The CO2 cost pass-through and market power in emission trading schemes with vertical relations

Recently, the use of pass-through as an economic tool has garnered increasing interest. This paper explores the relationship between CO2 cost pass-through and market power within emission trading schemes characterized by vertical relations. Our study finds that increased competition in the wholesale market can mitigate pass-through under mild conditions, while countervailing buyer power at the retail level can partially neutralize the effects of CO2 cost pass-through. Furthermore, our numerical tests reveal pass-through overshifting, occurring even under non-convex market demand conditions. Our results generalize and update some known findings in literature (e.g. Wang and Zhou, 2017; Yu et al., 2021; and Chen et al., 2023) and carry some important implications for energy policy, environmental regulation, and welfare analysis.