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

  • Alexander Brauneis

    ()

    (Department of Finance and Accounting, Alpen-Adria University Klagenfurt)

  • Roland Mestel

    ()

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

  • Stefan Palan

    ()

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

  • Michael Loretz

    (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 investments 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 find that a carbon price floor can be used to induce earlier low-carbon technology investment and show this result to be robust to a large variety of input parameter settings.

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Paper provided by Faculty of Social and Economic Sciences, Karl-Franzens-University Graz in its series Working Paper Series, Social and Economic Sciences with number 2011-01.

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Length: 40 pages
Date of creation: 11 Nov 2011
Date of revision:
Publication status: Published in Energy Policy 53, 2013, pp. 190-204
Handle: RePEc:grz:wpsses:2011-01
Contact details of provider: Postal: Universitaetsstrasse 15/AE, 8010 Graz
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Web page: http://sowi.uni-graz.at/de/forschen/working-paper-series/
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