An empirical analysis of the CO2 shadow price in Chinese thermal power enterprises

- Inefficiency and shadow price of CO2 for Chinese power enterprise are evaluated.
- The shadow price is sensitive to the choice of directional vector.
- Firm size, age, fuel mix and technology level are significantly correlated to the shadow price.
- The great variation of shadow price calls for a cost-effective instrument.

This paper estimates the shadow price of CO2 and explores its determinants for thermal power enterprises in China. Using a parametric quadratic directional distance function, we evaluate the inefficiency and shadow price of CO2 for 124 power enterprises in 2004, applying deterministic and econometric methods. A regression analysis is undertaken to examine the factors that drive shadow prices. Our results indicate that there are large inefficiencies in terms of electricity production and CO2 emissions. The shadow price is a negative function of firm size, age, and coal share, and is positively correlated with the technology level. This correlation between shadow prices and its determinants is not sensitive to changing assumptions regarding directional vectors, although such changes do alter the distribution of shadow prices. The large variation witnessed in shadow prices across power enterprises argues in favor of market-based regulation such as an emissions trading system as opposed to the command-and-control regulation currently used in China to minimize overall abatement cost.