8. Market-Based Instruments Emission Fees and Tradeable Emission Permits

Transcription

1 8. Market-Based Instruments Emission Fees and Tradeable Emission Permits 8.1 Introduction Recall that cost-effective implementation of a given aggregate emission target requires that marginal abatement costs are equated across sources. Command-and-control regulation can in principle achieve this solution but it requires knowledge of the marginal abatement costs for individual sources. This informational requirement is the main shortcoming of CAC regulation. Market-based instruments have the potential to alleviate this informational burden and implement environmental targets at lower cost than CAC. Market-based instruments (sometimes called incentive-based instruments or economic instruments ) refers to policies that put a price on sources of environmental damage. These include: emission fees tradeable emission permits deposit-refund schemes security deposits 8.2 Emission Fees An emission fee is essentially a tax on emissions designed to implement a target level of aggregate emissions. If the target level of emissions coincides with the efficient level of emissions, then an emission fee is exactly equivalent to a Pigouvian tax. Suppose a source is charged a per unit emission fee p. In response it will set emissions such that its marginal abatement cost is just equal to the fee. See Figure 8.1

2 Result: since all sources face the same fee, marginal abatement costs are equated across sources. Note that the regulator does not need to know the individual marginal abatement costs to achieve this least-cost solution. The results illustrates the important informational role of prices. Problem: in order to set p to implement the environmental quality target, the regulator must know how each source will respond to the fee; thus, it must know the MAC schedules. Thus, an emission fee will ensure that the aggregate level of emissions is achieved at least cost, but the regulator cannot be sure what that aggregate level of emissions will be unless it knows marginal abatement costs. An apparent solution: trial-and-error. The regulator could experiment with different emission fees until it finds the fee that achieves the desired aggregate target. Two main shortcomings with such a policy: (1) source responses to the emission charge may involve costly and irreversible changes to its activities. For example, firms may install equipment whose costs are sunk (irreversible) (2) firms may behave strategically in their response to the emissions fee if they realize that the regulator will adjust the emissions fee on the basis of how they respond. An alternative is to use emissions trading. 8.3 Tradeable Emission Permits: The Basics In the simplest form of a tradeable emission permits (TEP) scheme, the regulator issues emission permits for the target level of aggregate emissions. Example: 512 million permits each allowing 1 tonne of carbon dioxide emissions. These permits may be either auctioned, or grandfathered on the basis of historical emission levels. The chosen method of initial allocation reflects an implicit assignment of property rights: grandfathering assigns property rights to the waste to incumbent polluters; auctioning assigns property rights to the state, and reflects the same polluter pays

3 principle embodied in emission charges. The two methods also have very different revenue implications. (More on this later). The key to the TEP scheme is that allocated permits can be traded on an emissions permit market. If the market is competitive (in the sense that all buyers and sellers of permits are price-takers) then a polluter will demand demands permits up to the point where its MAC is just equal to the price of a permit. If a source is endowed with more permits than it demands at the prevailing price then it will sell permits on the market. Conversely, if a source is endowed with fewer permits than it demands then it will buy permits on the market. All sources face the same price for permits and so the price mechanism ensures that marginal abatement costs are equated across sources. Thus, emissions trading achieves the aggregate emission target at least cost. The equilibrium price of permits is determined by supply (fixed by the regulator) and aggregate demand. See Figure 8.2 Note that the TEP scheme is just the mirror image (or dual ) of the emission fee scheme. Under emission fees, the regulator sets the price of emissions and the quantity of emissions is determined endogenously. The opposite is true under the TEPs scheme: the regulator sets the aggregate quantity of emissions and the price is determined endogenously. The key advantage of the TEPs scheme over emission fees for the purposes of implementing a given target is that the regulator sets aggregate quantity directly. The target is met with certainty with minimal information requirements for the regulator. It is important to note that the initial allocation is not important for achieving the costeffective outcome.

4 Qualifications: the cost-minimizing result may not hold if an initial allocation concentrates permits in the hands of a few firms such that these firms obtain market power on the permit market if firms have imperfect and asymmetric access to capital markets. 8.4 Tradeable Permits for Non-Uniformly Mixed and Cumulative Pollutants We have so far assumed that the environmental quality target is defined simply in terms of aggregate emissions per period in the regulated area. Whether or not aggregate emissions per period are a good indicator of the damage associated with a particular pollutant depends on the physical characteristics of the pollutant and the regulated area. Pollutants are customarily classified as uniformly mixed or non-uniformly mixed, and dissipative or cumulative. Uniformly mixed pollutants become dispersed uniformly in the regulated area (eg. an airshed or water body) Examples include carbon dioxide, volatile organic compounds (VOCs), and CFCs. Non-uniformly mixed pollutants tend to pool around sources and so form hot spots within the regulated area. Examples include suspended particulates, sulphur and nitrous oxides, and biological oxygen demand. Whether a particular pollutant is uniformly or non-uniformly mixed depends on the size and physical characteristics of the regulated area (including such factors as weather patterns and current or tidal activity). A pollutant could potentially be uniformly mixed in some instances and non-uniformly mixed in others. Dissipative pollutants are those whose damaging impact is relatively short lived. They are assimilated quickly (but not so quickly as to cause no damage). The damage done by these pollutants in any given period is independent of emissions in previous periods. Examples: suspended particulates, VOCs, and sulphur and nitrous oxides. Note that dissipative pollutants can be uniformly or non-uniformly mixed. Cumulative pollutants build up in the environment over time. These pollutants are assimilated very slowly.

5 The damage done by emissions in any given period depends on the volume of emissions in previous periods. Examples include heavy metals, carbon dioxide, and CFCs. Cumulative pollutants can be uniformly or non-uniformly mixed. Note this distinction between dissipative and cumulative pollutants is somewhat artificial. Whether or not a pollutant is assimilated within a given period depends on the defined length of the period. Aggregate emissions per period is likely to be a good indicator of environmental quality in an area only for the case of uniformly mixed, dissipative pollutants. For non-uniformly mixed pollutants and cumulative pollutants it is generally necessary to set more highly specified policy targets. The TEP system needed to implement those targets are necessarily more complicated. For non-uniformly mixed pollutants: ambient permit markets For cumulative pollutants: cumulative permit markets 8.5 Potential Problems with Emissions Trading The appealing theoretical properties of a TEP scheme rely on the existence of a wellfunctioning and competitive market for permits. In practice there can be several problems: complexity and regulatory restrictions market thinness sovereign risk Complexity and regulatory restrictions Complexity and excessive regulation within the market for permits can lead to high transaction costs, which can in turn undermine the functioning of the market. Market thinness

6 A thin market (as opposed to a deep market) is one in which there are relatively few traders. There are two potentially adverse implications of market thinness: high transactions costs non-price-taking behavior. Sovereign risk Sovereign risk relates to the potential for the regulator to confiscate permits in response to new information about the damaging effect of the regulated pollutant. That is, the property rights over the permits may not be secure. This will undermine permit trading since sources will be reluctant to pay for a permit that may be confiscated in the future. 8.6 Emission Fees and Emissions Trading in Practice The US EPA Emissions Trading Program There are three main components: the bubble provision sets a standard for aggregate emissions of a particular pollutant from a plant allowing flexibility with respect to emissions from existing individual point sources within that plant. the netting provision allows firms to create a new point source at a plant if there is a compensating reduction in an existing point source at that plant. the offset provision allows new sources of a pollutant in a particular area to be offset by compensating reductions in other sources of that pollutant in that area. This provision allows for trades between firms. Recent examples include old car accelerated retirement programs. The US EPA Lead Trading Program Initiated in 1982 to minimize the cost of phasing out leaded gasoline. The key aspect of the program was permit banking, which allowed refiners who came in under the required standard in the early stages of the phase-out program to bank the difference either for later sale or for use against the tighter standards in later stages of the program. Banking allows firms to minimize the adjustment costs associated with complying with a gradual tightening of standards; it allows (discounted) marginal abatement cost to be equated over time.

7 EPA Sulfur Trading Program Initiated in 1992, this is a country-wide program designed to implement acid rain reductions. It is the largest, least restricted and most successful trading program yet established. Emission Fees in British Columbia Two part program: fixed license fee unit fees on emissions (linked loosely to toxicity) 8.7 Other Market-Based Instruments Deposit-refund schemes Traditionally and widely used on beverage containers, principally to reduce littering. A deposit is paid on the container at time of purchase and this deposit is refunded when the container is returned. A deposit-refund scheme is also used in some jurisdictions for car tires and batteries, and for used engine oil and paints. Security deposits A security is posted with the regulator prior to the conduct of an activity with which there is an associated risk of environmental damage. The security is forfeited if damage occurs; it is refunded otherwise. The purpose of the security is to elicit precautionary action from the regulated agent. Example applications: oil tankers may have to pay a security prior to entering a harbor a developer may have to pay a security on the proper functioning of a sewerage disposal system a hazardous waste transporter may have to pay a security to the jurisdictions through which the waste is being transported.

8 p MAC p eˆ ( p) e Figure 8.1

9 p $p n i= 1 e ( p) i $E E Figure 8.2