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Assessing the effects of CO2 price caps on electricity investments--A real options analysis

Listed author(s):
  • Szolgayova, Jana
  • Fuss, Sabine
  • Obersteiner, Michael
Registered author(s):

    This paper uses real options modeling to assess the impact of different climate change policy instruments on investment, profits and cumulative emissions in the electricity sector. Even though CO2 price caps or "safety valves" have been suggested as methods to limit uncertainty emanating from fluctuating prices of CO2 permits that would hurt the industry's profit and thereby also energy security, our analysis shows that price caps set at a too low level are detrimental to the adoption of e.g. modern biomass-fired capacity as a replacement for existing coal-fired power plants. We therefore conduct a series of experiments with different policy scenarios to analyze under which regime emissions are most effectively reduced. With respect to CO2 price uncertainty, it turns out that even for moderately rising CO2 prices, fluctuations frequently lead to investment into carbon capture and storage (CCS), while investment is often not triggered in the face of deterministic CO2 prices.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0301-4215(08)00347-9
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    Article provided by Elsevier in its journal Energy Policy.

    Volume (Year): 36 (2008)
    Issue (Month): 10 (October)
    Pages: 3974-3981

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    Handle: RePEc:eee:enepol:v:36:y:2008:i:10:p:3974-3981
    Contact details of provider: Web page: http://www.elsevier.com/locate/enpol

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    1. Yang, Ming & Blyth, William & Bradley, Richard & Bunn, Derek & Clarke, Charlie & Wilson, Tom, 2008. "Evaluating the power investment options with uncertainty in climate policy," Energy Economics, Elsevier, vol. 30(4), pages 1933-1950, July.
    2. Fleten, Stein-Erik & Maribu, Karl Magnus & Wangensteen, Ivar, 2005. "Optimal investment strategies in decentralized renewable power generation under uncertainty," MPRA Paper 218, University Library of Munich, Germany, revised Jun 2006.
    3. Hlouskova, Jaroslava & Kossmeier, Stephan & Obersteiner, Michael & Schnabl, Alexander, 2005. "Real options and the value of generation capacity in the German electricity market," Review of Financial Economics, Elsevier, vol. 14(3-4), pages 297-310.
    4. Uddin, Sk Noim & Barreto, Leonardo, 2007. "Biomass-fired cogeneration systems with CO2 capture and storage," Renewable Energy, Elsevier, vol. 32(6), pages 1006-1019.
    5. Laurikka, Harri & Koljonen, Tiina, 2006. "Emissions trading and investment decisions in the power sector--a case study in Finland," Energy Policy, Elsevier, vol. 34(9), pages 1063-1074, June.
    6. Chao, Hung-Po & Wilson, Robert, 1993. "Option Value of Emission Allowances," Journal of Regulatory Economics, Springer, vol. 5(3), pages 233-249, September.
    7. Jacoby, Henry D. & Ellerman, A. Denny, 2004. "The safety valve and climate policy," Energy Policy, Elsevier, vol. 32(4), pages 481-491, March.
    8. Fuss, Sabine & Szolgayova, Jana & Obersteiner, Michael & Gusti, Mykola, 2008. "Investment under market and climate policy uncertainty," Applied Energy, Elsevier, vol. 85(8), pages 708-721, August.
    9. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    10. Pizer, William A., 2002. "Combining price and quantity controls to mitigate global climate change," Journal of Public Economics, Elsevier, vol. 85(3), pages 409-434, September.
    11. Peter S. Reinelt & David W. Keith, 2007. "Carbon Capture Retrofits and the Cost of Regulatory Uncertainty," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4), pages 101-128.
    12. Pizer, William, 2005. "Climate Policy Design Under Uncertainty," Discussion Papers dp-05-44, Resources For the Future.
    13. Luke Reedman & Paul Graham & Peter Coombes, 2006. "Using a Real-Options Approach to Model Technology Adoption Under Carbon Price Uncertainty: An Application to the Australian Electricity Generation Sector," The Economic Record, The Economic Society of Australia, vol. 82(s1), pages 64-73, 09.
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