Exit Incentives for Carbon Emissive Firms

We develop a continuous-time model of incentives for carbon emissive firms to exit the market based on a compensation payment identical to all firms. In our model, firms enjoy profits from production modeled as a simple geometric Brownian motion and do not bear any environmental damage from production. A regulator maximizes the expected discounted value of firms profits from production minus environmental damages caused by production and proposes a compensation payment whose dynamics is known to the firms. We provide in both situations closed-form expressions for the compensation payment process and the exit thresholds of each firms. We apply our model to the crude oil market. We show that market concentration increases the total expected discounted payments to firms and reduces the expected closing time of polluting assets. A certain degree of market concentration can enable the regulator to halt production in a shorter time but at a higher cost. We extend this framework to the case of two countries each regulating its own market. We analyze scenarios involving two large producers and a combination of large and small producers. Our findings indicate that the proposed model facilitates an earlier exit of brown energy from the market compared to the scenario where each country independently regulates its market. This has significant implications for regulatory strategies aimed at accelerating the transition to cleaner energy sources.