An emissions trading scheme design for power industries facing price regulation

The electricity market, monopolistic in nature, with government price regulation, poses a serious challenge for policy makers with respect to the cost-effectiveness of emissions trading, particularly in Asian countries. This paper argues that a cap-and-trade regulatory system for indirect emissions combined with a rate-based allocation system for direct emissions can achieve market efficiency even in the presence of price and quantity controls in the electricity market. This particular policy mix could provide appropriate incentives for industries to reduce their electricity consumption while inducing power producers to reduce their direct carbon emissions cost-effectively in conditions where there is strict government control of electricity prices. Another advantage of the suggested policy mix is that it allows carbon leakage in cross-border power trades to be effectively eliminated. - Highlights: • A rate-based allocation induces power producers to minimize direct emissions. • A cap-and-trade on indirect emission induces firms to reduce electricity consumption. • These two can jointly achieve market efficiency even in the regulated power market