Investigating the Effects of Introducing Emission Trading Scheme To Shipping Industry -- Common vs. Marine Only Schemes

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Investigating the Effects of Introducing Emission

Trading Scheme To Shipping Industry

-- Common vs. Marine Only Schemes

IFSPA Conference, June 2013

Kun Wang

The Hong Kong Polytechnic University

Xiaowen Fu

ITLS, University of Sydney

Meifeng Luo

The Hong Kong Polytechnic University

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Background

• According to International Maritime Organization (IMO), international shipping produced 870 million tons of CO2 in year 2007, or 2.7% of global emission.

• Various emission / pollution control schemes have been introduced, covering issues such as port operations, ship standards (e.g. Energy Efficiency Design Index).

• EU ETS is the largest Market-based Measures (MBM).

– Inclusion of maritime industry was expected in 2013,

– But attempt on non-EU airlines short-lived due to strong resistance from foreign airlines (and their government)

• ETS

still a good option (Kageson 2007, Miola et al. 2011)

– Fuel tax may trigger tax evasion.

– Port dues and operational standards complicated by inter-port competition (Homsombat et al. 2012). Larger shipping firms may negotiate a better deal.

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The Emission Literature

Studies on EU ETS

– Adverse impacts due to additional cost associated (Bode 2006). – Empirical study on European iron and steel industry by

Demailly and Quirion (2006) found little effect.

– May benefit industries due to “windfall profit” associated with grandfathered free allowance (Sijm et al. 2006, Smale et al. 2006, Veith et al. 2009, Oberndorfer 2009, Kim et al. 2009).

– Study on Electricity industry by Mo et al. (2012) concludes it depends on factors such as allocation policy of free allowance, and market structure.

A lot of studies simulate the effects of fuel tax. Few

economic investigations considered following issues and

factors:

– Traffic volume and profit of shipping companies / carriers. – The effects of competition among carriers

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Issues to Investigate

Open/Common ETS or Closed ETS

Which is better if we want to achieve certain

emission reduction objective?

Which has less impact to the shipping industry?

Which has less impact on the international trade?

Shipping industry is not homogeneous

Compared with bulk sector, containerships are on

average newer, more expansive, faster, more energy

efficient; its market is more colluded; it carries more

valuable cargo; and receives higher freight rates.

What is the impact of ETS to different sectors?

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Steps to analyze the problem

Simplified two sector shipping markets with separated

demand, shipping distance, ship energy attributes;

Shipping companies in both sectors maximize their

profits.

Benchmark case: no emission reduction

objective

Open ETS: what is the impact of an exogenous

permit price?

Closed ETS: if trade is only allowed in the

maritime sector, what is the impact of the

emission reduction objective?

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The Economic Model -1

Symmetry shipping firms in Group 1 container carrier

and Group 2 bulk Carrier . Demand for each group is

Average shipping time

With fuel price and fuel efficiency level , fuel cost

of a firm

i

in group

r

A carrier maximizes its profit:

• Ship capital cost ; average ship size U; Capital utilization rate ρ;

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The Economic Model-2

Define a firm’s conduct parameter as

Bertrand Competition

Cournot Competition

Collusive / Cartel

Without ETS, at market equilibrium:

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With Common / Open ETS -1

Each carrier receives a proportion of , free

allowance of its original emission level.

Exogenously determined ETS charge

Shipping company’s objective function

With open ETS, at market equilibrium, straightforward to

show that quantity, cruising speed and fuel consumption

decreases in

Critical proportion

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With Common / Open ETS -2

The effects of emission allowance price on carrier profit

Price Raising Effect:

Emission Trading Effect

(negative if buy, positive if sell)

A carrier’s profit decreases if collude with each other;

increases if carriers compete in Bertrand;

If carriers compete in Cournot,

Profit decreases if , otherwise profit increases

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Intuition of Rising Profit

At equilibrium

Equilibrium depends on full opportunity cost of

allowance

But the true cost of allowance to carrier is

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With Marine Only / Closed ETS -1

Each carrier receives a proportion of , free

allowance of its original emission level.

Shipping company’s objective function

Langrangian:

If , all carriers benefit if Group 1 buys allowance

from Group 2 at any allowance price

h

between the two

shallow prices.

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Clearance price of allowance

Shadow price Change with allowance trading quantity:

12 𝜙𝜙 𝜙𝜙�1 ℎ� 𝜙𝜙�2 △� △1

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Clearance price decreases in proportion of free allowance.

For Group buying allowance, shadow price and trading price increases if competition sharper For Group selling allowance, shadow price and trading price decreases if competition sharper

Figure 4. Clearance price vs. Free proportion 13 𝜙𝜙 𝜙𝜙�1(𝜃𝜃1) 𝜙𝜙�1(𝜃𝜃2) 𝜙𝜙1(𝜃𝜃1) 𝜙𝜙2(𝜃𝜃1) 𝜙𝜙1(𝜃𝜃2) ℎ�1 𝜙𝜙2(𝜃𝜃2) ℎ�2 𝜙𝜙�2(𝜃𝜃1) △� (𝜃𝜃2) 𝜙𝜙�2(𝜃𝜃2) △� (𝜃𝜃1) △1

Figure 5. Clearance price vs. v1

𝜙𝜙1(𝜈𝜈1′) 𝜙𝜙1(𝜈𝜈1′′) ℎ�1 𝜙𝜙2(𝜈𝜈2) ℎ�2 △�(𝜈𝜈1′′) 𝜙𝜙�2(𝜈𝜈2) △�(𝜈𝜈1′) △1

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Simulation

Calibration using traffic volume data of 2007.

– Ship’s average cruising speed and size are calculated using data from Buhaug et al. (2009). Aggregate shipping throughput data is available from Review of Maritime Transport 2008 published by UNCTAD. Additional assumptions: Ship bunker fuel price is assumed to be η=250 USD/ton.

– Model calibration for Open ETS: dry-bulk sector will experience a larger proportion of throughput reduction. Effects on profit for dry-bulk sector is more severe.

– Model calibration for METS: container carrier will purchase emission permits from the dry-bulk sector. Small reduction of the permit allocation will result in significant change in market equilibrium of permit trading between container and dry-bulk sectors.

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Key Analytical Results -1

ETS Schemes, open or closed, always reduce carriers’

cruising speed, traffic volume and fuel consumption.

– Under open ETS, the proportion of free emission allowance influences carriers’ profits. Cruising speed, traffic volume and fuel consumption only depends on emission allowance price but not the proportion of free allowances.

– Under closed ETS, carrier group with higher shadow price (marginal profit) of emission allowance will purchase from the other carrier group. The allowance price decreases in the proportion of free allowance. Speed, traffic volume and fuel consumption thus increases in the proportion of free allowances.

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Key Analytical Results -2

Comparing between open and closed ETS schemes, when the

same proportions of free allowances are given, a carrier’s

profit is higher in a scheme with higher allowance prices.

Compared to the case without ETS, a carrier’s profit change

under ETS depends on proportions of free emission

allowance and type of competition among carriers:

– If free allowance proportion sufficiently large, carriers are better off under ETS.

– If carriers compete in Bertrand, carriers’ profit larger under ETS

– Otherwise the relative profit ranking depends on multiple factors such as the nature of carrier competition, proportion of free allowance, and number of carriers in the market. In many cases, it also depends on the market potential, shipping operations etc.

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Key Analytical Results -3

Comparing open ETS scheme to the case without ETS, it

can be found that:

– The marine industry may either buy or sell emission allowance depending on the proportion of free allowance allocated. The chance of selling allowance increases with allowance price.

– A carrier’s profit will always decrease if carriers collude with each other; will always increase if carriers compete in Bertrand; If carries compete in Cournot, then carriers will be better off if they receive sufficient proportion of free allowances, otherwise they will be worse off.

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Key Analytical Results -4

In the case of marine only (closed) ETS scheme, it can

be found that:

– If container carriers have different shadow price for allowance from bulk carriers, they will trade emission allowances. In particular, a carrier group is more likely to buy allowance as there is higher shipping demand, and as their average ship size is larger; Whereas a carrier group is more likely to sell when they are less fuel efficient, have higher capital costs, or carry cargo to a longer distance.

– For the carrier group buying allowances, they are willing to pay a higher price as they compete more aggressively.

– For the carrier group selling emission allowances, they ask for higher price as they are more collusive.

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Thank you for Listening

Q & A

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References

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