Working Paper

Recognizing Gravity as the Strong Force in Atmosphere Emissions Markets

May 16, 2018 | Dallas Burtraw, Amelia Keyes

Summary

This paper surveys emissions markets and factors influencing emissions allowance prices. It examines the consequences of the strong tendency for low prices and discusses how market design can anticipate and remedy this tendency.

Abstract

Environmental economics has made it possible to estimate prices for air pollution externalities. However, these values are rarely observed in emissions trading markets, as the stringency of these markets is often most dependent on political negotiations, and allowance prices typically fall below the marginal benefits of emissions reductions. Moreover, the political narrative of emissions markets has focused on concern for potential allowance price increases—yet market outcomes show prices persistently remain below expectations and frequently fall over time. Low allowance prices may appear virtuous, but often reflect poor market design that does not anticipate interaction with other policies, and may undermine confidence in market-based approaches to environmental policy. This paper surveys emissions markets and factors influencing prices, and concludes with a discussion of how market design can anticipate and remedy the strong tendency for low prices.