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Inducing Low-Carbon Investment in the Electric Power Industry through a Price Floor for Emissions Trading

  • Alexander Brauneis

    (Institute of Financial Management, Alpen-Adria-University Klagenfurt)

  • Michael Loretz

    (Institute of Banking and Finance, Karl-Franzens-University Graz)

  • Roland Mestel

    (Institute of Banking and Finance, Karl-Franzens-University Graz)

  • Stefan Palan

    (Institute of Banking and Finance, Karl-Franzens-University Graz)

Uncertainty about long-term climate policy is a major driving force in the evolution of the carbon market price. Since this price enters the investment decision process of regulated firms, this uncertainty increases the cost of capital for investors and might deter invest-ments into new technologies at the company level. We apply a real options-based approach to assess the impact of climate change policy in the form of a constant or growing price floor on investment decisions of a single firm in a competitive environment. This firm has the opportunity to switch from a high-carbon “dirty” technology to a low-carbon “clean” technology. Using Monte Carlo simulation and dynamic programming techniques for real market data, we determine the optimal CO2 price floor level and growth rate in order to induce investments into the low-carbon technology. We show these findings to be robust to a large variety of input parameter settings.

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Paper provided by Fondazione Eni Enrico Mattei in its series Working Papers with number 2011.74.

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Date of creation: Oct 2011
Date of revision:
Handle: RePEc:fem:femwpa:2011.74
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