Linking Carbon Markets with Different Initial Conditions
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.
Despite the global nature of climate change, carbon pricing is driven by regional and sectoral carbon taxes or trading programs, each with unique features and disparate marginal costs. Linking these fragmented regional or sectoral programs could improve environmental and economic outcomes, but differing initial conditions pose a challenge to linking. We explore the use of an allowance exchange rate, which denominates the compliance value of an emissions allowance differently in each program. In a theoretical model, we find that linking with an exchange rate in the politically plausible range—between traditional 1:1 trading (without an exchange rate) and the autarky price ratio—yields lower total abatement costs and greater economic surplus in each region, compared to autarky. Linking in this range also achieves greater emissions abatement than the (equal) amount achieved at each bookend. For this reason, 1:1 linking, which achieves a uniform allowance price and marginal cost, is nonetheless rarely socially optimal. When program caps achieve inefficiently low abatement, it would be welfare-improving to link at an exchange rate that increases total abatement in the linked system, so the socially optimal exchange rate lies within the politically plausible range. We further illustrate these results, and identify additional outcomes of interest to policymakers, using a simulation model of electricity markets.
Darius Gaskins Senior Fellow
Dallas Burtraw is a Darius Gaskins senior fellow at RFF. Burtraw’s research includes analysis of the distributional and regional consequences of climate policy and the evolution of electricity markets including renewable integration.
Karen Palmer is a Senior Fellow at Resources for the Future and an expert on the economics of environmental, climate and public utility regulation of the electric power sector. She also serves as the director of the Future of Power Initiative.
Report — Jan 30, 2023
Policies on the Road to Carbon Neutrality in the Intermountain West
Resources for the Future partnered with Intermountain West Energy Sustainability & Transitions (I-WEST) to map the existing policy landscape of the Intermountain West and define policy's role in decarbonizing the region.
Testimony and Public Comments — Jan 18, 2023
Comments to EPA on the IRA’s Transportation Programs
To the Environmental Protection Agency on the Request for Information related to the Inflation Reduction Act's Transportation Programs.
Working Paper — Jan 3, 2023
What Are the Climate, Air Pollution, and Health Benefits of Electric Vehicles?
This working paper models the climate and health benefits of plug-in vehicles under five different policy and market scenarios.
On the Issues — Dec 23, 2022
On the Issues: Happy Holidays from Resources from the Future
A biweekly newsletter connecting global current events, pressing climate and energy policy news, and economics research from RFF scholars. This week: RFF's top stories of 2022, the end of RFF's 70th anniversary, and more.