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Price and welfare effects of Price and welfare effects of

emission quota allocationemission quota allocation

Knut Einar Rosendahl

Statistics Norway

Presentation at North American IAEE Conference, Washington DC

October 2011

Based on paper with

Rolf Golombek and Sverre Kittelsen (Frisch Centre)

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Introduction

• Allocation of free allowances important element of existing

and proposed cap-and-trade (CAT) systems– EU Emissions Trading System (EU ETS)

– U.S. CAT: National SO2 and proposed CO2; regional CO2 and NOx

• Different ways of allocating free allowances– Unconditional grandfathering (lump sum) – rarely used

– Conditional grandfathering – much used in EU ETS so far

– Output-based allocation – main rule in EU ETS from 2013

– Capacity-based allocation – used for new entrants in EU ETS

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• Previous literature on allocation of free allowances:

– Choice of allocation mechanism can affect prices and quantities Welfare/cost effects

– Theoretical studies: Böhringer and Lange (SJE, 2005; EER, 2005); Fischer and Fox (LE,

2007; Ellerman (EJ, 2008); Rosendahl (JEEM, 2008)

– Allocation of free allowances can influence the electricity market –

for a given cap on emissions

– Numerical studies: Neuhoff et al. (CP, 2006); Burtraw et al. (El.J, 2006)

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Research question

• How may various allocation mechanisms play out in the

electricity market?– Use the European market as our context

– Detailed numerical partial equilibrium model for Western Europe

– More in-depth numerical analysis than previous (European) studies

• Main focus:– Comparing output-based allocation (OBA) with unconditional

grandfathering (GF) (= auctioning in PE model)

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Analytical part

• Compare OBA with GF, showing:– Emissions price is higher with OBA than with GF

– OBA favors more efficient firms and less emission-intensive firms

• Intuition:– OBA is an implicit subsidy of output

– Hence: OBA tends to increase output and thus emissions

– Price of emissions must increase to comply with the target

– Higher emissions price is bad news for emission-intensive firms

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Numerical model: LIBEMOD

• Numerical partial equilibrium model of the Western European energy market

– Static model: Do not consider updating of base year for allocation

• The electricity market interacts with the markets of other energy goods

• Electricity production and transmission between countries, including investments in new capacity, are modeled

– A number of different power technologies

• Electricity consumption is determined by the price of electricity and other energy carriers.

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Policy scenarios

• Emission trading market for the electricity sector

• CO2 taxes for other energy use

• Two main alternatives in the paper1. Identical CO2-price across countries and sectors

– Focus of this presentation

2. Total CO2-emissions in the electricity sector is fixed (see paper)

• Four allocation mechanisms1. Unconditional grandfathering (= auctioning)

2. Conditional grandfathering (require maintenance of capacity)

3. Output-based allocation (proportional to production)

4. Capacity-based allocation (proportional to maintained capacity)

• Relevance: Mix of allocation mechanisms in EU ETS

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Numerical results: Prices

0

10

20

30

40

50

60

Base Case A1 A2 A3 A4

Electricity (€2010/MWh) CO2-price (€2010/tonne)

OBA leads to:

• Substantially higher emissions price

• Much smaller increase in electricity price

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Numerical results: Output (TWh per year)

0

200

400

600

800

1000

1200

Coa

l

Gas O

il

Nuc

lear

Hyd

ro

Oth

erre

new

.

Coa

l

Gas O

il

Nuc

lear

Hyd

ro

Oth

erre

new

.

Existing plants New plants

Base Case A1 A2 A3 A4

Choice of

allocation

mechanism

have

substantial

impacts on

market

shares

• More gas

power with

OBA

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Numerical results: Capacity (GW)

0

50

100

150

200

250

Coal Gas Oil Nuclear Hydro Other renew.

Scenario

Choice of

allocation

mechanism

have

substantial

impacts on

capacities0

200

400

600

800

1000

1200

Coa

l

Gas O

il

Nuc

lear

Hyd

ro

Oth

erre

new

.

Coa

l

Gas O

il

Nuc

lear

Hyd

ro

Oth

erre

new

.

Existing plants New plants

Base Case A1 A2 A3 A4

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Numerical results: Welfare (Billion Euro)

OBA is most

costly, also

for power

producers

jointly

-80

-60

-40

-20

0

20

40

A1 A2 A3 A4

Power producers Consumers, government and other producers Total

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Conclusions

• Choice of allocation mechanism may have substantial

influence on the electricity market– Electricity price and market shares

• Costs of reaching an emissions target may increase

significantly if output-based allocation is chosen– Gas producers will benefit and expand production

– Consumers face lower electricity price but higher CO2-price

– Producers of renewable power stand to lose

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Thank you for the attention!

Link to paper:http://tinyurl.com/allocation2011