The CO2 cost pass-through in nonlinear emission trading schemes

Abstract

In this paper, we theoretically study the issues that how nonlinear structures of energy market affect CO2 costs of energy firms being passed through to energy prices in emission trading schemes. We set up oligopoly models to investigate CO2 cost pass-through under different emission right allocations, characterize analytic derivations of CO2 cost pass-through rates and then explore the connections between CO2 pass-through rates and nonlinear market structures. Our findings suggest that the CO2 cost pass-though rates are not only dependent on the elasticities of energy demand and supply, but largely determined by the convexity of demand curve and the competition intensity of energy market. More importantly, an economic curiosity (CO2 cost pass-through overshifting) is also observed in the emission trading schemes under suitable market conditions. The existence of CO2 cost pass-through overshifting provides regulators and policy makers important information that the emission trading schemes are at the risk of imperfect competition and may require further policy adjustments.