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Carbon Capture Retrofits and the Cost of Regulatory Uncertainty

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  • Peter S. Reinelt
  • David W. Keith
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    Abstract

    Power generation firms confront impending replacement of an aging coal-fired fleet in a business environment characterized by volatile natural gas prices and uncertain carbon regulation. We develop a stochastic dynamic programming model of firm investment decisions that minimizes the expected present value of future power generation costs under uncertain natural gas and carbon prices. We explore the implications of regulatory uncertainty on generation technology choice and the optimal timing of investment, and assess the implications of these choices for regulators. We find that interaction of regulatory uncertainty with irreversible investment always raises the social cost of carbon abatement. Further, the social cost of regulatory uncertainty is strongly dependent on the relative competitiveness of IGCC plants, for which the cost of later carbon capture retrofits is comparatively small, and on the firmÕs ability to use investments in natural gas generation as a transitional strategy to manage carbon regulation uncertainty. Without highly competitive IGCC or low gas prices, regulatory uncertainty can increase the expected social cost of reducing emissions by 40 to 60%.

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    Bibliographic Info

    Article provided by International Association for Energy Economics in its journal The Energy Journal.

    Volume (Year): Volume 28 (2007)
    Issue (Month): Number 4 ()
    Pages: 101-128

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    Handle: RePEc:aen:journl:2007v28-04-a05

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    Cited by:
    1. Klaus Rennings & Peter Markewitz & Stefan Vögele, 2013. "How clean is clean? Incremental versus radical technological change in coal-fired power plants," Journal of Evolutionary Economics, Springer, vol. 23(2), pages 331-355, April.
    2. Szolgayová, Jana & Golub, Alexander & Fuss, Sabine, 2014. "Innovation and risk-averse firms: Options on carbon allowances as a hedging tool," Energy Policy, Elsevier, vol. 70(C), pages 227-235.
    3. Shahnazari, Mahdi & McHugh, Adam & Maybee, Bryan & Whale, Jonathan, 2014. "Evaluation of power investment decisions under uncertain carbon policy: A case study for converting coal fired steam turbine to combined cycle gas turbine plants in Australia," Applied Energy, Elsevier, vol. 118(C), pages 271-279.
    4. Wilson, Nathan E., 2012. "Uncertain regulatory timing and market dynamics," International Journal of Industrial Organization, Elsevier, vol. 30(1), pages 102-115.
    5. Pahle, Michael & Fan, Lin & Schill, Wolf-Peter, 2011. "How emission certificate allocations distort fossil investments: The German example," Energy Policy, Elsevier, vol. 39(4), pages 1975-1987, April.
    6. Ruester, Sophia & Neumann, Anne, 2008. "The prospects for liquefied natural gas development in the US," Energy Policy, Elsevier, vol. 36(8), pages 3150-3158, August.
    7. Fuss, Sabine & Johansson, Daniel J.A. & Szolgayova, Jana & Obersteiner, Michael, 2009. "Impact of climate policy uncertainty on the adoption of electricity generating technologies," Energy Policy, Elsevier, vol. 37(2), pages 733-743, February.

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