Abstract
Market power in permit markets has been examined in some detail following the seminal work of Hahn (Q J Econ 99(4):753–765, 1984), but the effect of free allocation on price manipulation with market power in both product and permit market has not been fully addressed. I show that in this case, the threshold of free allocation above which a dominant firm will set the permit price above its marginal abatement costs is below its optimal emissions in a competitive market, and that overall efficiency cannot be achieved by means of permit allocation alone. In addition to being of general economic interest, this issue is relevant in the context of the EU ETS. I find that the largest German, UK and Nordpool power generators received free allowances in excess of the derived threshold. Conditional on having price-setting power in both the electricity and permit markets, these firms would have found it profitable to manipulate the permit price upwards despite being net permit buyers.
Similar content being viewed by others
References
Alberola E, Chevallier J et al (2008) Price drivers and structural breaks in European carbon prices 2005–2007. Energy Policy 36: 787–797
Boehringer C, Lange A (2005) Mission impossible!? On the harmonization of national allocation plans under the EU emissions trading directive. J Regul Econ 27(1): 81–94
Bovenberg AL, Goulder LH (1996) Optimal environmental taxation in the presence of other taxes: general-equilibrium analyses. Am Econ Rev 86(4): 985–1000
Bovenberg AL, Goulder LH (2000) Neutralizing the adverse industry impacts of CO2 abatement policies: what does it cost? RFF Discussion Papers. Washington, Resources for the Future: 48
Brown-Kruse J, Elliot SR et al (1995) Strategic manipulation of pollution permit markets: an experimental approach. McMaster University, Department of Economics Working Papers, p 35
Bunn DW, Fezzi C (2008) A vector error correction model of the interactions among gas, electricity and carbon prices: an application to the cases of Germany and United Kingdom. In: Gulli F (ed) Markets for carbon and power pricing in Europe: theoretical issues and empirical analyses. Edward Elgar Publishing, pp 145–159
Disegni Eshel DM (2005) Optimal allocation of tradable pollution rights and market structures. J Regul Econ 28(2): 205–223
Ellerman AD, Buchner B (2008) Over-allocation or abatement? A preliminary analysis of the EU ETS based on the emissions 2005 data. Environ Resour Econ 41(2): 267–287
European Environment Agency (2006) Application of the emissions trading directive by EU member states. EEA Technical Report No. 2/2006
Fell H (2008) EU-ETS and Nordic electricity: a CVAR approach. Resources For the Future, Discussion Paper 08–31
Godby R (2002) Market power in laboratory emission permit markets. Environ Resour Econ 23(3): 279–318
Grubb M, Neuhoff K (2006) Allocation and competitiveness in the EU emissions trading scheme: policy overview. Clim Policy 6(1): 7–30
Hahn RW (1984) Market power and transferable property rights. Q J Econ 99(4): 753–765
Hart O, Tirole J (1990) Vertical integration and market foreclosure. Brookings Papers on Economic Activity (special issue), pp 205–276
Hepburn C, Grubb M et al (2006) Auctioning of EU ETS Phase II allowances: how and why?. Clim Policy 6(1): 137–160
Hintermann B (2009) An options pricing approach to CO2 allowances in the EU ETS. CEPE working paper # 64. Zurich, ETHZ
Hintermann B (2010) Allowance price determinants in the EU ETS. J Environ Econ Manag (in press)
Krattenmaker TG, Salop SC (1986a) Anticompetitive exclusion: raising rivals’ costs to achieve power over price. Yale Law J 96(2): 209–293
Krattenmaker TG, Salop SC (1986b) Competition and cooperation in the market for exclusionary rights. Am Econ Rev 76(2): 109–113
Kruger J, Pizer W (2004) The EU emissions trading directive: opportunities and potential pitfalls, Washington. Resources for the Future discussion papers: 62
Liski M, Montero J-P (2005) A note on market power in an emission permits market with banking. Environ Resour Econ 31(2): 159–173
Maeda A (2003) The emergence of market power in emission rights markets: the role of initial permit distribution. J Regul Econ 24(3): 293–314
Mansanet-Bataller M, Pardo A et al (2007) CO2 prices, energy and weather. Energy J 28(3): 73–92
Misiolek WS, Elder HW (1989) Exclusionary manipulation of markets for pollution rights. J Environ Econ Manag 16(2): 156–166
Muller RA, Mestelman S (1998) What have we learned from emissions trading experiments. Manag Decis Econ 19(4-5): 225–238
Neuhoff K, Keats K et al (2006) Allocation, incentives and distortions: the impact of EU ETS emissions allowance allocations to the electricity sector. Clim Policy 6(1): 73–91
Ordover JA, Saloner G et al (1990) Equilibrium vertical foreclosure. Am Econ Rev 80(1): 127–142
Parry IWH (1995) Pollution taxes and revenue recycling. J Environ Econ Manag 29(3): S64–77
PEW Center on Global Climate Change (2005) The European emissions trading scheme (EU-ETS); Insights and Opportunities: 20
Reilly JM, Paltsev S (2005) An analysis of the European emission trading scheme, vol 27. Joint Program on the Science & Policy of Global Change. Massachussetts Institute of Technology, Cambridge
Rickels W, Dusch V et al (2007) The determinants of allowance prices in the European emissions trading scheme—can we expect an efficient allowance market 2008? vol 28. Kiel Institute for the World Economy Working Paper No. 1387
Salop SC, Scheffman DT (1983) Raising rivals’ costs. Am Econ Rev 73(2): 267–271
Salop SC, Scheffman DT (1987) Cost-raising strategies. J Ind Econ 36(1): 19–34
Sartzetakis ES (1997a) Raising rivals’ cost strategies via emission permits markets. Rev Ind Organ 12(5–6): 751–765
Sartzetakis ES (1997b) Tradeable emission permits regulations in the presence of imperfectly competitive product markets: welfare implications. Environ Resour Econ 9(1): 65–81
Sijm J, Neuhoff K et al (2006) CO2 cost pass through and windfall profits in the power sector. Clim Policy 6(1): 49–72
Sijm JPM, Hers SJ et al (2008) The impact of the EU ETS on electricity prices. Energy Research Centre of the Netherlands (ECN), 230 pp
Sinn H-W, Schmoltzi U (1981) Eigentumsrechte, Kompensationsregeln und Marktmacht-Anmerkungen zum Coase Theorem. Jahrbuecher fur Nationalokonomie und Statistik 196(2): 97–117
Smale R, Hartley M et al (2006) The impact of CO2 emissions trading on firm profits and market prices. Clim Policy 6(1): 29–46
van Egteren H, Weber M (1996) Marketable permits, market power, and cheating. J Environ Econ Manag 30(2): 161–173
Vollebergh HRJ, De Vries JL et al (1997) Hybrid carbon incentive mechanisms and political acceptability. Environ Resour Econ 9(1): 43–63
von der Fehr N-HM (1993) Tradable emission rights and strategic interaction. Environ Resour Econ 3(2): 129–151
Westskog H (1996) Market power in a system of tradeable CO2 quotas. Energy J 17(3): 85–103
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Hintermann, B. Market Power, Permit Allocation and Efficiency in Emission Permit Markets. Environ Resource Econ 49, 327–349 (2011). https://doi.org/10.1007/s10640-010-9435-9
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10640-010-9435-9