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

Author

Listed:
  • 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)

Abstract

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.

Suggested Citation

  • Alexander Brauneis & Michael Loretz & Roland Mestel & Stefan Palan, 2011. "Inducing Low-Carbon Investment in the Electric Power Industry through a Price Floor for Emissions Trading," Working Papers 2011.74, Fondazione Eni Enrico Mattei.
    • Handle: RePEc:fem:femwpa:2011.74
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Carbon price; price floor; technological change; investment decision; real option approach;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • O38 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Government Policy
    • Q55 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Technological Innovation

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