Climate Policy

Climate Policy 6 (2006) 477–493

Research Article

Simple rules for targeting CO2 allowance allocations to compensate firms

Karen Palmer, Dallas Burtraw and Kahn Danny

Policies to cap emissions of carbon dioxide (CO₂), such as the recently announced agreement among the northeastern states of the USA, are expected to have important effects on the electricity industry and on the market value of firms that own electricity generation assets. A study of the economics literature reveals potentially large efficiency advantages for initial distribution of tradable emissions allowances through an auction and direction of allowance value to public purposes. However, an auction raises the costs for the regulated firms. This article identifies rules for free distribution of a portion of the allowances that satisfy a compensation goal for firms while maximizing the value of allowances that can be directed to public purposes. The article employs a detailed simulation model to calculate numerical results for the market value of generation assets under the CO₂ cap-and-trade programme in the northeastern USA.

Keywords: Emissions trading; Allowance allocations; Electricity; Auction; Grandfathering; Asset value

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