Emissions Trading, Wealth Transfers and the Wounded Bull Scenario in Power Generation

Abstract

Abstract Electricity generators accept that emissions trading is fundamental to meeting CO2 reduction targets. But unless a percentage of permits are allocated, existing generators will face non‐trivial wealth transfers. Seldom contemplated in academic works are the adverse economic consequences of an all‐auction approach to emissions trading. Using Victoria to illustrate, we find that once CO2 prices exceed $17.50/t, the marginal coal generator facing large wealth transfers will withhold generating capacity to raise prices and recoup stranded investments, thus becoming a ‘wounded bull’ in the market place. This has material welfare implications with modelling results indicate an intermediate‐run 300 per cent increase in wholesale power prices.