A Note on Market Power in an Emission Permits Market with Banking

In this paper, we investigate the effect of market power on the equilibrium path of an emission permits market in which firms can bank current permits for use in later periods. In particular, we study the market equilibrium for a large (potentially dominant) firm and a competitive fringe with rational expectations. We characterize the equilibrium solution for different permits allocations. We find, for example, that if the large firm enjoys a dominant position in the after-banking market, this position gets extended to the market during the banking period regardless of the allocation of the stock (bank) of permits. ∗Liski is at the Economics Department of the Helsinki School of Economics and Montero is at the Economics Department of the Catholic University of Chile (PUC). Both authors are also Research Associates with the MIT Center for Energy and Environmental Policy Research. We thank John List, an anonymous referee and participants at a workshop held in October of 2002 at Helsinki School of Economics for comments. Montero also thanks PUC grant No. 2002/19E and Fondecyt grant No. 1030961.