Updating allowance allocations in cap-and-trade: Evidence from the NOx Budget Program

Abstract

The level and distribution of the costs of tradable allowance schemes are important determinants of whether the regulation is enacted. Theoretical and simulation models have shown that updating allowance allocations based on firm emissions or output can improve the efficiency of the scheme by acting as a production subsidy. Using the U.S. NOx Budget Program as a case study, this analysis tests whether electricity generators in states which chose an updating allocation increase their electricity production relative to plants in states that chose a fixed allocation. Econometric results provide evidence that updating allocations lead to an increase in generation for natural gas combined cycle generators, but not for coal generators. This effect is concentrated in low-demand overnight hours and varies both by the local mixture of coal and NGCC generators and by percentile. These findings imply that an updating allocation confers a modest but meaningful subsidy to production relative to a fixed allocation and that firm responses are heterogeneous based on production technology and market conditions.