Effects of Allowances Allocation Schemes on the Emission Leakage and Contract Shuffling in Electric Markets

This paper examines the effects of emissions allowances allocation schemes on the extent of the GHG (greenhouse gas) leakage and the contract shuffling. Two allocation methods, grandfathering and the output-based method, are considered. Whereas grandfathering separates future allowances allocation from today’s decisions, the output-based approach links the future awarded allowances to today’s output level. The latter effectively subsidizes generators’ production costs, encourages more output and consequently elevates GHG allowances prices in current period. In this paper, we first analyze the effect of output-update allocation on the leakage and shuffling using a stylized duopoly model, which abstracts from details of point-of-regulation. A single-stage computable model, which allows representing source-based, load-based and first-seller-based programs, is then applied to examine the implications. The latter model is equivalent to a two-stage formulation with perfect foresight. Our results suggest that the magnitude of GHG leakage is inversely associated with per MWh of the future allowances awarded for today’s output. The power prices under output-update approach could be either higher or lower compared to the grandfathering. Yet, the equivalence among source-, load-based and first-deliverer approaches remains valid only under certain conditions.