News Release

Cap and trade policies limiting CO2 can increase value of some electricity generating firms

Granting free allowances to compensate firms can be costly

Peer-Reviewed Publication

Wiley

Washington, D.C. – December 17, 2008 – A new study in the Journal of Policy Analysis and Management explores ways to target the compensation provided by the free allocation of emission allowances under a CO2 cap and trade policy in order to avoid overcompensation of firms that already are benefiting from the program.

In most prior cap and trade programs, emission allowances have been given away for free to pollution emitting firms as a way to compensate them for the costs imposed by the policy. In the case of a CO2 cap and trade program affecting the electricity sector, some firms actually profit from the policy and others lose. Consumers as a group will lose in the sense that they will see increases in electricity prices.

A cap and trade policy that limits emissions of CO2 can increase the value of some electricity generating firms. Free distribution of just 6 percent of the total allowances would be sufficient to compensate shareholders for the loss in market value on an industry-wide basis.

However, granting free allowances to compensate firms for their losses under a cap and trade policy can be costly. It is difficult to compensate losers without also compensating undeserving parties. The researchers find that compensating firms for the last $2.6 billion in losses at the federal level imposes a cost of roughly $25 billion.

"Climate policy promises to be more costly than all prior air pollution policies. The use of a cap and trade approach will help to keep the costs low, but it will impose costs on various sectors of the economy," the authors note. "Information about how to deliver compensation in a cost-effective manner could help to increase the political acceptability of climate policy and help preserve a larger share of allowance value that might be used in ways that lower the costs of compliance with the program and, thereby lower the economic impact of the policy."

Dallas Burtraw, Ph.D., and Karen Palmer, Ph.D., both of Resources for the Future, utilized a detailed simulation model of the electricity sector to quantify the effects of different allocation approaches on asset values for electricity generators.

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This study is published in the Fall 2008 issue of the Journal of Policy Analysis and Management. Media wishing to receive a PDF of this article may contact journalnews@bos.blackwellpublishing.net.

Dallas Burtraw is affiliated with Resources for the Future and can be reached for questions at Burtraw@rff.org.

The Journal of Policy Analysis and Management encompasses issues and practices in policy analysis and public management. Listed among the contributors are economists, public managers, and operations researchers. Featured regularly are book reviews and a department devoted to discussing ideas and issues of importance to practitioners, researchers, and academics.

Wiley-Blackwell was formed in February 2007 as a result of the acquisition of Blackwell Publishing Ltd. by John Wiley & Sons, Inc., and its merger with Wiley's Scientific, Technical, and Medical business. Together, the companies have created a global publishing business with deep strength in every major academic and professional field. Wiley-Blackwell publishes approximately 1,400 scholarly peer-reviewed journals and an extensive collection of books with global appeal. For more information on Wiley-Blackwell, please visit www.wiley-blackwell.com or http://interscience.wiley.com.


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