Borenstein, Severin, Bushnell, James, Wolak, Frank, and Zaragoza-Watkins, Matthew “Expecting the Unexpected: Emissions Uncertainty and Environmental Market Design” (Revised August 2019) (Revised version published in American Economic Review, 109(11), 3953-3977, November 2019) | WP-274R | Appendix
We study potential equilibria in California’s cap-and-trade market for greenhouse gases (GHGs) based on information available before the market started. We find large ex ante uncertainty in business-as-usual emissions and in the abatement that might result from non-market policies, much larger than the reduction that could plausibly occur in response to an allowance price within a politically acceptable range. This implies that the market price is very likely to be determined by an administrative price floor or ceiling. Similar factors seem likely to be present in other cap-and trade markets for GHGs.
This paper is a substantial revision of sections I through VI of Energy Institute at Haas Working Paper #251, “Report of the Market Simulation Group on Competitive Supply/Demand Balance in the California Allowance Market and the Potential for Market Manipulation“, July 2014.