Allocation and Leakage in Regional Cap-And-Trade Markets for CO2

The allocation or assignment of emissions allowances is among the most con-tentious elements of the design of emissions trading systems. Policy-makers usuallytry to satisfy a range of goals through the allocation process, including easing thetransition costs for high-emissions rms, reducing leakage to unregulated regions,and mitigating the impact of the regulations on product prices such as electricity.In this paper we develop a detailed representation of the US western electricitymarket to assess the potential impacts of various allocation proposals. Severalproposals involve the \updating" of allowance allocation, where the allocation istied to the ongoing output of plants. These allocation proposals are designed withthe goals of limiting the pass-through of carbon costs to product prices, mitigat-ing leakage, and of mitigating the costs to high-emissions rms. However, someforms of allocation updating can also inate allowance prices, thereby limiting thebenets of such schemes to high emissions rms. Thus, the anticipated benetsfrom allocation updating can be diluted and further distortions introduced into thetrading system.[...]