Assessment of initial emission allowance allocation methods in the Korean electricity market

Korea will introduce an emission trading policy from 2015. The rules for the initial allocation of emission allowances have not been decided yet. This paper assesses the effect of various initial emission allowance allocation methods of the Korean electricity market. This study employs the mixed complementarity problem, which is able to incorporate operation, investment, and emission trade decisions in the deregulated electricity market in order to provide more realistic results. In particular, the allocation rules to existing plants and new entrants are modeled separately in this study. The model quantifies the impacts of different allocation rules on emissions, capacity mix, emission allowance prices, electricity prices, and social welfare. We examine typical allocation rules such as auction to all power plants, best available technology (BAT) benchmark to all power plants, fuel-specific benchmark to existing power plants along with BAT benchmark to new entrants, and fuel-specific benchmark to all power plants. We find that giving free allocations to new power plants prompts more new investment and this raises overall social welfare even though the direct cost of achieving the emission reduction target rises. While the auction is the most powerful policy to reduce emissions in the electricity sector, giving away permits to all power plants based on a fuel-specific benchmark encourages investment, increases output, and leads to a greater level of welfare from an imperfectly competitive industry.