Flexible Mandates for Investment in New Technology

Regulators often seek to promote the use of improved, cleaner technology when new investments occur; however, technology mandates are suspected of raising costs and delaying investment. We examine investment choices for electricity generation under a strict emissions rate performance standard requiring the installation of carbon capture and storage (CCS) on fossil-fired plants. We compare the strict standard with a flexible one that imposes a surcharge for emissions in excess of the standard. A third policy allows the surcharge revenue to fund later CCS retrofits. Analytical results indicate that increasing flexibility leads to earlier introduction of CCS, lower aggregate emissions and higher profits. We test this using multi-stage stochastic optimization, with uncertain future natural gas and emissions allowance prices. Under perfect foresight, the analytical predictions hold. With uncertainty, these predictions hold most often but we find outcomes that contradict the theory. In some cases, investments are delayed to enable the decisionmaker to learn additional information.