Market Power in International Emission Trading - the Impacts of U.S. Withdrawal from the Kyoto Protocol

This paper investigates the implications of U.S. withdrawal from the Kyoto Protocol on environmental effectiveness, economic efficiency, and the distribution of compliance costs for remaining Annex-B countries taking into consideration the monopoly power by the Former Soviet Union (FSU) on international emission permit markets. Based on a multi-region partial equilibrium framework of marginal carbon abatement cost curves, we find that U.S. withdrawal considerably alters the environmental and economic implications of FSU market power in permit trade. Under U.S. compliance, monopolistic permit by FSU has no impact on environmental effectiveness as compared to a competitive trading system. Aggregate emissions of Annex-B regions fall by 10% below business-as-usual emission levels. Excess costs of market power amount to 40% of total compliance costs under competitive permit markets. Under U.S. withdrawal, monopolistic permit supply on behalf of the Former Soviet Union will assure some environmental effects of the Kyoto Protocol, with aggregate Annex-B emissions (including U.S.) falling by 3% vis-a-vis the business-as-usual emission level. For competitive permit trade, environmental effectiveness would be reduced to zero since the U.S. withdrawal implies an excess supply of permits driving permit prices down to zero. Efficiency losses from monopoly behavior by FSU under U.S. withdrawal double total compliance costs compared to a competitive permit market system which achieves the same environmental target. Given FSU monopoly power, U.S. withdrawal provides some cost reduction to complying non-U.S. OECD countries because reduced overall permit demand drives down the permit price. On the other hand, FSU and its competitive fringe EEC must bear a larger decline in revenues from permit sales