Allocation and leakage in regional cap-and-trade markets for CO2

The allocation or assignment of the emissions permits is one of the most contentious elements of the design of cap-and-trade systems In this paper we develop a detailed representation of the U.S. western electricity market to assess the potential impacts of various permit allocation proposals. Several proposals involve the “updating” of allocations, where the allocation is tied to the ongoing output, or input use, of plants. These allocation proposals are designed with the goals of limiting the pass-through of carbon costs to product prices, mitigating leakage, and of mitigating the costs to high-emissions firms. However, allocation updating can also inflate permit prices, thereby limiting the benefits of such schemes to high emissions firms.

► We model a cap and trade market for CO2 in the western U.S. ► We measure extent of emissions leakage from caps that cover only part of the market. ► We test the impact of alternative allocation policies on leakage, prices, and profits.