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Electricity capacity investment under risk aversion: A case study of coal, gas, and concentrated solar power

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  • Fan, Lin
  • Norman, Catherine S.
  • Patt, Anthony G.

Abstract

The policy instrument many economists favor to reduce greenhouse gas emissions and to shift new investment towards low carbon technologies is the tradable allowance system. Experience with this instrument has been mixed, with a crucial design issue being the choice of whether to auction allowances to firms, or to grandfather them based on historical emissions. In this paper, we examine the changing incentives of investment in different technologies, when investors are risk averse and are expecting an allowance system with a certain allocation rule but do not know if the policy is going to take place in the near future. Investors also cannot fully predict future investment costs for the low-carbon technology. We apply a game theoretic model to examine the combined effects of uncertainty and risk aversion on the actions of potential investors into high and low carbon generating capacity, under both allocation rules and uncertain costs. We find that uncertainty and risk aversion do have implications towards investment incentives. We discuss policy implications of these findings.

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Bibliographic Info

Article provided by Elsevier in its journal Energy Economics.

Volume (Year): 34 (2012)
Issue (Month): 1 ()
Pages: 54-61

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Handle: RePEc:eee:eneeco:v:34:y:2012:i:1:p:54-61

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Web page: http://www.elsevier.com/locate/eneco

Related research

Keywords: Emissions trading; Allowances; Allocation rules; Uncertainty; Risk aversion;

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References

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  1. Babcock, Bruce A. & Choi, E. Kwan & Feinerman, Eli, 1993. "Risk and Probability Premiums for Cara Utility Function," Staff General Research Papers 596, Iowa State University, Department of Economics.
  2. Fan, Lin & Hobbs, Benjamin F. & Norman, Catherine S., 2010. "Risk aversion and CO2 regulatory uncertainty in power generation investment: Policy and modeling implications," Journal of Environmental Economics and Management, Elsevier, vol. 60(3), pages 193-208, November.
  3. Held, Hermann & Kriegler, Elmar & Lessmann, Kai & Edenhofer, Ottmar, 2009. "Efficient climate policies under technology and climate uncertainty," Energy Economics, Elsevier, vol. 31(Supplemen), pages S50-S61.
  4. Williges, Keith & Lilliestam, Johan & Patt, Anthony, 2010. "Making concentrated solar power competitive with coal: The costs of a European feed-in tariff," Energy Policy, Elsevier, vol. 38(6), pages 3089-3097, June.
  5. Pahle, Michael, 2010. "Germany's dash for coal: Exploring drivers and factors," Energy Policy, Elsevier, vol. 38(7), pages 3431-3442, July.
  6. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680.
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Cited by:
  1. Christian Winzer, 2013. "Robustness of Various Capacity Mechanisms to Regulatory Errors," Cambridge Working Papers in Economics 1338, Faculty of Economics, University of Cambridge.
  2. Meunier, Guy, 2013. "Risk aversion and technology mix in an electricity market," Energy Economics, Elsevier, vol. 40(C), pages 866-874.

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