Topic 7 Transferable Discharge Permits

CASE-AGAINST-CAP-AND-TRADE.HTML The Case For and Against CAP and TRADE Systems

How Transferable Discharge Permits Operate TDPs operate by creating a property right which is a permit to emit pollutants Government decides on the total number of permits Allocates permits between different polluting sources Permits are transferable; bought and sold in the market place

Illustration of emissions trading between two countries Kyoto target for both countries Country A Low abatement cost Country B High abatement cost CO2 equivalents Quotas sold Quotas purchased Emissions 2010

In emissions trading firms must choose (1) To reduce emissions to the level covered by permits (2) To maintain or increase emission levels by buying additional permits (3)Reduce emission levels below the original permit award and sell the permits they don’t need

How efficient are TDPs? Emissions are distributed among polluters in a way that is consistent with the equi-marginal principle Example 1 2 polluters; 2 different MAC Total emissions are 210 tons/yr; 120 tons from source A and 90 from source B Gov wishes to reduce emissions to 105 tons/yr and create 105 TDPs Source A gets 60 and source B gets 45 MAC for source A are 1200 at emission level of 60 MAC for source B are 4000 for 45 tons Both firms are better off if they can trade

How TDP’s operate? Fig 1 Source A Source B € € Emissions (tons per year)

Gains from trading permits Gains from trading permits between both sources until MACs are equalised Firm B would be better off if it could buy a permit for less that 4000 Firm A would be better off if it could sell a permit at any price above 1200 The equimarginal principal is satisfied at emission levels of 40 tons for Source A and 65 for B The normal forces of the market will bring about a single price for permits

Under what conditions do TDPs operate best? When the Initial Rights Allocation (IRA) is managed equitably When clear trade rules and systems exist Who may participate? How are permits to be reduced in the future? How to deal with non-uniform emissions? Should trade be restricted? When they can be effectively monitored and enforced

TDPs and R&D Incentives TDP programs are as effective as emission charges in providing an incentive to innovate Consider Fig 2 Assume Firm has MAC1 Emission permits sell for P each (constant) Firm currently owns e1 permits

TDPs and Innovation Fig 2: Incentive to innovate How much is it worth for the firm to shift to MAC2? With MAC2 firm would reduce its emissions to e2 Total abatement costs =(b+d) Sells (e1-e2) in permits for revenue of (c+d) Benefit to firm = (a+c) € Emissions (tons/year) 0 MAC1 P e1 ē MAC2 a b e2 e d c

Emission Charges or TDPs Which are the most effective and efficient policies to deal with current environment issues such as climate change?

Policy tools: benefits and drawbacks Policy tool Tax Emissions trading Benefits Cost-effectiveness Well-known policy tool Replacement of other taxes may give additional benefits Cost-effectiveness Emission reduction target achieved with certainty Drawbacks Uncertain emission reduction The state may have fiscal objectives  reduced cost-effectiveness Unilateral use can lead to migration and ‘carbon leakage’ Uncertain quota price Not much experience with use Could conserve industry structure – reduce rate of technological progress? Unilateral use can lead to ‘carbon leakage’

Summary Emission charges put a price on pollution Prime advantage = efficiency aspects Also provide strong incentive to innovate Provide a source of tax revenue Difficult to determine the impact of the tax on emission reductions and revenue Difficult to monitor

Summary TDPs are an efficient and cost effective method of pollution control A major advantage is that they encourage innovation However, their effectiveness depends on the initial rights allocation, clear trade rules, large and competitive markets and effective monitoring and enforcement

Reading Field & Field, chapter 12 & pdf pdf