A Welfare Model for a Global Carbon Market Under Uncertain Information

Abstract

In the transition to a sustainable global economy, market organization is challenged by the recent financial and economic crises. However, at the instance of the European Union’s Emission Trading Scheme (EU ETS) [2] accounting for 66% of all dioxide of carbon (CO2) traded worldwide - major players recognise the role of market mechanisms in the fight against climate change. This paper presents a Welfare model in the context of a global carbon market with uncertain information. The objective is to analyse whether a global carbon market could achieve a fair distribution of resources and risks in the framework of four sets of energy and climate scenarios at 2030 and 2100 time horizons: A1 scenarios of rapid economic growth and efficient technology spread worldwide; A2 scenarios of slower and more fragmented technological changes and improvements of per capita income with a regionally-oriented economic development; B1 scenarios of a more integrated and more ecologically friendly world; B2 scenarios of a more divided, but more ecologically friendly world.The agents in the model are households, firms, and a public institution. In the long run it is assumed that the allocated quotas diminish, and the price increases strongly. However, this process may not be linear and the public institution in charge of the carbon policy may have to adjust the reduction path when it receives new information about the climate risk and the investment requirements.This paper highlights the need to move away from the current barter system to a global exchange system, and shows how such an exchange system could achieve a fair welfare distribution between firms, households and an independent public institution. When the market is not constrained Pareto efficient, an active and dynamic carbon policy can make all players better-off. In this framework the carbon market is likely to be a key driving force of future energy policies and strategies.