The effect of market power on the inter-temporal allocation of abatement under a rate-based emissions trading scheme

Abstract

Imperfect competition in permit markets negatively affects the cost-effectiveness of emissions trading schemes by distorting the abatement allocation across both firms and periods. Different from most studies examining the inter-firm effect of market power, we focus on the inter-temporal effect when only permit banking is allowed. In this study, two-period models are developed under a rate-based scheme where one dominant firm and some followers are included, and we examine the effect of market power in the permit market and the strategic interplay between output and permit markets on the inter-temporal allocation of abatement. We find that the influence mechanism of market power depends on the relationship between discounted permit prices and that the strategic interaction between markets can intensify the inter-temporal effect. Moreover, the inter-temporal allocation might still be inefficient even though the condition for removing efficiency loss caused by market power in a single period holds. We also perform simulations based on China's iron and steel industry and find that the dominant firm will have an incentive to decrease the growth rate of the permit price for a higher profit when borrowing is prohibited.