Price limits in a tradable performance standard

Tradable performance standards are widely used sectoral regulatory policies. Examples include the US lead phasedown, fuel economy standards for automobiles, renewable portfolio standards, low carbon fuel standards, and—most recently—China's new national carbon market. At the same time, theory and experience with traditional cap-and-trade programs suggest an important role for price limits in the form of floors, ceilings, and reserves. In this paper we develop a simple analytical model to derive the welfare comparison between tradable performance standards and a price-based alternative. This model works out to be a simple variant of the traditional Weitzman prices-versus-quantities result. We use this result to show that substantial gains—perhaps 50% or more when prices are low—could arise from shifting two programs, China's new national carbon market and the California Low Carbon Fuel Standard, to a price mechanism. This finding will generally be true when the coefficient of variation in the price under a TPS is larger than 50%. We end with a brief discussion of implementation issues, including consignment auctions.