Banking tradable emission permits under upstream-downstream strategic interaction

Banking tradable emission permits under upstream-downstream strategic interaction

Joana Resende
CORE, Université catholique de Louvain
CETE,University of Porto

and

María Eugenia Sanin
CORE, Université catholique de Louvain
Chair Lhoist Berghmans in Environmental Economics and Management

Version: 15 December 2007


Summary:

In this paper, we investigate how two strategic firms’ under environmental regulation based on tradable emission permits interact, both in the permits and in the output market, and both in a static and in a dynamic context so as to study strategic banking behavior. Our main findings are (i) that the outcome in the permits market is determined by the strategic interaction in the output market (and vice versa); (ii) that a price-taking firm in the permits market can exploit the strategic linkages between the upstream and the downstream market to counterbalance the fact that she has no direct influence on the permits’ price; and (iii) that the possibility of banking reinforces the possibility of the price taking firm to counterbalance the price-setting firm’s market power. Accordingly, we derive some policy implications regarding the maximization of welfare in a context of strategic interaction.

Key Words: tradable emission permits; banking behavior; upstreamdownstreamstrategic interaction.