Modeling intertemporal trading and management of emission permits in greenhouse gas emission trading systems

Abstract

Emission trading systems are an efficient solution for governments to guarantee the output emissions level of industry sectors. In the present study we form a theoretical model to describe complex relations between participant firms. Our modeling includes all of the EU ETS rules and considers a realistic form of competition (excess of market power from leader companies) between firms on the permit market, while letting them to interact in the output market.

We come up with a system of equilibrium equations and a price function. These equations indicate that the leaders play a central role for the system. By manipulating the price, they force the followers to avoid abatement and buy all the permits they need, while the environmental outcome depends completely from their abatement level. They can also transfer their market power across the two markets (permit and output markets) and gain more profit. As for the price, we show that it is in the form of the marginal abatement cost of the followers, it depends from the followers' business as usual emissions, it is positively correlated with the total amount of banking and negatively correlated with the overall initial period allocation.

We then run some simulations on our mathematical model which provide us with great information. We show that an increase in banking lead to better system functionality in the present, normalizes the price in the future, but makes the system more unstable in future exogenous turmoils. Additionally, under a cap reduction the system is more stable for greater abatement levels, while for a cap rise it works better under small abatement levels. We also find that under specified abatement levels the emissions variate analogously to the output product variation, while for smaller abatement levels, the price is more prone to an output product change. Finally, an interesting result is that the excess of market power from the leaders raise the overall emissions.