Emissions Trading with Shares and Coupons when Control over Discharges Is Uncertain

Abstract

Two important decisions in designing markets for tradable emissions permits are whether to allow banking and whether to allow trading in entitlements to future permits Banking is predicted to reduce price instability when firms trade in a reconciliation market after the quantity of emissions has been determined Tradable entitlements ("shares") are a common feature in proposals for emissions trading in Canada We conduct a laboratory experiment to I INTRODUCTIONTwo important decisions in designing markets for tradable emissions permits are whether to allow banking and whether to allow trading in entitlements to future permits Banking refers to the ability to carry unused emission permits forward from one compliance period to the next It is sometimes considered undesirable since it reduces the regulators' control over the temporal distribution of emissions Banking might lead to a concentration of emissions in one time penod, thus increasing pollution damages if the damage function is convex Banking is particularly desirable when firms cannot control emissions precisely during a compliance penod In this case, they may arrive at the end of the compliance period with a surplus or deficit of coupons An emission trading plan can provide for a reconciliation market in which firms clear these surpluses or deficits If the entire market is long, however, excess supply of permits in the reconciliation penod may lead to extremely low prices for permits unless the permits can be banked for later use Alternatively, excess demand for permits may dnve prices very high unless it can be met out of a stock of banked coupons Carlson el al provide experimental evidence supporting this proposition Explicit trading in entitlements to future permits is a feature of several emission trading plans under discussion in Canada These proposals distinguish between coupons and shares A coupon is the permission to discharge a unit quantity of waste (it thus corresponds to the permit of economic theory or the allowance of the U S EPA Sulphur Dioxide market)A share is an entitlement to a specified fraction of coupons to be issued in future periodsFor example, a firm holding 10% of the shares in a emissions trading market would receive 10% of the coupons issued in any year, even if the absolute number of coupons is variableIn a world of complete and perfect contingent future markets in coupons, shares would be redundant But m the practical world of environmental regulation, shares may have some advantages in allowing more secure long term planning for firms acquiring or selling coupons and in providing an explicit method for allocating any future variation in aggregate allowable emissions Emission plans under discussion in Canada typically provide both for trading in shares and for banking coupons, while plans implemented in the United States tend not to provide a formal mechanism for trading entitlements and have, in al least one case, restricted banking 'Neither design feature has been fully investigated in the laboratory Previous experim...

An experimental analysis of compliance in dynamic emissions markets

“…Permit banking in laboratory experiments have been motivated by a variety of reasons. Cason and Gangadharan's (2006) experiments involved stochastic emissions, while subjects in Godby et al (1997) were motivated by both stochastic emissions and a reduction in the permit supply. Cason et al (1999) focused solely on banking motivated by a reduction in the permit supply as we do.…”

“…The calculator did not reveal optimal production or permit trading behavior. This is like the planner used by Godby et al (1997). At the end of each period, subjects were given a summary of their production earnings, revenue or expenditures from permit trades, any penalties for the period, and a running tally of their cumulative cash balance.…”

Endogenous Monitoring and Enforcement of a Transferable Emissions Permit System

“…6 We have already discussed the marginal impacts of a change in some element of ex k on a k-type firm's choices. We have also noted that a firm's choice of emissions is independent of the monitoring and enforcement effort applied to it (Result 1); therefore, its choice of violation is affected by monitoring and enforcement only through induced changes in the number of permits it chooses to hold.…”

Key features of the global climate system to be considered in analysis of the climate change issue

“…Fortunately some resolution of this dilemma seems possible. One solution is to define the entitlement in terms of a share of a target aggregate emission level, rather than as a constant emission level (Godby et al, 1997). This share, the entitlement, would remain constant over time, though the aggregate target to which it is applied could be adjusted by a predetermined process as circumstances merit.…”