Abstract
If one jurisdiction regulates power plant emissions with a cap-and-trade (mass) program and another with an intensity (rate) standard, is it a good idea for them to link? Specifically, what effects does introducing electricity and rate-mass allowance trade between differently-regulated regions have on emissions and ultimately welfare? We explore these questions first with a simple theoretical model and then with a sophisticated numerical model of the electricity sector. The theoretical model isolates the policy effects by assuming that two otherwise identical regions are regulated differently. With fixed demand, their autarky marginal abatement costs are identical, but electricity prices are lower in the rate-limited region. Adding electricity trade shifts generation to the rate-limited region, expanding its allowance allocation, while emissions remain capped in the mass-capped region. Adding rate-mass allowance trade exacerbates this shift in generation and expansion of emissions. The increase of emission damage could make the net welfare effects negative. However, if the mass cap is sufficiently more stringent than the rate limit, allowing rate-mass allowance trade in the presence of electricity trade can lower emissions. The numerical model of the eastern US illustrates the effects predicted in the theoretical model, and projects their magnitudes. In our simulation that is loosely based on the US Clean Power Plan, the estimated CO2 damage makes the estimated net benefits of allowing rate-mass trading negative. Our results also illustrate that linking can shift the geographic distribution of SO2 and NOX emissions, which can counteract the effect of the CO2 damage on estimated total welfare.
| Original language | English |
|---|---|
| Pages (from-to) | 326-336 |
| Number of pages | 11 |
| Journal | Energy Economics |
| Volume | 73 |
| Early online date | 26 Apr 2018 |
| DOIs | |
| Publication status | Published - Jun 2018 |
Funding
Fischer is grateful for the support of the Mistra Carbon Exit program and European Community's Marie Skłodowska–Curie International Incoming Fellowship, ‘STRATECHPOL – Strategic Clean Technology Policies for Climate Change’, financed under the EC Grant Agreement PIIF-GA-2013-623783. Mao and Shawhan are grateful to Gurobi Optimization for the use of Gurobi Optimizer; Energy Visuals, Inc. for the use of data from their Transmission Atlas and FirstRate products; and the US Department of Energy, US National Science Foundation, New York Independent System Operator, and Power Systems Engineering Research Center for past support of building the simulation tools and models used in this paper. They also thank participants at the Workshop on Environmental Regulation: Emission trading scheme and market power, hosted by ETH–Zurich (Sept 29–30, 2017), and at the Energy Modeling Forum Workshop held by the Brookings Institution, Washington DC (February 3, 2017). They also thank the following colleagues who have been fellow builders of the E4ST software and models: Carlos Murillo-Sanchez, Paul D. Picciano, William D. Schulze, Di Shi, John T. Taber, Robert J. Thomas, Daniel J. Tylavsky, Yujia Zhu, Ray D. Zimmerman, Zamiyad Dar, Andrew Kindle, Nan Li, Yingying Qi, and Richard E. Schuler. All of the authors are grateful to two anonymous reviewers who provided excellent suggestions, and to the EMF 32 organizers. Declarations of interest None. Appendix A Proof of Proposition 2 Formally, production in R from source i is q iR = ( p R − t R ( u i − r ) − a i )/ b i . The allowance price t R is endogenous to the total level of production, as equilibrium requires u c q cR + u d q dR = rQ R where Q R = q cR + q dR . In the equilibrium, given this endogenous t R , Q R = u d − u c b d r − u c 2 + b c r − u d 2 p R u d − u c − a c u d − r − a d r − u c . Clearly, ∂Q R / ∂p R > 0. Production in M from source i is q iM = ( p M − t M u i − a i )/ b i . The allowance price t M is endogenous to the total level of production (and thereby the price of electricity), as equilibrium requires u c q cM + u d q dM = A and Q M = q cM + q dM . In the equilibrium, t M = p M b d u c + b c u d − a c b d u c − a d b c u d − Ab c b d b d u c 2 + b c u d 2 , so ∂t M / ∂p M > 0; the emissions price thus falls if the electricity price falls in the mass-capped region. Proof of Proposition 4 Derivations 10 10 From here, the algebra becomes more complicated, so we will report the key differences in scenarios, and note that Mathematica is used to solve the system; the NoteBook file is available by request. show that with otherwise identical regions and equivalent but asymmetric regulations, the difference in emissions between an equilibrium with cross-regime electricity trade versus without it is E R Trade − E R NoTrade = r 2 χ D b c u d − r + b d u c − r + a c − a d u d − u c where χ = b c r − u d 2 + u d 2 + b d r − u c 2 + u c 2 > 0 More derivations show that E R Flex − E R Trade = E R Trade − E R NoTrade b c r − 2 u d + b d r − 2 u c 2 r 2 b c + b d 2 + 4 b c b d u d − u c 2 ⏟ + Therefore, adding rate-mass allowance trade has the same directional effect on emissions as does electricity trade, which Proposition 2 found to be positive. We can also put a clear sign on the effects by stating the following relationships. The exercise is akin to calibrating the model to a baseline, but with general parameter values. Let γ ≡ b c / b d be the ratio of the supply slopes, and let α = q d 0 / D be the share of dirty energy in the baseline. Let us observe the baseline electricity price to be P 0 . From these relationships we can back out the cost function variables. b c = γ b d a c = P 0 − γ b d D 1 − α a d = P 0 − b d Dα Substituting, we get that E PS Trade − E PS NoTrade = r 2 χ Db d 1 + γ α u d + 1 − α u c − r > 0 The term αu d + (1 − α ) u c is the average emissions rate in the baseline, which is higher than the rate applied by the regulation.
| Funders | Funder number |
|---|---|
| U.S. Department of Energy | |
| National Science Foundation | |
| Seventh Framework Programme | 623783 |
| European Commission | PIIF-GA-2013-623783 |
Keywords
- Cap and trade
- Carbon price
- Electric power
- Leakage
- Linking
- Performance standard
