Working Paper

Linking Carbon Markets with Different Initial Conditions

Jul 24, 2017 | Dallas Burtraw, Clayton Munnings, Karen L. Palmer, Matthew Woerman

Summary

We develop a framework to analyze the economic implications and emissions market outcomes of linking emissions trading systems with different features, including stringency, and apply it to the potential linking of the California and RGGI trading programs.

Key Findings

  • This paper provides an analytical model that formalizes the economic implications and emissions market outcomes of linking trading programs.
  • We formulate several novel propositions on the results of linking emissions markets, illustrated by simulating a link between the California and Regional Greenhouse Gas Initiative trading programs.
  • In a qualitative evaluation, we conclude that the emissions allowance markets in California and the Regional Greenhouse Gas Initiative are almost ready for linking when assessed based on administrative measures.
  • However, a simulation exercise verifies potentially difficult outcomes under linking due to differences in stringency and design.

Abstract

Linkage of emissions trading systems theoretically minimizes total abatement costs by allowing fungibility of emissions reductions across jurisdictions. We develop a theoretical framework to investigate the implications of linking systems with unique designs. We qualitatively assess the California and the Regional Greenhouse Gas Initiative systems, which we find to be nearly ready to link despite some differences in their initial conditions, including design and stringency. We use a simulation model of regional electricity markets to investigate market outcomes under such a linked system. We consider possible exchange rates for allowances to adjust for differences in program stringency, and we examine how they interact with price floors and ceilings while explicitly representing other program features (e.g., leakage policies, companion policies, and allowance allocation). We find that aggregate emissions and emissions in each jurisdiction change in ways predicted by theory but that efficiency gains can be distributed in nuanced and nonintuitive ways.

Figures

Figure 1. Marginal Abatement Cost Curves and Results for Unlinked Programs

Figure 2. Marginal Abatement Cost Curves and Results under One-for-One Trading

Figure 3. Marginal Abatement Cost Curves and Results of Three-for-One Trading

Figure 4. Marginal Abatement Cost Curves and Results without Linking under High Gas Prices

Figure 5. Marginal Abatement Cost Curves and Results without Linking under High Gas Prices and High Electricity Demand