Market Power in an Exhaustible Resource Market: The Case of Storable Pollution Permits

Abstract

Motivated by the structure of existing pollution permit markets, we study the equilibrium path that results from allocating an initial stock of storable permits to an agent, or a group of agents, in a position to exercise market power. A large seller of permits exercises market power no differently than a large supplier of an exhaustible resource. However, whenever the large agent’s endowment falls short of his efficient endowment – allocation profile that would exactly cover his emissions along the perfectly competitive path – market power is greatly mitigated by a commitment problem, much like in a durable‐goods monopoly. We illustrate our theory with two applications: the US sulphur market and the international carbon market that may eventually develop beyond the Kyoto Protocol.