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Commitments through financial options: an alternative for delivering climate change obligations

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  • ROLAND ISMER
  • KARSTEN NEUHOFF

Abstract

Governments willing to commit themselves to maintain carbon prices at or above a certain level face the challenge that their commitments need to be credible both for investors in low-carbon technology and for foreign governments. This article argues that governments can make such commitments by issuing long-term put option contracts on the price of CO 2 allowances. This mechanism gives investors the right, but not the obligation, to sell allowances to the government at the strike price. From the investors' point of view, a government is therefore fully committed to a price floor for allowances in the future. This proposed approach alters the incentives that a government faces when considering noncompliance and serves to prevent non-compliance. The proposal fares well when assessed against criteria to determine its suitability in legitimacy, enforcement, proportionality, lack of interference from other contracting States, and transparency. It also allows for fine-tuning through the number and duration of issued options and the strike price. A robust contract structure is proposed to protect against government interference that might threaten the credibility of commitments.

Suggested Citation

  • Roland Ismer & Karsten Neuhoff, 2009. "Commitments through financial options: an alternative for delivering climate change obligations," Climate Policy, Taylor & Francis Journals, vol. 9(1), pages 9-21, January.
    • Handle: RePEc:taf:tcpoxx:v:9:y:2009:i:1:p:9-21
    DOI: 10.3763/cpol.2008.0358
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    Citations

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    Cited by:

    1. Fankhauser, Samuel & Hepburn, Cameron, 2010. "Designing carbon markets. Part I: Carbon markets in time," Energy Policy, Elsevier, vol. 38(8), pages 4363-4370, August.
    2. Fankhauser, Samuel & Hepburn, Cameron, 2009. "Carbon markets in space and time," LSE Research Online Documents on Economics 37606, London School of Economics and Political Science, LSE Library.
    3. Alistair Ulph & David Ulph, 2013. "Optimal Climate Change Policies When Governments Cannot Commit," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 56(2), pages 161-176, October.
    4. Hertwich, Edgar G., 2020. "Carbon fueling complex global value chains tripled in the period 1995–2012," Energy Economics, Elsevier, vol. 86(C).
    5. Alistair Ulph & David Ulph, 2011. "Optimal Climate Change Policies When Governments Cannot Commit," Discussion Paper Series, School of Economics and Finance 201104, School of Economics and Finance, University of St Andrews.
    6. Bing Zhang & Hanxun Fei & Yongjing Zhang & Beibei Liu, 2015. "Regulatory Uncertainty and Corporate Pollution Control Strategies: An Empirical Study of the ‘Pay for Permit’ Policy in the Tai Lake Basin," Environment and Planning C, , vol. 33(1), pages 118-135, February.
    7. Olga Chiappinelli & Karsten Neuhoff, 2020. "Time-Consistent Carbon Pricing: The Role of Carbon Contracts for Differences," Discussion Papers of DIW Berlin 1859, DIW Berlin, German Institute for Economic Research.
    8. Hertwich, Edgar, 2020. "Carbon fueling complex global value chains tripled in the period 1995-2012," SocArXiv zb3rh, Center for Open Science.
    9. Taran Faehn and Elisabeth T. Isaksen, 2016. "Diffusion of Climate Technologies in the Presence of Commitment Problems," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).

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