Prior research has shown, firstly, that firms subjected to a cap-and-trade system can enjoy scarcity rents and, secondly, that they can manipulate the price of permits as a rent seeking behaviour. We analyse these issues using a duopoly model under Cournot and Stackelberg competition. We identify the different sources of scarcity rents and determine under which conditions they can generate incentives for the firms to lobby the permit price up. We show that, under reasonable assumptions, Stackelberg competition eliminates incentives to collude if ther is no grandfathering. However, such incentives appear if there is an initial free allocation of permits, which is a policy argument against grandfathering. This effect is increasing with the amount of permits allocated to the leader and those parameter changes that undermine the leader's advantage in output production or reduce the leader's abatement cost.
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