Emission trading with absolute and intensity caps

Abstract

The Kyoto Protocol introduced emission trading to help reduce the cost of compliances for the Annex B countries that have absolute caps. However, we need to expand the emission trading to cover developing countries in order to achieve the maximum benefits from both higher environment quality and lower abatement cost. In this sense, the emission trading scheme at a global level in the future needs to consider the inclusion of countries with intensity caps as well as with absolute caps, since many countries, including developing countries and the United States, are interested in intensity caps. In this thesis, we aim to address the issue of two different emission cap-setting methods, absolute and intensity caps, under international emission trading; How would the changes in BAU emission levels and GDP affect the market-clearing price, total cost, and costs for the affected countries? What would be the differences in the price and costs when a country with an intensity cap is the trading partner instead of one with an absolute cap? A two-country mathematical model is developed to answer these questions. The model analysis shows that there are complex interactions among the elasticities of price and costs in response to the changes in emissions and GDP of the affected countries. For the same emission size countries, the BAU condition changes of a country have greater impacts on the own cost changes than the changes of the trading partner do. For the different size emission countries, the relative size of emissions of the countries is the key factor to determine the total cost and its distribution to each country. The changes of the bigger emission country tend to dominate the trading system in terms of price and costs. Generally, we can conclude that selection of proper caps should be made considering the relative size of emissions and commitment levels of the affected countries, their marginal coefficients and own characteristics of correlation between GDP and emissions.