strategic behavior and private information and show that private information attenuates the effects of strategic behavior.      

Emission Permit Trading Between Imperfectly Competitive Product Markets

The present paper analyzes the efficiency of emission permit trading between two imperfectly competitive product markets. Even if firms are price takers in permit markets, the integration of permit markets can decrease welfare because of imperfect competition in product markets. If there is asymmetric information between the regulator and firms, the integration of the permit markets could have a positive effect related to the flexibility of an integrated market; this flexibility can justify integrating the permit markets.     

An Experimental Investigation of Hard and Soft Price Ceilings in Emissions Permit Markets

Tradable emissions permits have been implemented to control pollution levels in various markets and represent a major component of legislative efforts to control greenhouse gas emissions. Because permits are supplied for a fixed level of pollution, allowing the market for permits to determine the price, price control mechanisms may be needed to protect firms from price spikes caused by fluctuations in the demand for permits. We test permit markets in an experimental laboratory setting to determine the effectiveness of several price control mechanisms, with special attention on the soft price ceiling. We focus on a static setting similar to some of the earliest experimental work focused on price ceilings. Results indicate that both permit supply adjustments and price ceilings (hard ceilings) effectively limit elevated prices in this setting. By contrast, reserve auctions to implement soft ceilings do not consistently control prices, especially when a minimum reserve permit price is applied. Furthermore, the grandfathering of permits allows permit sellers to realize significant welfare gains at the expense of buyers under a soft ceiling policy. Our results thus highlight several advantages of hard ceilings for controlling short term price increases.     

The Emergence of Market Power in Emission Rights Markets: The Role of Initial Permit Distribution

This paper offers an analytical model of emission permit markets in which a large number of regulated emitters participate, and derives formulae that estimate the degree of market distortion. These formulae clearly show the entire dependence of the ratio of market prices to competitive levels on the permit initial distribution as well as the existence of a threshold for effective market power. While the findings challenge a well-known conception of the Coase Theorem, they have significant policy implications vis-à-vis the Kyoto Protocol and the related policy debates on excess emission rights known as hot air.     

The Informational Role of the EPA SO2 Permit Auction

We consider the ex ante informational implications of the mandatory surrender feature of a stylized emission permit auction, similar to that in the U.S. EPA SO₂ permit scheme, but modeled as a uniform price auction. The theory suggests that generally the auction gives misleading signals concerning the expected price of permits in the post-auction permit market; in the cases where the permit auction is designed to correctly predict the post-auction permit market equilibrium price, the permit auction preempts the permit market, and all trading occurs in the auction. Ex post auction/market experience suggests that the market may have enabled the auction and consequently raises the possibility that the market may have worked in spite of the auction and not because of it.     

On the Endogeneity of Market Power in Emissions Markets

Previous approaches on market power in emissions trading markets rely on the existence of a subset of competitive players. In this paper, I relax this assumption and treat market power as an endogenous concept which depends on the initial allocation of allowances. All parties realize their potential influence on the market price. This approach allows a clear comparative statics analysis of the impact of the allowance allocation on the efficiency of markets. I provide specific examples that illustrate the implications that stem from the proposed modeling approach relative to previous models.     

Strategic manipulation of a pollution permit market and international trade

We consider a framework where firms which compete in an international product market are not all submitted to a pollution permit market. Using the Brander and Spencer’s framework (J Int Econ 18:83–100, 1985), we seek to determine the optimal strategies of both a dominant firm in the pollution permit market and the regulator in a such context. We first show that the dominant firm pursues a strategic manipulation to increase its profit. We also find that the regulator uses a sophisticated strategic policy to increase the domestic welfare by using two instruments: the initial allocation of pollution permits and the pollution cap.     

Market Power in Laboratory Emission Permit Markets

Many proposals suggesting the use of markets tocontrol pollution assume markets will becompetitive. When markets do not exhibitcompetitive characteristics, however, shouldthey still be expected to result in efficiencyimprovement relative to traditional approaches? This paper employs experimental economicmethods to examine the effect of marketstructure on the use of marketable emissionspermits. Results indicate that in a market withone dominant firm and a number of fringe firms,strategic manipulation occurs repeatedly in thelaboratory as predicted by market power models,undermining the allocative and dynamicefficiency benefits such markets offer. Whenfirms compete in a downstream product marketdominated by the same single firm, marketefficiency can actually be reduced with theimplementation of permit markets. Final marketefficiencies reflect initial endowments and areinfluenced by competitive conditions elsewherein the economy, indicating that policy-makersshould carefully consider whether markets areappropriate in such circumstances.     

Trading Hot-Air. The Influence of Permit Allocation Rules,Market Power and the US Withdrawal from the Kyoto Protocol

After the conferences in Bonn and Marrakech, it is likely that international emissions trading will be realized in the near future. Major influences on the permit market␣are the institutional detail, the participation structure and the treatment of hot-air. Different scenarios not only differ in their implications for the demand and supply of permits and thus the permit price, but also in their allocative effects. In this paper we discuss likely the institutional designs for permit allocation in the hot-air economies and the use of market power and quantify the resulting effects by using the computable general equilibrium model DART. It turns out that the amount of hot-air supplied will be small if hot-air economies cooperate in their decisions. Under welfare maximization, more hot-airis supplied than in the case where governments try to maximize revenues from permit sales.     

Market Power with Interdependent Demand: Sale of Emission Permits and Natural Gas from Russia

With implementation of the Kyoto Protocol, Russia will most likely be able to exert market power in the emission permit market. But, as Russia is also a big exporter of fossil fuels, the incentives to boost the permit price may be weak. However, a significant share of Russia’s fossil fuel exports is natural gas. If a high permit price boosts the demand for natural gas through substitution from more polluting fuels and thus increase gas profits, this may increase the incentives to exert monopoly power in the permit market. Moreover, a large fossil fuel exporter may use its market position to influence the effective demand for permits. Hence, the relationship between permit income and fossil fuels exports runs in both directions. In this article, we explore the interdependence between the revenues from permit and fossil fuel exports both theoretically and numerically. A computable general equilibrium model suggests the fact that Russia as a big gas exporter has small effect on the incentives to exert monopoly power in the permit market. Moreover, Russia’s monopoly power in the permit market has a small, but non-negligible impact on the optimal level of Russian gas exports.     

初始排污权定价的分散决策模型

提出利用分散决策模型进行排污权在一级市场的定价,并证明了其合理性。在明确排污权总量的条件下,利用"多对象、多轮次"的"试错法"得到排污权的价格,并给出具体的实施步骤。结果显示:该方法具有操作性强、成本低的优点,是一种可在完全竞争市场中进行排污权定价的合理方法。     

Competitive Permit Markets and Vertical Structures: The Relevance of Imperfectly Competitive Eco‐Industries

Permit markets lead polluting firms to purchase abatement goods from an eco‐industry which is often concentrated. This paper studies the consequences of this sort of imperfectly competitive eco‐industry on the equilibrium choices of the competitive polluting firms. It then characterizes the second‐best pollution cap. By comparing this situation to one of perfect competition, we show that Cournot competition on the abatement good market contributes not only to a nonoptimal level of emission reduction but also to a higher permit price, which reduces the production level. These distortions increase with market power, measured by the margin taken by the noncompetitive firms, and suggest a second‐best larger pollution cap.     

Technology Diffusion with Market Power in the Upstream Industry

This paper compares taxes and tradable permits when used to regulate a competitive and polluting downstream industry that can purchase an abatement technology from a monopolistic upstream industry. Second-best policies are derived for the full range of the abatement technology’s emission intensities and marginal abatement costs. The second-best permit quantity can be both above or below the socially optimal emission level. Explicit consideration of the output market provides further insights on how market power distorts the allocation in the downstream industry. The ranking between permits and taxes is ambiguous in general, but taxes weakly dominate permits if full diffusion is socially optimal. In addition, it is analysed how a cap on the permit price affects the diffusion of an abatement technology.     

Multi-Sector Model of Tradable Emission Permits

This paper presents a multi-sector model of tradable emission permits, which includes oligopolistic and perfectly competitive industries. The firms in oligopolistic industries are assumed to exercise market power in the tradable permit market as well as in the product market. Specifically, we examine the effects of the initial permit allocation on the equilibrium outcomes, focusing on the interaction among these product and permit markets. It is shown that raising the number of initial permits allocated to one firm in an oligopolistic industry increases the output produced by that firm. Under certain conditions, raising a “clean” (less-polluting) firm’s share of the initial permits can lead to reductions in both the product and permit prices. We discuss criteria for the socially optimal allocation of initial permits, considering the trade-off between production inefficiency and consumer benefit.     

Contingent certificate allocation rules and incentives for power plant investment and disinvestment

The electricity generation mix of many countries is strongly dominated by fossil fuelled power plants. \(\hbox {CO}_{2}\) certificate trading is then advocated as a first best instrument for emission abatement in Europe, the US and beyond. An important element of the trading scheme is the initial allocation of allowances. This article is to show how permit allocation rules, applied within an Emission Trading System (ETS), interfere with the long-term pricing and investment on power markets. In particular it is demonstrated that free allocation of certificates contingent on plant availability and fuel used is likely to provide distorting incentives both for continued operation of existing plants and for investments. Consequently, marginal abatement costs within the ETS are increased above efficient levels and new power plant investments may crowd out excessively older power plants. Analytical results are derived for two technology cases and a numerical case study is devoted to the EU 27 power sector.     

The effects of information costs on search and convergence in experimental markets

Nearly all markets contain some kind of friction, making it difficult to reach full efficiency. One ubiquitous source of market friction is the cost of obtaining pricing information. We determine how market performance as well as buyer and seller behavior are affected by the introduction of price information costs in experimental posted markets.Rothschild [Journal of Political Economy (1973) 1283; Journal of Political Economy (1974) 689] theorizes that search is negatively related to knowledge of the price dispersion and the cost of search, and positively related to market price dispersion. We find that market knowledge and the cost of search itself affect search, but we find no evidence supporting the role of price dispersion in search decisions.We also find evidence supporting Smith and Plott [Review of Economic Studies (1979) 133] and Walker and Williams (1988), both of which show price convergence comes from below in posted-bid markets and from above in posted-offer markets. High information costs tend to reduce or eliminate convergence. Average prices are above the market-clearing price for posted-offer markets, and below for posted-bid markets, and never cross the market-clearing threshold, also consistent with Walker and Williams.More generally, our results support the notion of symmetry between experimental posted-offer and posted-bid markets, broadening the relevance of experimental search research.     

Producer price adjustment to commodity price shocks: An application of threshold cointegration

During the 1980s and 1990s, most developing countries in Sub-Saharan Africa and Latin America implemented structural adjustment reforms, which included the liberalization of export crop markets and the abolition of marketing boards. The emergence of new marketing systems may have altered price transmission mechanisms, especially if collusion behaviors have appeared among domestic stakeholders along the marketing chain. I use threshold cointegration tools to analyze the dynamics of world price transmission to coffee growers in three deregulated markets. The methods I use allow me to test the presence of a threshold in both the cointegrating relationship and its corresponding error correction model. Over the pre-reform period, I detect asymmetric price adjustments that appear favorable to producers - deviations from the long-run equilibrium resulting from largest increases in world prices being eliminated relatively quickly - and disappear in the post-reform period. On the contrary over the post-reform period, the results suggest that largest decreases in world prices may be transmitted relatively quickly to growers. These results can be seen as expressions of a favorable pricing policy over the pre-reform period and an unfavorable influence of new private agents over the post-reform period, meaning that in some cases reforms may have failed to create competitive market structures.     

Carbon sequestration and permit trading on the competitive fringe

This paper makes two contributions to the carbon-sequestration policy literature. First and foremost, we develop a theoretical framework in which sequestration and permit-trading markets are analyzed jointly in the context of a competitive fringe model. Our framework formalizes the linkage between regulatory policy changes (as they manifest themselves in the permit market) and subsequent equilibrium allocations in the sequestration market. Second, we perform a numerical analysis demonstrating the role market structure, or market power, might play in the determination of the equilibrium sequestration allocation and carbon price. Both our analytical and numerical results demonstrate the importance of incorporating into empirical supply-side models demand-side information that is reflective of an underlying market structure.     

Bargaining power and enforcement in credit markets

In a credit market with enforcement constraints, we study the effects of a change in the outside options of a potential defaulter on the terms of the credit contract, as well as on borrower payoffs. The results crucially depend on the allocation of “bargaining power” between the borrower and the lender. We prove that there is a crucial threshold of relative weights such that if the borrower has power that exceeds this threshold, her expected utility must go up whenever her outside options come down. But if the borrower has less power than this threshold, her expected payoff must come down with her outside options. In the former case a deterioration in outside options brought about, say, by better enforcement, must create a Lorenz improvement in state-contingent consumption. In particular, borrower consumption rises in all “bad” states in which loans are taken. In the latter case, in contrast, the borrower's consumption must decline, at least for all the bad states. These disparate findings within a single model permit us to interpret existing literature on credit markets in a unified way.