Output-based Allocation Research Articles

Measures Against Carbon Leakage – Combining Output-Based Allocation with Consumption Taxes

Measures Against Carbon Leakage – Combining Output-Based Allocation with Consumption Taxes

The Climate PoLicy ANalysis (C-PLAN) Model, Version 1.0

This paper documents Version 1.0 of the Climate PoLicy ANalysis (C-PLAN) model and presents results for the model's baseline and a policy scenario. The C-PLAN model is a global, recursive dynamic computable general equilibrium (CGE) model tailored to the economic and emissions characteristics of Aotearoa/New Zealand. Distinguishing features in the model include methane-reducing technologies for livestock, bioheat from forestry residues, and explicit representation of output-based allocations of emissions permits. The model was built for the New Zealand Climate Change Commission (CCC) to inform policy advice provided to the government. The computer code for the model and instructions for reproducing results used by the CCC are publicly available. It is hoped that the C-PLAN model will assist transparency in setting climate policies, help build capacity for climate policy analysis, and ultimately set the foundations for future climate policy initiatives in New Zealand and other countries.

Smart hedging against carbon leakage

SUMMARY Policy makers in the EU and elsewhere are concerned that unilateral pricing of the carbon externality induces carbon leakage through relocation of emission-intensive and trade-exposed production to other regions. A common measure to mitigate such leakage is to combine an emission trading system with output-based allocation (OBA) of allowances where the latter works as an implicit production subsidy to regulated industries. We show analytically that it is optimal to impose in addition a consumption tax on the OBA goods (i.e., goods that are entitled to OBA) at a rate which is equivalent in value to the OBA subsidy rate. The explanation is that the consumption tax alleviates excessive consumption of the OBA goods, which is a distortionary effect of introducing OBA. Using a multi-region multi-sector computable general equilibrium model calibrated to empirical data, we quantify the welfare gains for the EU of imposing such a consumption tax on top of its existing emission trading system with OBA. We run Monte Carlo simulations to account for uncertain leakage exposure of goods entitled to OBA. The consumption tax increases welfare whether the goods are highly exposed to leakage or not, and hence can be regarded as smart hedging against carbon leakage.

Addressing competitiveness of emissions-intensive and trade-exposed sectors: a review of Alberta's carbon pricing system

In 2018, the Canadian province of Alberta introduced a revamped carbon pricing regime – the Carbon Competitiveness Incentives Regulation (CCIR) – for large industrial emitters. This regulation set product benchmark emissions intensities and required that facilities purchase emissions credits for the portion of emissions that fell above that product benchmark. With a focus on Alberta's oil and gas industry, this paper assesses mechanisms used under the CCIR to address competitiveness-driven carbon leakage for emissions-intensive and trade-exposed sectors. These mechanisms include exclusions, output-based allocations and financial compensation in the form of market-based compliance flexibility and access to innovation funding. The CCIR also provided additional cost containment for facilities that demonstrated significant economic risk resulting from carbon compliance costs. The output-based allocation, which is the primary policy mechanism for addressing competitiveness, is compared with the carbon pricing system in California. This review suggests that the CCIR failed to provide evidence that emission allocation levels were sufficient to mitigate carbon leakage. Further, the system's definition of competitiveness failed to incorporate the ability to attract new investment, which is particularly important for the oil and gas sector due to its capital-intensive nature. Understanding policy options for protecting industry competitiveness from carbon pricing may help to inform future regulatory design that mitigates the likelihood of carbon leakage.

Working Longer but Not Harder: The Effects of Incentivizing Inputs versus Outputs in a Heterogeneous Workforce

ABSTRACTTo address the empirical phenomenon that organizations often reward time on the job as an end in itself, we design an experiment in which participants solve anagram puzzles, manipulating whether a compensation pool generated from the output of paired workers is allocated based on the individual inputs of relative time spent or on the individual outputs of puzzles solved. Relative to an output-based allocation, we find that an input-based allocation leads participants to spend more time on the task. However, when paired participants have widely different abilities, an input-based allocation also leads to less effort intensity, defined as puzzles solved per unit of time spent. We attribute these findings to fairness considerations, an interpretation we corroborate in a second experiment with purely individual incentives that finds the same effort duration advantage of input-based pay, but no offsetting disadvantage in effort intensity.JEL Classifications: D91; J33; M40.

Allowance allocation matters in China's carbon emissions trading system

Abstract China's national carbon emissions trading system (ETS) initially started by covering the power generation sector with a rate-based allocation of emission allowances. This single-sector ETS scheme is a tradable performance standard and loosens the participants' emission abatement effort. Given the stringent emission reduction targets implied by China's Nationally Determined Contributions (NDCs) and the expectation that ETS will cover more sectors in the future, we simulate a national ETS of ten carbon-intensive sectors with mass-based, output-based allocation (OBA) of emission allowances. We uncover the impacts and mechanisms of this ETS by comparing the sectoral abatement behaviors across policy scenarios with varying allocation schemes and numbers of benchmarks. We evaluate if the simulated ETS meets important efficiency principles and exhibits desired features. The results show that this ETS achieves China's NDCs with modest macroeconomic losses. The mass-based OBA leads to evenly distributed emission reduction efforts for all ETS participating sectors. It also limits the emission trading volumes and results in slight to modest impacts on sectoral output, especially for the upstream sectors. OBA with fewer benchmarks enhances emission abatement efforts with the caveats of relatively cleaner participants being subsidized by the ETS and slightly higher impacts on the macroeconomy.

Aggregate impacts of cap-and-trade programs with heterogeneous firms

Abstract We study the long-run effects on output, aggregate TFP, and welfare of alternative permit allocation schemes in a cap-and-trade program. We use a firm dynamics model with heterogeneous firms and add an emission market with a cap-and-trade regulation. We calibrate the model with establishment and emission data in the US and study three permit allocation methods: auctions, output-based-allocation, and grandfathering. A 40% reduction in emissions is associated with a welfare cost that is highest for auctioning (1.20%), followed by grandfathering (0.78%) and, finally, output-based allocation (0.70%). We also consider an endogenous abatement technology, which implies smaller but still significant welfare costs.

Taxing Consumption to Mitigate Carbon Leakage

Unilateral actions to reduce CO2 emissions could lead to carbon leakage such as relocation of emission-intensive and trade-exposed industries (EITE). To mitigate such leakage, countries often supplement an emissions trading system (ETS) with free allocation of allowances to exposed industries, e.g. in the form of output-based allocation (OBA). This paper examines the welfare effects of supplementing OBA with a consumption tax on EITE goods. In particular, we investigate the case when only a subset of countries involved in a joint ETS introduces such a tax. The analytical results suggest that the consumption tax would have unambiguously global welfare improving effects, and have welfare improving effects for the tax introducing country as well unless there are strong unfavorable terms-of-trade effects. Numerical simulations in the context of the EU ETS support the analytical findings, including that the consumption tax is welfare improving for the single country that implements the tax.

Moving the Coal-Posts: Ottawa’s Wrong Turn on Carbon Pricing for Electricity Generation

New federal government carbon pricing regulations for electricity generators will reduce the average carbon cost for coal plants, while decreasing incentives for cleaner wind, solar and hydro projects, says a new report from the C.D. Howe Institute. As phase two of the carbon-pricing “backstop”, originally enacted in 2018 under the Greenhouse Gas Pollution Pricing Act, the federal government has proposed an emissions benchmark for electricity generators that will vary by the type of fuel used. In “Moving the Coal-Posts: Ottawa’s Wrong Turn on Carbon Pricing for Electricity Generation,” author Grant Bishop examines Ottawa’s proposed plan and finds that a fuel-specific approach creates an unlevel playing field between different sources of electricity. The federal government’s fuel-specific method contrasts with Alberta’s current Carbon Competitiveness Incentive Regulation, which uses a uniform benchmark for all fuels used to generated electricity. The report finds that relative to a uniform standard for output-based allocations, Ottawa’s fuel-specific benchmark risks distorting the order in which plants are dispatched (i.e. turned on and off as demand requires) – potentially pushing high-emission coal plants ahead of lower-emission natural gas plants. In addition, unlike Alberta’s approach, Ottawa’s system does not allocate credits to zero-emission electricity producers such as hydro, wind and solar, and will diminish incentive for new investment in renewable generation. “Ottawa’s approach undercuts the concept of a single economy-wide carbon price and the economic rationale behind carbon pricing,” says Bishop. “While the federal government is likely concerned to avoid spikes in power prices in those provinces where power generation currently relies on coal, Ottawa risks distorting provincial power markets and investment incentives by differentiating carbon costs for producers of the same product.”

Emissions reduction and wholesale electricity price targeting using an output-based mechanism

Higher electricity prices following the introduction of an emissions abatement policy are generally considered a foregone conclusion, with complementary schemes or tax cuts often proposed to deal with their economic and political consequences. Rather than considering these price rises as an inevitable consequence of an emissions abatement policy, we demonstrate how wholesale electricity prices can be targeted while simultaneously placing a price on emissions. This is accomplished by implementing an output-based allocation mechanism which penalises or rewards generators based on their emissions intensity with respect to a sectoral baseline. A systematic modelling framework is presented that can be used to calibrate parameters for this scheme in order to achieve given environmental and economic objectives. Topological considerations and network constraints are captured within this framework, along with strategic interactions between a policy maker seeking to implement the scheme, and market operator responsible for dispatching generators. This highly generalisable framework is then implemented using data for the Australian system, and demonstrates how a price on emissions can be established while simultaneously minimising disruptions to average wholesale electricity prices.

Striving for equivalency across the Alberta, British Columbia, Ontario and Québec carbon pricing systems: the Pan-Canadian carbon pricing benchmark

ABSTRACTThe Pan-Canadian Framework on Clean Growth and Climate Change is designed to put Canada on track to meet its Paris commitments. A key pillar of the plan is the introduction of a pan-Canadian carbon price by the end of 2018. However, four Canadian provinces, nearly 85% of the Canadian economy and population, have already implemented carbon pricing systems. British Columbia (BC) has a carbon tax. Alberta is transitioning from an output-based allocation system for industrial emitters to a hybrid system combining a carbon levy and refined output-based system. Québec and Ontario have implemented cap-and-trade systems, linked to California. Recognizing these existing systems, rather than impose a single carbon pricing mechanism, the Pan-Canadian Approach to Carbon Pricing gives provinces and territories the flexibility to adopt a carbon tax, a hybrid system, or a cap-and-trade system. To address concerns relating to ‘fairness’ and equivalency of carbon price, a federal carbon pricing benchmark establishes criteria relating to minimum ‘common scope’ and ‘increases in stringency’ that provincial and territorial carbon pricing systems must meet. This article explores the design features of the existing Alberta, BC, Ontario and Québec carbon pricing systems, and considers how the benchmark affects stringency and addresses equivalency of carbon price across these different systems.Key policy insightsCanada is taking advantage of its federal structure of government to introduce a minimum pan-Canadian carbon price of $10/tCO2e in 2018, rising by $10/year to $50/tCO2e in 2022.Rather than imposing a uniform pricing mechanism, the Canadian federal government is recognizing existing subnational carbon pricing mechanisms with very different design features – BC’s carbon tax, Québec and Ontario’s cap-and-trade systems, and Alberta’s hybrid system – to deliver the pan-Canadian carbon price.In order to deliver a minimum level of increasing stringency and to address issues of equivalency of carbon price across sub-national jurisdictions, the federal government is in the early stages of implementing a federal carbon-pricing benchmark.The lessons learned from the Canadian experience will be relevant to harmonizing carbon pricing systems across both other federal jurisdictions and countries.

Effectiveness of pilot carbon emissions trading systems in China

ABSTRACTChina is in the process of establishing a national emissions trading system (ETS). Evaluating the implementation effectiveness of the seven pilot ETSs in China is critical for designing this national system. This study administered a questionnaire survey to assess the behaviour of enterprises covered by the seven ETS pilots from the perspective of: the strictness of compliance measures; rules for monitoring, reporting and verification (MRV); the mitigation pressure felt by enterprises; and actual mitigation and trading activities. The results show that the pilot MRV and compliance rules have not yet been fully implemented. The main factors involved are the lack of compulsory force of the regulations and the lack of policy awareness within the affected enterprises. Most enterprises have a shortage of free allowances and thus believe that the ETSs have increased their production costs. Most enterprises have already established mitigation targets. Some of the covered enterprises are aware of their own internal emission reduction costs and most of these have used this as an important reference in trading. Many enterprises have accounted for carbon prices in their long-term investment. The proportion of enterprises that have participated in trading is fairly high; however, reluctance to sell is quite pervasive in the market, and enterprises are mostly motivated to trade simply in order to achieve compliance. Few enterprises are willing to manage their allowances in a market-oriented manner. Different free allowance allocation methods directly affect the pathways enterprises take to control emissions.Key policy insightsIn the national ETS, the compulsory force of ETS provisions should be strengthened.A reasonable level of free allowance shortage should be ensured to promote emission reduction by enterprises.Sufficient information should be provided to guide enterprises in their allowance management to activate the market.To promote the implementation of mitigation technologies by enterprises, actual output-based allocation methods should be used.The government should use market adjustment mechanisms, such as a price floor and ceiling, to ensure that carbon prices are reasonable and stable, so as to guide long-term low carbon investment.

Output-based allocations in pollution markets with uncertainty and self-selection

We study pollution permit markets in which a fraction of permits are allocated to firms based on their output. Output-based allocations, which are receiving increasing attention in the design of carbon markets around the world (e.g., Europe, California, New Zealand), are shown to be optimal under demand and supply volatility despite the output distortions they may create. In a market that covers multiple sectors, the optimal design combines auctioned permits with output-based allocations that are specific to each sector and increasing in its volatility. When firms are better informed about the latter or must self select, the regulator resorts to some free (i.e., lump-sum) allocations to sort firms out.

Using output-based allocations to manage volatility and leakage in pollution markets

Output-based allocations (OBAs) are typically used in emission trading systems (ETS) with a fixed cap to mitigate leakage in sectors at risk. Recent work has shown they may also be welfare enhancing in markets subject to supply and demand shocks by introducing some flexibility in the total cap, resulting in a carbon price closer to marginal damage. We extend previous work to simultaneously include both leakage and volatility. We study how OBA permits can be implemented under an overall cap that may change with the level of production in contrast with a design that deducts OBA permits from the overall permit allocation as is the current practice in the EU-ETS and California. We show that introducing OBA permits while keeping the overall cap fixed would only increase price fluctuations and induce severe welfare losses to non-OBA sectors.

Can an emission trading scheme promote the withdrawal of outdated capacity in energy-intensive sectors? A case study on China's iron and steel industry

Outdated capacity and substantial potential for energy conservation are the two main features of energy-intensive sectors in developing countries. Such countries also seek to implement market-based options to further control domestic carbon emissions as well as to promote the withdrawal of outdated capacity and upgrade production level. This paper presents a quantitative assessment of the emission trading scheme (ETS) for China's iron and steel industry. The diverse array of normal and outdated capacities was modeled in a two-country, three-good partial equilibrium model. Simulation results show that the abatement potential can be underestimated if the energy-saving effects that result from emission abatement are not considered. In the scenario analysis, we demonstrated that the free allocation of allowances can cause a competitiveness distortion among domestic normal and outdated capacities. Given the government's intention to promote outdated capacity withdrawal and production-level upgrading, an output-based allocation approach is strongly suggested for China's iron and steel sector.

Solving the clinker dilemma with hybrid output-based allocation

Output-based allocation (OBA) is one of the main options discussed for addressing carbon leakage in emissions trading systems. This paper studies how different OBA designs affect incentives on mitigation and trade in the cement sector. To do so, we develop an analytical model of sector emissions as a function of technical parameters representing abatement levers. We propose a specific design called hybrid OBA, and show that unlike the alternatives, it provides incentives for firms to reduce the carbon intensity of production without offshoring production. We assess the feasibility of hybrid OBA through expert interviews and find that the main barriers identified, including technical and administrative complexities, are manageable. However, hybrid OBA represents a mid-term solution until more robust anti-leakage measures can be introduced, because of two key limitations of OBA in general - it does not provide incentives to reduce the consumption of cement or to accelerate the development of radical low-carbon technologies, both of which are necessary to deliver deep decarbonisation.

Using Output-Based Allocations to Manage Volatility and Leakage in Pollution Markets

Output-based allocations (OBAs) are typically used in emission trading schemes to mitigate leakage in sectors at risk. Recent work has shown they may also help to stabilize prices in markets subject to supply and demand shocks. We extend previous work to simultaneously include both leakage and volatility. Motivated by discussions on how to reform carbon markets around the world, and in Europe in particular, we use our model to revisit several critical issues in the design of these markets. In particular, we look at how different OBA schemes manage permit price uctuations and what are the implications of deducting OBA permits (the majority going to trade-exposed and carbon intensive sectors) from the overall permit allocation, so as to keep the global cap on emissions fixed (as it is the case in California and in the EU).

Working Longer But Not Harder: The Effects of Input- and Output-Based Pay Allocations on the Duration and Intensity of Effort

To address the empirical phenomenon that organizations often reward time on the job as an end in itself, we design an experiment in which participants solve anagram puzzles, manipulating whether a compensation pool generated from the output of paired workers is allocated based on the individual inputs of relative time spent or on the individual outputs of puzzles solved. Relative to an output-based allocation, we find that an input based allocation leads participants to spend more time on the task. However, when paired participants have widely different abilities, an input-based allocation also leads to less effort intensity, defined as puzzles solved per unit of time spent. We attribute these findings to fairness considerations, an interpretation we corroborate in a second experiment with purely individual incentives that finds the same effort duration advantage of input-based pay but no offsetting disadvantage in effort intensity.

Windfall Profits Under Pollution Permits and Output-Based Allocation

This paper analyzes the implementation of pollution permits. It focuses on the distributional impacts linked with the stringency of output-based allocation when two sectors are covered by the market for permits and the total cap is held constant. A new type of profit increase in sectors that are not exposed to international competition, when energy-intensive trade-exposed (EITE) sectors are granted output-based allocations, is demonstrated theoretically. The paper also illustrates a profit increase in the electricity sector in a possible fourth phase of the European Union Emission Trading Scheme, in which output-based allocation will be granted to EITE sectors, compared with the case in which all permits are auctioned.

Chapter 4. Economic Considerations: Cost-Effective and Efficient Climate Policies

In this chapter we discuss the economics of climate change. We begin with a discussion of economic considerations that are important to take into account when designing and evaluating climate policy, including cost effectiveness and efficiency. We then discuss specific policies at the state, national, and international level in light of these economic considerations.We have several recommendations for the path forward for climate policy. First, the goal of climate policy should be to reduce the damages caused by greenhouse gases. In addition to mitigation policy to reduce greenhouse gas concentrations in the atmosphere, one can also reduce the damages causes by greenhouse gases by adaptation measures that reduce our vulnerability to climate change impacts.Second, policy-makers should use incentive- (or market-) based instruments as opposed to command and control policies (including quantity-based mandates) whenever possible. Whenever unpriced emissions are the sole market failure, incentive-based instruments such as a carbon tax or cap and trade program are more likely to achieve the social optimum and maximize social net benefits [12]. Lin and Prince [3] calculate that the optimal gasoline tax for the state of California is $1.37 per gallon.Our third recommendation is to address the risk of emissions leakage, which arises when only one jurisdiction (e.g., California) imposes climate policy, but not the entire world. One way to reduce emissions leakage is to use the strategic distribution of emissions allowances to local producers. This method, known as “output-based allocation” or benchmarking, effectively subsidizes local producers and at least partially offsets the increase in their costs caused by an emissions cap [4]. Importantly, only local production is eligible for an allocation of valuable allowances, providing a counterweight to the incentive for emission leakage.Our fourth recommendation is that if they are used instead of incentive-based instruments, quantity-based mandates such as the federal Renewable Fuel Standard, California’s Low Carbon Fuel Standard, renewable portfolio standards, and the Clean Power Plan should be combined with a cost containment mechanism. The findings of Lade, Lin Lawell and Smith [5] suggest that pure quantity-based mechanisms leave policies susceptible to large increases in compliance costs, particularly in the presence of capacity or production constraints that are inherent in energy markets. Given the experiences with the federal RFS2 in 2013, anticipating and designing climate policies in a way that can contain compliance costs is imperative.Our fifth recommendation is that for international leverage, we should develop a climate club backed by border tax adjustments to non-participants. University of California at Berkeley Professor Larry S. Karp has been proposing an agreement between the top 10 emitters as an alternative to the UN framework [6]. Without international leverage or cooperation, unilateral climate policies, such as California’s AB 32 or the American Clean Energy and Security Act, are not only unlikely to fully combat climate change, but can also have other detrimental effects such as the reduction of economic competitiveness and the possible displacement of jobs from the U.S. to countries without carbon pricing [7].Our final, and main, recommendation is that, as University of California at Berkeley Professor Severin Borenstein points out, California should focus on solving the problem of global climate change. The primary goal of California climate policy should be to invent and develop the technologies that can replace fossil fuels, allowing the poorer nations of the world – where most of the world’s population lives – to achieve low-carbon economic growth [8].