The effects of allowance price on energy demand under a personal carbon trading scheme

doi:10.1016/j.apenergy.2016.02.111

Applied Energy

Volume 170, 15 May 2016, Pages 242-249

https://doi.org/10.1016/j.apenergy.2016.02.111 Get rights and content

Highlights

•
Personal carbon trading is an innovative policy instrument to reduce carbon emissions at the individual level.
•
A CES utility function is adopted to examine the effect of carbon allowance price changes.
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An increase (decrease) in the elasticity of substitution results in an enhanced (reduced) effect of allowance price changes.

Abstract

Personal carbon trading (PCT) is a downstream cap-and-trade scheme which could be used to reduce carbon emissions from the household sector. To explore the effectiveness of this scheme, it is necessary to investigate how consumers respond to allowance price change. In this paper, a general utility optimization (GUO) model and a constant elasticity of substitution (CES) utility function are proposed to examine the price, substitution and income effects of carbon allowance price changes. It is shown that higher income consumers are more sensitive to the allowance price changes than lower income consumers. Moreover, the short-run adjustment in consumers’ consumption of electricity in response to a change in allowance price would be lower than the long-run value. According to the sensitivity analysis, downward (upward) adjustments in the elasticity of substitution result in a positive (negative) effect on price effect. The findings in this study are used to draw policy implications. Suggestions for future research are also provided.

Introduction

Carbon emissions caused by the energy consumption of households have become a significant source of total emissions and have attracted widespread attention from scholars and government agencies [1], [2]. For instance, according to Reinders et al. [3] the proportion of direct energy (electricity, coal, gasoline, etc.) consumption by the households accounts for the total energy demand in different EU countries varies from 34% to 64%. In China, about 30% of carbon emissions are generated by households’ energy consumption [4]. Moreover, due to the increase in disposable income, population growth, mobility, urbanization, and growing penetration of energy intensive appliances in households, households’ energy consumption and associated carbon emissions will continue to grow rapidly [5], [2], [6]. Thus, to avoid catastrophic climate change, changes in consumer behavior are generally considered to be an option for CO₂ reduction [3]. These changes are essential to build awareness of sustainable lifestyles and the synergies between policy, technology, and ethical imperatives. It is expected that sustainable lifestyles, as one of the carbon mitigation measures, would contribute to carbon reduction and mitigate climate change.

Personal carbon trading (PCT) has been generally regarded as a potentially powerful and innovative policy instrument to reduce carbon emissions at the individual and household level and promote low-carbon lifestyles. The concept of PCT was first proposed by Fleming in 1996 [7]. In recent years, at national government level, it has aroused great interest and considerable discussion in the UK where government aims to achieve a legally binding emissions reduction target of an 80% cut by 2050 relative to the 1990 level [8]. PCT is usually seen as a variety of the downstream “cap and trade” policies that allocate rights and responsibilities for carbon emissions from the household energy use. In a PCT scheme, each consumer would be allocated with an initial allocation of carbon allowances based on carbon reduction targets, which could be used alongside traditional money, to cover the consumer’s emissions associated with the consumption of energy commodities, such as gas, coal, and electricity. Such allowances could also be traded between consumers. The over-emitters who emit more than their initial allowances have to buy extra allowances from the under-emitters who emit less than their allowances allocated. The demand and supply of allowances, which would be influenced by initial allowance allocation, energy emission rate, energy price and so on, will determine their price [9].

As a market-based approach to internalize environmental externalities at the level of personal emissions, PCT scheme provides a pricing mechanism for carbon emissions and a market for trading allowances. Specifically, allowance price enhances the cost of a high-carbon lifestyle and can pass through a more direct signal to reduce carbon emissions. The higher the allowance price, the more the consumers would be willing to shift from carbon intensive energies to less carbon intensive ones [10], [11]. Therefore, the carbon allowance price plays a critical role to affect consumers’ consumption decision making, especially the decision of energy consumption.

Considering the importance of the allowance price, it is essential to explore its effect on consumers’ energy demand which reflects the effectiveness and efficiency of the PCT scheme to reduce carbon emission. In a PCT scheme, carbon allowances could be viewed as a form of complementary currency (CC) which could be used to solve some environmental problems that conventional currency cannot address directly [12]. Since allowances and energy can be treated as complementary goods, the allowances could be used either for supporting energy consumption or for being exchanged for money to generate a benefit [13]. When allowance price changes, the opportunity cost of selling allowances and the purchasing cost of energy consumption will change. How would consumers with different income respond to the allowance price changes? Would consumers’ responses in the short-run be different from those in the long run? These questions are investigated for the first time in this paper. The empirical exercises are conducted by using a constant elasticity of substitution (CES) utility function. The paper thus fills the void in the literature.

The remainder of the paper is organized as follows. Section 2 provides a literature review. Section 3 introduces a theoretical model to obtain the formulae of the price effect, substitution effect and income effect under the PCT scheme. Section 4 evaluates the parameters of the model. Sections 5 Results and discussion, 6 Sensitivity analysis present the results, discussion and sensitivity analysis. Finally Section 7 concludes the paper and points out the implication and limitations of the results.

Section snippets

Literature review

The potential for the introduction of PCT at individual or household level has attracted much attention in both academic research and policy making. For example, in 2010, the Climate Policy journal devoted a special issue to PCT scheme with ten articles. Most studies in the existing literature focused on scheme design, implementation, distributional effects, its comparison with other emission reduction instruments such as carbon tax (CT) and upstream trading scheme [8], [14], [15], [16], [17].

Methods

A PCT scheme incorporates energy consumption choices into a decision-making frame [18]. This decision-making process can be framed as a budgeting process which may encourage self-control over one’s carbon emissions through basic economic mechanisms [38]. It is reasonable to assume that consumers allocate expenditure between energy goods and non-energy goods [39]. The model is based on the theory of consumer choice behavior which assumes that a rational consumer always chooses consumption

Simulation

To explore how different consumers react to a PCT scheme and try to manage it differently, in this section, we will utilize electricity consumption statistics to estimate the parameters of our CES utility model if a PCT scheme is introduced in the US residential sector. In the U.S., the residential sector accounts for 37 percent of national electricity consumption and 17 percent of carbon dioxide emissions [47]. For simplicity, it is assumed that the PCT scheme only covers the household

Results and discussion

Given the parameters identified in Section 4 and Eqs. (14), (16), the income effect, substitution effect and the price effect of allowance price on electricity demand in the short and long-run can be calculated. The specific results are presented in Table 5, Table 6. The allowance price effect on electricity demand in both short and long-run is negative for all households with different income. Thus, when the allowance price rises, the consumer will reduce electricity consumption. It is

Sensitivity analysis

According to the discussion in the preceding section, the adjustment range of consumers’ electricity consumption in response to allowance price changes is closely related to the value of elasticity of substitution. In fact, the change of elasticity of substitution may have a significant effect on our findings. Thus, in this section, we perform a sensitivity analysis check to further explore this effect. The value of elasticity of substitution changes from −20% to +20% of the baseline values of

Conclusion

PCT is a new, untried policy proposal to reduce carbon emissions at the household level by using carbon rationing and tradable emission allowances. It is a downstream extension of the “cap and trade” scheme in the production sectors, with the aim to provide market signals and incentives for consumers to adapt to lower-carbon lifestyles. To explore the effectiveness of the PCT scheme, it is necessary to investigate how consumers respond to allowance price changes. This paper mainly focuses on

Acknowledgements

The authors acknowledge the National Natural Science Foundation of China (71301157, 71571172 & 71473105) for generous financial support and editors and several anonymous reviewers of the Journal for constructive comments and suggestions.

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