Price Containment for Cap-and-Trade Camp Resources 6/24/2010 Peter Maniloff* and Brian Murray*^ *Nicholas School of the Environment ^Nicholas Institute for Environmental Policy Solutions

Prices are volatile Dec 2007 Dec 2008 Dec 2012 Prices from Point Carbon

3 Strategic Reserve Fund Expected Demand Pollution (Emissions) $ Q* Price Cap Expected Price Supply Reserve fund size

4 Strategic Reserve Fund Pollution (Emissions) $ Q* Price Cap Realized Demand 1 2 Supply Reserve fund size

Model allowance price time reserve price expected price

Model Random walk in prices allowance price time reserve price realized price

Model Random walk in prices Constant elasticity of demand allowance price time reserve price realized price

Model Jump diffusion random walk in prices Constant elasticity of demand Parameterization based on simulation models and the EU ETS experience

Model Jump diffusion random walk in prices Constant elasticity of demand Parameterization based on simulation models and the EU ETS experience

Sample price paths

Results High offsets availabilityLow offsets availability Hit reserve36% probability79% probability Hit reserve in any given year10%33% Prices are contained to target price cap 91%80% Reserve contains prices (conditional on being triggered) 75% 6 billion tons is enough cumulatively 93%67% 10 billion tons is enough cumulatively 98%80%

Acknowledgements Thanks to Nat Keohane and Alexander Golub Randy Kramer, Lori Bennear, Justin Baker, and participants in the Duke environmental social sciences seminar Two reviewers The Nicholas Institute for Environmental Policy Solutions

Next Steps Further estimation and projection of parameters. This may include an expert elicitation process. Add a utility framework to model optimal reserve size given price cap.

Review comments Review comment - Are upward price spikes more likely in early years of the program when banks have not had time to build and downward spikes more common in later years for reverse reason? – Explored: Yes, perhaps, but balances out to have little effect on effective reserve size Review comment – lots of comments about our parameters. – We are exploring other estimation and projection methods. – We are also considering an expert elicitation process. Consider a price floor – That is omitted from these results, but does not substantially alter them. Very few runs substantially trigger both a price ceiling and price floor.