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.