Tuesday, November 20, 2007

Cap-and-Trade: On hoarders, speculators and do-gooders

Common Tragedies has a good post on some of the things to be avoided in the design of a C & T plan and/or practical ideas for gaming the system.

....Yet with that being said, there is one difference between the two that has a lot of insiders/bureaucrats worried, but that hasn’t been discussed all that much in the blogosphere to date: the potential for manipulation of carbon permits. I’ll discuss some of the potential threats, real and imagined, below the fold.

* Disclaimer - this post mainly applies to the electricity sector

** Thanks to Anthony Paul for explaining most of this stuff to me.


As California and the RGGI states forge ahead with their plans to cap carbon, insiders and interested parties have become increasingly concerned about possibility of hoarding. When permits are eventually auctioned off, some fear that large generators or colluding groups of generators could buy up large shares of permits in order to drive up the electricity price and increase profits. Some very preliminary analysis at RFF reveals that this threat is in fact plausible. There is essentially only one price for electricity in a given market at a given point in time, which all generators receive. Thus, for a clean (i.e. low carbon emitting) generator, an increase in the price of carbon permits increases revenues without affecting costs. Under certain circumstances, for certain firms, this increase in revenue more than offsets the price of buying up and sitting on unnecessary permits.

What makes hoarding truly problematic is the fact that it would be very difficult to detect or punish. This is because most cap-and-trade systems allow banking. So even if a regulator observed a generator buying up and not using permits, it would be very hard to prove that it was doing this in an attempt to drive up the price, as opposed to simply preparing for future cap restrictions....MORE