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.
On the Issues — Jan 19, 2024
On the Issues: New Magazine, City-Splitting Highways, and More
A biweekly newsletter connecting global current events, pressing climate and energy policy news, and economics research from RFF scholars. This week: US emissions trends, city-splitting highways, and more.
Resources Radio — Jan 2, 2024
2023 Year in Review: Energy and Environmental Policy, with Karen Palmer and Joseph Majkut
Karen Palmer and Joseph Majkut discuss the important and overlooked stories in energy and environmental policy from 2023, along with stories and issues to watch for in 2024.
Working Paper — Dec 18, 2023
Widening the Scope: The Direct and Spillover Effects of Nudging Water Efficiency in the Presence of Other Behavioral Interventions
This working paper describes the results of a social information campaign designed to nudge water conservation.