A Study of the Feasibility of International ETS Cooperation between Shanghai and Korea from Environmental Efficiency and CO2 Marginal Abatement Cost Perspectives

Abstract

With the worldwide spread of emissions trading schemes (ETSs) and the need for international cooperation on climate change, there is growing interest in linking ETSs. Along with sustainable development, preventing and controlling pollution, is now regarded as an urgent priority by China and Korea. In the context of the willingness of the Chinese and Korean governments to cooperate on ETS, this paper examines the feasibility of a pilot ETS cooperation between Shanghai and Korea from environmental efficiency and CO2 marginal abatement cost (MAC) perspectives. We apply a directional distance function (DDF) and stochastic frontier analysis (SFA) to estimate the environmental efficiency and the CO2 MAC of coal-fueled power plants in Shanghai and Korea using cross-sectional data from 2015. The results indicate that the group frontier environmental efficiency of Shanghai and Korea reached a similarly high score. However, as to meta-frontier environmental efficiency, the coal-fueled power plants in Korea performed better than those in Shanghai. The CO2 MAC results indicate that, despite the small gap in efficiency performance, the CO2 MAC of coal-fueled power plants is much higher than that in Shanghai due to the big feed-in tariff difference. This is because the MAC not only relates to the environmental efficiency, but also to the feed-in tariff. A higher feed-in tariff leads to higher MAC. To tackle this serious problem, which has also been addressed in previous studies, we suggest that policymakers should focus on the huge CO2 MAC differences caused by feed-in tariff differences to avoid equity problems when building the structure of the Shanghai-Korea ETS cooperation. For instance, compared with power plants in Shanghai, policymakers should set a looser cap and a higher offset for Korean plants. To reduce the impact of feed-in tariff on carbon trading in the market, it would also be effective to arrange a higher quota or a lower carbon tax for coal-fueled power plants in Korea. In addition, policymakers should fill the gaps of 85.15% and 67.6% between the realistic market price and the MAC results of coal-fueled power plants in Shanghai and Korea, respectively, by introducing stricter regulations.