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Counterpart Choice in Emission Markets: Beyond Pollution Abatement Motives

This paper examines the determinants of electricity generator's trading strategies in the U.S. Acid Rain Market. Model estimates show that the SO2 allowances market is de facto regionalized due to the regionalization of the electricity market. The national dimension only appears when there are local imbalances in the electricity market that give strong incentives to search for a better deal outside of the generator's regional market. We also identify the importance of counterpart differentiation and the influence on the counterpart choice of the regulatory framework, market evolution and transaction size. These findings are shown to be robust to Enron's abnormal behavior during 2000-2001 and its subsequent bankruptcy. The results suggest that, contrary to received knowledge, abatement costs are not the only consideration when trading pollution allowances: market microstructure can play a crucial role.

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Energy Specializations: Electricity – Markets and Prices ; Energy and the Environment – Other Pollution ; Energy and the Economy – Other

JEL Codes: Q58: Environmental Economics: Government Policy, Q41: Energy: Demand and Supply; Prices, Q42: Alternative Energy Sources, Q53: Air Pollution; Water Pollution; Noise; Hazardous Waste; Solid Waste; Recycling, F18: Trade and Environment

Keywords: tradable emission permits, counterpart choice, acid rain market

DOI: 10.5547/01956574.39.SI2.msan

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Published in Volume 39, Special Issue 2 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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