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Buy coal and gas? Interfuel carbon leakage on deposit markets with market power
Abstract
Unilateral climate policies can lead to carbon leakage between countries. Deposit markets, where participants trade the right to keep fossil fuels unexploited in-situ, are a promising policy proposal to prevent leakage. For a single fossil fuel, deposit markets can only restore efficiency if there is no market power on the deposit market. With multiple fuels, however, multiple (interdependent) deposit markets could give rise to additional market power. We thus study deposit markets with market power and multiple fuels, and focus on comparing second-best policies. In contrast to a setting with a single fuel, more complex carbon leakage channels between both, countries and fuels, arise. Such effects can even hinder deposit markets covering all fuels from being implemented. At the same time, we identify conditions where deposit markets induce countries without emission reduction incentives to supply a cleaner fuel mix. Regarding the political economy, deposit markets covering all fuels can improve each country’s welfare compared to those covering only one fuel. Deposit markets which cover only a single fuel or multiple fuels rank differently in terms of consumer and producer rents. These welfare rankings can have highly relevant implications for policy-making. Even with market power, deposit markets covering multiple fuels can Pareto-dominate a situation with unilateral, domestic policies.
This paper examines the effects of political pressure groups (lobbies) on transboundary emissions of individual countries and on the stability of international environmental agreements to reduce emissions. We consider two types of lobbies, industry and environmentalists, and we allow for asymmetric countries to consider differences in lobby strengths to study strategic international spillovers of national lobby activities. In our model, lobby groups in countries that are non-signatories to the agreement will impact abatement of the lobby’s home country only. In contrast, lobby activities in signatory countries have spillover effects on the abatement decisions of other member countries. As lobby strength impacts abatement, it will, in turn, impact the incentives to participate in the agreement. We find that lobby activities from both lobby groups, industry and environmentalists, can have the potential to facilitate international cooperation to abate global pollution. This, however, depends on the distribution of lobby activities across countries and on whether green lobby groups have a national or international focus.
Coalition formation is often analysed in an almost non-cooperative way, as a two-stage game that consists of a first stage comprising membership actions and a second stage with physical actions, such as the provision of a public good. We formalised this widely used approach for the case where actions are simultaneous in each stage. Herein, we give special attention to the case of a symmetric physical game. Various theoretical results, in particular, for cartel games, are provided. As they are crucial, recent results on the uniqueness of coalitional equilibria of Cournot-like physical games are reconsidered. Various concrete examples are included. Finally, we discuss research strategies to obtain results about equilibrium coalition structures with abstract physical games in terms of qualitative properties of their primitives.
In this article, we propose a sequential Nash bargaining solution and apply it to a dynamic bargaining game on exhaustible-resource extraction. The government and two agents bargain via the asymmetric Nash bargaining solution. Should the trilateral negotiation fail, the government chooses one agent for a bilateral negotiation. In this negotiation, the disagreement point is to bargain with the other agent. Finally, should this second bilateral negotiation break down, the government chooses the welfare maximizing policy. In our dynamic bargaining game, the environmental organization is willing to pay for less extraction, because of stock-pollution effects, while the extraction firm is willing to pay for extraction per se. The government dislikes extraction, because of flow-pollution effects, but is willing to accept some if it is paid for it. It turns out that the disagreement point in the trilateral negotiation is always to bargain with the environmental organization. This is because there is no conflict of interest between the government and the environmental organization concerning extraction. However, as long as stock pollution is still low, it might be optimal for the environmental organization to let this bilateral negotiation break down. We demonstrate how these considerations shape the payments in case of agreement and disagreement, in total and over time.
A well-known theorem by Herfindahl states that the low-cost nonrenewable resource must be exploited first. Consider resources that are differentiated only by their pollution content. For instance, both coal and natural gas are used to generate electricity, yet coal is more polluting. We show that the ordering of extraction need not be driven by whether a resource is clean or dirty. Coal may be used first, followed by natural gas, and again by coal. Such "vacillation" does not occur under cost heterogeneity. A perverse policy implication is that regulating pollution may accelerate use of the polluting resource.
Does climate change adaptation require that investments are designed to be more robust? What about when climate change is more uncertain? What if the climate changes faster? This decision problem is difficult if the design of the investments is irreversible for their lifetime, for instance, in the construction industry. We study an irreversible design decision when the investment starts, combined with an irreversible option to abandon. The design determines the investment’s robustness to sustain detrimental conditions. We find that for short-lived investments, optimal robustness decreases if the climate changes faster, and increases if uncertainty is higher. For long-lived investments, these effects reverse. This has implications for decision makers who plan infrastructure adaptation, for instance, that adverse climate change does not require more robust investments under the identified circumstances.
When multiple power plants are curtailed at the same time and in the same region, electricity system costs rise. If transmission lines are congested, these costs might be amplified and spatially more concentrated, because there are less spatial spill-overs. We study how such costs and their distribution depend on the market design (nodal pricing or uniform pricing). We extend the literature on curtailment by considering space and market design, and the literature on market design by considering curtailment. We expose a DC load-flow model for Germany to severe correlated curtailment scenarios. We find that additional costs are moderate. For the simulated week, curtailment of 9.3% non-renewable capacity reduces welfare by 2.7% (uniform pricing). With nodal pricing, welfare loss can be reduced by 1.5%. Distributional differences are multiple times larger. For nodal pricing, producer surplus rises more, and costs are spatially more concentrated at the curtailed power plants. Consumer surplus becomes lower. The difference is unlikely to justify changes of the current market design. If also wind or photovoltaic feed-in is unavailable, economic impacts can decrease or increase, but remain in the same order of magnitude. The spatial electricity system structure matters more than the volume of curtailment.
The policy of purchasing fossil fuel deposits for preservation is an alternative to the demand‐side climate policies that predominate in practice and in professional studies. This paper analyzes the deposit purchase approach and compares it to the standard demand‐side policy in a model with international trade and non‐cooperative governments that account for the effects of their policies on equilibrium prices. We investigate how the two regimes differ with respect to their equilibrium allocations and, in particular, with respect to the countries’ mitigation effort and welfare. If countries are symmetric, mitigation is stronger in the demand‐side than in the supply‐side regime and the transition from the latter to the former is welfare enhancing for all countries. If countries have different endowments of deposits in a two‐country economy, the country with higher extraction costs does not purchase deposits for preservation, and the country with lower extraction costs is better off with the supply‐side than with the demand‐side policy. Finally, we consider the case of combined policies and find surprisingly that no equilibrium in pure strategies exists, when heterogeneous countries apply both policy instruments.
In a two‐period model with two groups of countries that extract, trade, and consume fossil fuel, a climate coalition fights against climate change by purchasing or leasing deposits to prevent their extraction, and seeks to manipulate the fuel prices in its favor. The policy of purchasing deposits is inefficient because it leaves the first‐period climate externality non‐internalized. By contrast, the deposit‐lease policy turns out to be efficient if it eliminates strategic action in the fuel markets. In an empirically calibrated economy, the coalition's welfare and total welfare are greater at the deposit‐lease policy than at the deposit‐purchase policy if the discount rate is smaller than 2.7% p.a. This article is protected by copyright. All rights reserved.
The Paris Agreement can be strengthened by a treaty limiting global fossil fuel supply
We investigate whether global cooperation on emissions abatement can be improved if asymmetric countries agree to sign one out of several environmental agreements. The analysis is based on a two-stage game theoretical model. Conditions for stable coalitions and the resulting global emissions are determined. We allow for multiple coalitions with all countries being different, and analyze the effects in the cases of increasing marginal damages from emissions and of decreasing marginal benefits of emissions. We find that in the case of decreasing marginal benefits and constant marginal damages, admitting multiple coalitions increases the number of cooperating countries and reduces emissions (compared to the standard case with a single coalition). For increasing marginal damages and constant marginal benefits, however, multiple stable coalitions cannot coexist. If both damages and benefits are nonlinear, admitting multiple coalitions can decrease emissions. The paper thus contributes to the emerging discussion on the scope and limits of climate clubs.
We consider a climate coalition that seeks to reduce global emissions in the presence of carbon leakage and resource exhaustibility. We show that a credible announcement of future unilateral supply‐side policies delays foreign emissions, and we derive the optimal combination of consumer taxes and producer taxes when leakages from free riders, both within periods and across periods, are considered. The tax shares generally differ over time. A decline in the present value of the social cost of carbon over time supports a time path where the consumer tax's share of the total carbon tax also declines over time. We illustrate our findings with a numerical model.
This article is protected by copyright. All rights reserved.
A coalition of given size fights climate change by a policy of purchasing fossil fuel deposits, and it seeks to manipulate the fuel price in its favor. Assuming that non-signatories are price takers in the fuel market, Harstad (2012) designs a policy of trading deposits that attains efficiency despite the coalition’s option to act strategically in the fuel market. The deposit transactions constituting that policy include the trade of deposits which the non-signatories would have exploited and the coalition will exploit. The present paper shows that in a proper subset of economies a simpler policy is (also) efficient that consists of deposit purchases for preservation only. In these economies the coalition is unable to raise its welfare above the level in the benchmark case of fuel price taking. In the economies, where the efficient policy requires deposit transactions for exploitation, the coalition is better off and the non-signatories are worse off than in case of price taking.
The literature on self-enforcing environmental agreements (SIEAs) focuses on de- mand-side emission-reduction policies. To our knowledge, Harstad (2012) is the only study on SIEAs, in which countries purchase fossil-energy deposits to prevent their exploitation. He finds that for any coalition size there exists a (small) subset of parameters, different for each size, such that the coalition of that size is stable. However, the comparison of Harstad's results with the prevailing demand-side SIEA analyses is hampered by major differences in the structure of the respective game models. This paper develops a game model with a deposit market and deposit purchases for preservation that is in line with some demand-side SIEA literature. It turns out that either no coalition is stable or the grand coalition is the only stable coalition. We compare the outcome of our model not only with Harstad's model but also with Eichner and Pethig's (2015) model of the formation of SIEAs in which climate policy takes the form of (demand-side) emissions taxes.
Keeping temperature change below 2° C will require leaving large reserves of fossil fuels unextracted. We assess alternative policies to achieve this goal in a world divided into two regions, one regulated with emissions pricing and one unregulated, supplied by multiple resource pools with different extraction costs and a carbon-free backstop whose costs decline over time. Global emissions can be reduced by combinations of three policies: (1) increasing the size of the regulated coalition, (2) raising the tax (or tightening the cap) within the regulated coalition, and (3) accelerating cost reductions of the clean technology. We ask how combinations achieving the same cumulative CO2 emissions (the “carbon budget”) affect the discounted surplus of regulated and unregulated consumers and the wealth of the extractors. We first evaluate these policy alternatives in a two-pool, theoretical model with high and low-cost extractors and, once tradeoffs are illuminated, in a calibrated oil market model. A global CO2 tax is both cost-effective and the best policy for regulated consumers. Extractors and unregulated consumers, however, prefer a technology-only policy. When the regulating coalition is subglobal, support for the clean substitute is desired and often required. But the preferred policy portfolio of the coalition involves a tighter cap and less technology policy than is globally optimal, leaving room for bargaining over who pays for clean innovation.
A coalition of given size fights climate change by a policy of purchasing fossil
fuel deposits, and it seeks to manipulate the fuel price in its favor. Assuming
that non-signatories are price takers in the fuel market, Harstad (2012) designs
a policy of trading deposits that attains efficiency despite the coalition’s option
to act strategically in the fuel market. The deposit transactions constituting that
policy include the trade of deposits which the non-signatories would have exploited
and the coalition will exploit. The present paper shows that in a proper subset of
economies a simpler policy is (also) efficient that consists of deposit purchases for
preservation only. In these economies the coalition is unable to raise its welfare
above the level in the benchmark case of fuel price taking. In the economies, where
the efficient policy requires deposit transactions for exploitation, the coalition is
better off and the non-signatories are worse off than in case of price taking.
This paper reviews the game-theoretic literature on collaborative environmental management. It begins with a survey of static models of international environmental agreements (IEAs), comparing their underlying assumptions and their results. Extensions of the basic model to allow for both adaptation and mitigation, and for transfer payments are considered. We review the various concepts of coalitional stability, such as internal and external stability and far-sighted stability in the noncooperative strand, and the gamma core concept in the cooperative strand. The network approach to cooperation building is reviewed. We next survey extensions of IEA theory to dynamic models with stock pollutants, allowing membership status to change over time. Finally, dynamic cooperative games of pollution with transfer payments that take place over time are discussed.
This paper presents a distributional argument for the use of supply-side climate policies whereby carbon emissions are controlled through (i) depletion quotas or (ii) permanent confiscation of a fraction of the in situ carbon stocks. The modeling considers intertemporal competitive equilibria in the Cobb-Douglas version of the Dasgupta-Heal-Solow-Stiglitz model of capital accumulation and costless resource extraction. It is shown how policies (i) and (ii) preserve the functional distribution of income between capital owners and resource owners, compared to the case where no climate policy is needed, while suggested demand-side policies do not. Such observations are of interest as avoiding functional redistribution may facilitate climate change negotiations. The paper discusses policy implications of the analysis outside the simplified setting of the stylized model.
Carbon dioxide emissions correspond to fossil resource use. When considering this supply side of climate protection, crucial questions come to fore. It seems likely that owners of fossil resources would object to emission reductions. Moreover, policy instruments such as taxes may not be effective at all: it seems individually rational to leave no fossil resources unused. In this context, it can be expected that economic sectors will react strategically to climate policy, aiming at a re-distribution of rents.To address these questions, we investigate the effectiveness, efficiency, and resource rents for energy taxes, resource taxes, and quantity rationing of emissions. The analysis is based on a game theoretic growth model with explicit factor markets and policy instruments. Market equilibrium depends on a government that acts as a Stackelberg leader with a climate protection goal. We find that resource taxes and quantity rationing achieve this objective efficiently, energy taxation is only second-best. The use of quantity rationing to achieve climate protection generates substantial rents for resource owners.
In global environmental problems, each country's own contribution to worldwide emissions is small, so there is little a country can do by itself. To solve global environmental problems one needs coordinated actions between countries. Environmental groups often advocate that in spite of the global character of the problem, a country ought to take unilateral actions to reduce its environmentally harmful emissions. The argument for such unilateral actions is that they at least give a contribution in the right direction (however small), and also that by “setting a good example” of this type one might affect the behavior of other countries, and/or improve the chances of reaching international agreements of coordinated reductions of harmful emissions. The paper gives an analysis of the consequences of unilateral reductions of harmful emissions. It is shown that such a policy will generally affect the outcome of international negotiations about reduced emissions. The outcome of such negotiations may very well imply higher total emissions when one country reduces its emissions unilaterally than if both countries act selfishly.
As a first step toward a global treaty to control CO2 emissions, individual countries contemplate unilateral reductions in their fuel use. Such actions, if significant, would reduce world-market fuel prices, thereby stimulating fuel use elsewhere and causing problems for exporting countries, possibly jeopardizing this policy initiative. Among the policy alternatives for mitigating the price effects of reduced demand, reduced fuel consumption combined with buying or leasing fuel deposits to achieve a reduced supply is discussed in particular. This policy, which at first seems prohibitively costly, is shown to dominate the original policy approach under a fairly wide set of circumstances.
This paper considers whether international environmental public goods provision, such as mitigation of climate change, is better dealt with through regional cooperation than through a global treaty. Previous research suggests that, at best, a global environmental treaty will achieve very little. At worst, it will fail to enter into force. Using a simple dynamic game-theoretic model, with weakly renegotiation-proof equilibrium as solution concept, we demonstrate that two agreements can sustain a larger number of cooperating parties than a single global treaty. The model provides upper and lower bounds on the number of parties under each type of regime. It is shown that a regime with two agreements can Pareto dominate a regime based on a single global treaty. We conclude that regional cooperation might be a good alternative–or supplement–to global environmental agreements.
This paper analyzes a model of duopoly with fixed costs. Leadership by one "established" firm may yield an outcome in which the second is inactive, but entry prevention is not a prior constraint. We find that two aspects of product differentiation have distinct effects: an absolute advantage in demand for the established firm makes entry harder, but a lower cross-price effect facilitates it. In the basic model we maintain the same quantity after entry. An extension of the model deals with the case where the threat of a predatory output increase after entry is made credible by carrying excess capacity prior to entry.
If all countries participate in a climate agreement, policies affecting the supply of fossil fuels have identical economic consequences as policies affecting the demand of fossil fuels. This is no longer true when there is limited participation in an international agreement. In the paper, it is assumed that a group of countries commit themselves to cooperating, while the remaining countries act independently and in pure self-interest. The paper compares supply and demand policies in this context and demonstrates that policies which affect only demand or only supply of carbon generally are inferior to policies affecting both demand and supply of carbon. The optimal mix of supply and demand policies is derived in the paper, with particular emphasis on carbon taxes. An important result is that if the marginal environmental costs of total emissions are sufficiently high (in the cooperating countries), then both production and consumption of carbon should be taxed at a positive rate. If on the other hand the marginal environmental costs of total emissions are sufficiently low, it may be optimal to subsidize production or consumption. In this case, production should be subsidized if the cooperating countries are net importers of carbon, while consumption should be subsidized if the cooperating countries are net exporters of carbon. Another important conclusion of the paper is that the cooperating countries should try to induce the non-cooperating countries, through appropriate transfers, to tax consumption and production of carbon at the same rate as in the cooperating countries. (C) 1994 Academic Press, Inc.
A recursively dynamic general equilibrium model featuring six world regions with trade in energy and non-energy goods is used to simulate the period from 1990 through 2100 in 10-year intervals. The simulations explore the effect of unilateral action by the OECD to curb global CO2 emissions. Unilateral cuts create incentives for free-riding by non-participating regions, so that global emissions are reduced by less than the amount that the OECD cuts back its regional emissions. Carbon "leakage" occurs through two channels. First, basic materials production increases in unconstrained regions, resulting in increased carbon intensity of GDP. Second, reductions in OECD oil imports cause the world oil price to fall, leading to an increased energy intensity in the non-participant regions. In this paper, we use a general equilibrium model to assess the extent to which these two mechanisms reduce the effectiveness of OECD reductions in curbing global CO2 concentrations.
We study the optimal design of a carbon tax when a group of countries seeks to maximize its net income minus its environmental costs, which depend on the sum of CO2 emissions from all countries. When both production and consumption of internationally traded fossil fuels are taxed, a particular combination of producer and consumer taxes exists which is optimal. It is also shown that with this tax the sum of the consumer tax and producer tax should be equal across all fossil fuels per unit of carbon. On the other hand, when the cooperating countries use a tax on consumption (or production) of fossil fuels as the only policy instrument, the tax per unit of carbon should in general be differentiated across fossil fuels. We close the paper by giving an empirical illustration of the theoretical analysis, assuming that the cooperating countries are those of the OECD.
Optimal emission pricing in the presence of international spillovers: Decomposing leakage and terms-of-trade motives
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Designing long-lived investments under uncertain and ongoing change
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Buy coal! A case for supply-side environmental policy
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