Pricing carbon allowance based on marginal abatement cost

As China is facing increasingly severe challenge of climate change, Chinese government is actively promoting market-oriented strategy to achieve carbon emissions reduction at a relatively lower cost. Carbon emissions allowance trading is regarded as the major policy instrument to achieve the goal. Carbon allowance price formation mechanism and forecasting are crucial for a nascent carbon market. This paper used a directional distance function approach to estimate the shadow prices of carbon emissions of 33 sectors of the secondary industry of Shenzhen, and deduced carbon market allowance price based on the shadow prices. The results indicate that carbon market price is heavily influenced by the power & heat production industry as its huge emission amount and lowest reduction cost. Carbon offset mechanism is commonly adopted as a price stabilizing instrument in a carbon market. The results showed that the carbon market price was negatively correlated with the maximum offset ratio and positively correlated with certified emission reductions (CER) price.