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Market Power with Tradable Performance-Based CO2 Emission Standards in the Electricity Sector

The U.S. Clean Power Plan stipulates a state-specific performance-based CO2 emission standard, delegating states with considerable flexibility for using either a tradable performance-based or a mass-based permit program. This paper analyzes these two standards under imperfect competitive. We limit our attention to (1) short-run analyses and (2) a situation in which all states are subject to the same type of standard. We show that while the cross-subsidy inherent in the performance-based standard might effectively reduce power prices, it could also inflate energy consumption. A dominant firm with a relatively clean endowment under the performance-based standard would be able to manipulate the electricity market as well as to elevate permit prices, which might worsen market outcomes compared to its mass-based counterpart. On the other hand, the "cross-subsidy" could be the dominant force leading to a higher social welfare if the leader has a relatively dirty endowment.

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Energy Specializations: Energy and the Environment – Climate Change and Greenhouse Gases; Energy and the Environment – Policy and Regulation

JEL Codes: L11: Production, Pricing, and Market Structure; Size Distribution of Firms, Q54: Climate; Natural Disasters and Their Management; Global Warming, L13: Oligopoly and Other Imperfect Markets, Q58: Environmental Economics: Government Policy, D21: Firm Behavior: Theory, D22: Firm Behavior: Empirical Analysis, Q41: Energy: Demand and Supply; Prices, D43: Market Structure, Pricing, and Design: Oligopoly and Other Forms of Market Imperfection, D42: Market Structure, Pricing, and Design: Monopoly, Q42: Alternative Energy Sources

Keywords: Climate policy, Electricity industry, Mathematical program with equilibrium constraints, Performance-based standards

DOI: 10.5547/01956574.39.6.yche

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Published in Volume 39, Number 6 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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