Intertemporal Links in Cap-and Trade Schemes

I study the effects of intertemporal emission permits trading in a cap-and-trade scheme when firms' abatement investments have long-term effects. In a two-period general equilibrium model, firms make trading and investment decisions in each period to meet their caps. I compare equilibrium abatement levels and permit prices, with and without intertemporal trading. Intertemporal trading may reduce total abatement investments over the scheme. Without intertemporal trading, some investments in period 1 are entirely driven by second-period abatement needs; in this case, intertemporal trading may reduce investments in period 1 as some are substituted by intertemporal permit trading. Descriptive evidence from the EU Emissions Trading System (ETS) illustrates this potential effect. I also show that if the number of permits issued by the regulator is not equal to the socially optimal level of emissions, then banning intertemporal trading may reduce the social cost thanks to the long-term properties of investments.