Why Would Polluting Firms Want to Bank Credits co.

1
Why Would Polluting Firms Want to Bank Credits
(co.)

• Saving Purchase/Sale Transactions Costs if
  polluting firms dont know if they will need an
  excess credit for future use, banking may mean
  that they will avoid some purchase/sale-related
  transactions costs.
• Example Assume 50/50 if excess allowance in
  future (at time t2) will be needed by the firm to
  cover its t2 emissions. If firm sells allowance
  now (at time t1), 50 chance the firm will have
  to buy an allowance at t2, 50 chance that the
  firm wont have to.
• If any sale or purchase transaction means 100 in
  transactions costs, expected transaction costs of
  selling at t1 plan is 100 (.5 X 100) or 150.
  
• If firm banks credit at t1, expected transactions
  costs are (.5 X 100) or 50.
• The greater the purchase/sale transactions costs
  per purchase/sale, the more compelling is this
  transactions costs explanation of banking.

2
Why Would Polluting Firms Want to Bank Credits
(co.)

• Tax-related advantages of banking excess
  allowances.
• If the firm sells at t1 and then needs to buy an
  allowance at t2, it will post a gain at t1 and a
  loss/expense at t2. If it turns out the firm
  doesnt need another allowance at t2, the firm
  will just post a gain at t1.
• By contrast if the firm banks at t1 and then
  sells at t2, it will post a gain at t2. If the
  firm banks and then uses the credit at t2, the
  firm will have no tax gain or losses to post.
• From a tax minimization/avoidance perspective,
  the tax possibilities associated with the banking
  plan (50 prospect of a late/t2 gain, and 50
  prospect of no gain or loss) are preferable to
  those associated with the no banking/sell in time
  t1 plan (50 prospect of an early/t1 gain, and
  50 prospect of an early/t1 gain combined with a
  late/t2 loss)

3
Why Would Polluting Firms Want to Bank Credits
(co.)

• Banking allowances also may reflect an
  anti-competitive strategy
• If established firms hoard allowances, it will
  be difficult for new entrants to buy bulk of
  allowances necessary to begin new production
  operations
• Banking allowances also may reflect fear of firms
  that they will be unable to buy allowances they
  may need at time 2, some firms may be very risk
  averse regarding hold-ups to meeting future
  production demand
• For example, power provider may worry that it
  wont be able to find enough allowances to cover
  emissions in t2, if its an unusually hot (heat)
  or cold (air conditioning) year

4
Banking and Industry-Wide Political Economy

• Question If a polluting/regulated industry has
  firms with substantial banks of allowances, can
  we predict that the industry, as a political
  actor, will act differently than if firms in the
  industry had not built substantial banks?
• Prediction An industry with firms with many
  banked credits will be (all else being equal)
  less politically supportive of government efforts
  to mandate and/or encourage the development of
  new pollution control/reduction technologies than
  an industry with firms that have banked no or
  very few credits.
• Why The development of new, diffusible pollution
  technology translates into a reduction in the
  market price of pollution credits, and a
  reduction in that market price represent a loss
  in asset value for firms that have banked
  allowances

5
Political Economy co.

• Industry may be less supportive of regulatory
  experiments that offer industry rewards for
  experiments with new prevention technology as in
  Project XL model
• Industry may be less supportive of at least
  work less intensely to obtain -- favorable tax
  treatment for investments in prevention
  technology
• Industry may be less supportive of at least
  work less intensely to obtain -- government
  subsidies/funding for prevention technology
  efforts

6
Hypothetical Example

• -- New pollution reduction/control technology
  means fewer allowances sold in marketplace, and a
  lower market price for those allowances sold
• -- e.g. before diffusion of new technology,
  quantity sold is 1 million allowances at 10 per
  allowance, afterwards, 800,000 allowances at 8
  per allowance
• -- so industry saves 3.6 million in allowance
  costs (1million)(10)-(800,000)(8)
• -- but if firms in industry had (for example)
  800,000 allowances banked at the time of the
  diffusion of new technology and the corresponding
  drop in market price, then those firms will
  experience a 1.6 million loss in asset value,
  and that loss in asset value will in effect eat
  up half of industry savings from new technology
• Ex ante, prospective loss in asset value (the
  asset being banked credits) will make industry
  less enthusiastic about government efforts to
  promote new pollution technology than if the
  industry had no firms with banked credits and
  hence faced no prospective loss in asset value

7
Banking and Individual Firm Investment Decisions

• Question does the fact that a polluting firm has
  banked a substantial number of allowances make it
  less likely (all else being equal) that the firm
  will make an investment in a the development of a
  potentially diffusible pollution
  control/reduction technology?
• Answer yes, because expected value of investment
  will be lesser, reflecting loss in asset value
  (in the asset of banked allowances, the value of
  which will drop if new, diffusible technology is
  in fact developed).

8
Banking and Individual Firms, co.

• Question does the fact that an individual firm
  (Firm X) knows that other firms in the industry
  have banked allowances make it less likely (all
  else equal) that the firm will invest in
  pollution reduction/control technology?
• Answer yes but analysis not entirely
  straightforward

9
Greater Upside Part of Analysis

• On one hand, Firm X will assume that other firms
  will be less interested in investing themselves
  (because of their banked allowances) and the
  potential for Firm X to be a first-inventor, and
  capture invention rents, will seem greater.
• Thus, to the extent Firm X is concerned primarily
  with upsides in considering whether to make the
  investment decision, the fact that other firms
  have banked credits will make the firm more
  likely to invest in pollution reduction/control
  technology.

10
Lesser Downside Part of the Analysis

• But Firm X will also understand that the fact
  that other firms have banked allowances means
  that the other firms are less likely to invest in
  new technology, and that means Firm X, if it
  makes no investment in research, will face a
  lesser risk of being in the difficult market
  position of having to catch up or pay rents to
  other firms that develop a new technology.
• Thus, the downside risk of not making the
  research investment will be reduced as a result
  of the fact that other firms have banked.