Uncertain long-run emissions targets,CO2 price and global energy transition: A general equilibrium approach

The persistent uncertainty about mid-century CO₂ emissions targets is likely to affect not only the technological choices that energy-producing firms will make in the future but also their current investment decisions. We illustrate this effect on CO₂ price and global energy transition within a MERGE-type general-equilibrium model framework, by considering simple stochastic CO₂ policy scenarios. In these scenarios, economic agents know that credible long-run CO₂ emissions targets will be set in 2020, with two possible outcomes: either a “hard cap” or a “soft cap”. Each scenario is characterized by the relative probabilities of both possible caps. We derive consistent stochastic trajectories—with two branches after 2020—for prices and quantities of energy commodities and CO₂ emissions permits. The impact of uncertain long-run CO₂ emissions targets on prices and technological trajectories is discussed. In addition, a simple marginal approach allows us to analyze the Hotelling rule with risk premia observed for certain scenarios.     

Impact of climate policy uncertainty on the adoption of electricity generating technologies

This paper presents a real options model where multiple options are evaluated simultaneously so that the effect of the individual options on each other is accounted for. We apply this model to the electricity sector, where we analyze three typical technologies based on fossil fuel, fossil fuel with carbon capture and renewable energy, respectively. In this way, we can analyze the transition from CO₂-intensive to CO₂-neutral electricity production in the face of rising and uncertain CO₂ prices. In addition, such a modelling approach enables us to estimate precisely the expected value of (perfect) information, i.e. the willingness of investors and producers to pay for information about the correct CO₂ price path. As can be expected, the expected value of information rises with increasing CO₂ price uncertainty. In addition, the larger the price uncertainty, the larger are the cumulative CO₂ emissions over the coming century. The reason for this is that the transition to less CO₂-intensive technologies is increasingly postponed with rising CO₂ price uncertainty. By testing different price processes (geometric Brownian motion versus jump processes with different jump frequencies), we can also make useful recommendations concerning the importance of policy predictability. We find that it is better to have climate change policies that are stable over a certain length of time and change abruptly than less abrupt but more frequently changing policies. Less frequent fluctuations reduce the expected value of information and result in smaller cumulative CO₂ emissions.     

Investment under market and climate policy uncertainty

Climate change is considered as one of the major systematic risks for global society in the 21st century. Yet, serious efforts to slow the accumulation of emissions are still in their primordial stage and policy makers fail to give proper long-term signals to emitters. These days, investors do not only face uncertainty from volatile prices in the traditional markets, but also from the less conceivable uncertainty of stricter climate change policy. This paper investigates the impact of learning about the commitment of government to a climate policy regime in a real options framework. Two types of uncertainty are distinguished: market-driven price volatility around a mean price and bifurcating price trajectories mimicking uncertainty about changing policy regimes. One of the findings is that the producer facing market uncertainty about CO₂ prices invests into carbon-saving technology earlier than if the actual price path had been known on beforehand. This is not a typical real options outcome, but the result of optimizing under imperfect information, which leads to decisions that are different from the optimal strategies under full information. On the other hand, policy uncertainty induces the producer to wait and see whether the government will further commit to climate policy. This waiting is a real options effect. In other words, if learning about government commitment is more valuable than investing into mitigation technologies immediately, the option value exceeds the value of the technology and investment will be postponed. This might lead to supply shortages and limited diffusion of less carbon-intensive technology.     

Oil and natural gas prices and greenhouse gas emission mitigation

The hikes in hydrocarbon prices during the last years have lead to concern about investment choices in the energy system and uncertainty about the costs for mitigation of greenhouse gas emissions. On the one hand, high prices of oil and natural gas increase the use of coal; on the other hand, the cost difference between fossil-based energy and non-carbon energy options decreases. We use the global energy model TIMER to explore the energy system impacts of exogenously forced low, medium and high hydrocarbon price scenarios, with and without climate policy. We find that without climate policy high hydrocarbon prices drive electricity production from natural gas to coal. In the transport sector, high hydrocarbon prices lead to the introduction of alternative fuels, especially biofuels and coal-based hydrogen. This leads to increased emissions of CO₂. With climate policy, high hydrocarbon prices cause a shift in electricity production from a dominant position of natural gas with carbon capture and sequestration (CCS) to coal-with-CCS, nuclear and wind. In the transport sector, the introduction of hydrogen opens up the possibility of CCS, leading to a higher mitigation potential at the same costs. In a more dynamic simulation of carbon price and oil price interaction the effects might be dampened somewhat.     

The long-term impact of the market stability reserve on the EU emission trading system

To provide a strong price signal for greenhouse gas emissions abatement, Europe decided to strengthen the European Union Emissions Trading System (EU ETS) by implementing a market stability reserve (MSR) that includes a cancellation policy and to increase the linear reduction factor from 1.74% to 2.2% after 2020. Results of a detailed long-term investment model, formulated as a large-scale mixed complementary problem, show that this strengthened EU ETS may quadruple EUA prices and may decrease cumulative CO₂ emissions with 21.3 GtCO₂ compared to the cumulative cap before the strengthening (52.2 GtCO₂). Around 40% of this decrease (8.3 GtCO₂) is due to the increased linear reduction factor and 60% due to the cancellation policy (13 GtCO₂). Without the increased linear reduction factor, the MSR's cancellation policy would decrease emissions by only 4.1 GtCO₂, indicating their complementarity. A sensitivity analysis on key model assumptions and parameters reveals that the impact of the MSR is, however, strongly dependent on other policies (e.g., renewable energy targets, nuclear, lignite and coal phase-outs) and cost evolutions of abatement options (e.g., investment cost reductions for wind and solar power). This renders the effective CO₂ emissions cap highly uncertain. In our simulation results, cancellation volumes range between 5.6 and 17.8 GtCO₂, which is to be compared with our central estimate of 13 GtCO₂. We calculate the required linear reduction factors to achieve these CO₂ emission reductions without an MSR, which would remove all uncertainty on the cumulative CO₂ emissions and interference with other complementary climate or energy policies.     

The EU Decarbonisation Roadmap 2050—What way to walk?

We carry out a detailed computable general equilibrium (CGE) analysis of the EU Decarbonisation Roadmap 2050 on a macroeconomic and on a sectoral level. Herein, we study a Reference scenario that implements existing EU policies as well as 3 unilateral and 3 global climate action scenarios. We identify global climate action with international emissions trading and the full equalisation of CO₂ prices across all (EU) sectors as an economically reasonable policy option to avoid additional costs of the Decarbonisation Roadmap to a large extent. This policy option may include CDM (Clean Development Mechanism in the sense of ‘where’-flexibility) in an extended form if there are countries without emissions caps. Moreover, we identify diverse sectoral effects in terms of output, investment, emissions and international competitiveness. We conclude that the successful realisation of the EU Decarbonisation Roadmap probably requires a wise and joint consideration of technology, policy design and sectoral aspects.     

Techno-economic evaluation of coal-to-liquids (CTL) plants with carbon capture and sequestration

Coal-to-liquids (CTL) processes that generate synthetic liquid fuels from coal are of increasing interest in light of the substantial rise in world oil prices in recent years. A major concern, however, is the large emissions of CO₂ from the process, which would add to the burden of atmospheric greenhouse gases. To assess the options, impacts and costs of controlling CO₂ emissions from a CTL plant, a comprehensive techno-economic assessment model of CTL plants has been developed, capable of incorporating technology options for carbon capture and storage (CCS). The model was used to study the performance and cost of a liquids-only plant as well as a co-production plant, which produces both liquids and electricity. The effect of uncertainty and variability of key parameters on the cost of liquids production was quantified, as were the effects of alternative carbon constraints such as choice of CCS technology and the effective price (or tax) on CO₂ emissions imposed by a climate regulatory policy. The efficiency and CO₂ emissions from a co-production plant also were compared to the separate production of liquid fuels and electricity. The results for a 50,000 barrels/day case study plant are presented.     

Nucs down in Germany—Prices up in Europe?

Current legislation on power production from nuclear energy in Germany defines certain remaining quantities of permitted electricity production for nuclear power plants. These quantities are defined for each nuclear power plant and are measured in TWh. In the discussion about climate protection and market trend of electricity prices, it is regularly stated by policy makers that the nuclear phase-out will result in an increase in electricity prices and CO₂ emissions. As a consequence a revision is proposed, especially from the Liberals (FDP) and Conservatives (CDU). The following article discusses this issue analysing the different options investors and operators under different scenarios have. It shows firstly that both emissions and power prices can indeed increase, and secondly that the mere discussion about potentially reversing the phasing-out decision can lead to an increase in electricity prices as investment behaviour may change based on expectations regarding future regulation. I conclude that – ceteris paribus – the nuclear phase-out is likely to result in an increase in CO₂ emissions and prices.     

Impact of international climate policies on CO2 capture and storage deployment: Illustrated in the Dutch energy system

A greenhouse gas emission trading system is considered an important policy measure for the deployment of CCS at large scale. However, more insights are needed whether such a trading system leads to a sufficient high CO₂ price and stable investment environment for CCS deployment. To gain more insights, we combined WorldScan, an applied general equilibrium model for global policy analysis, and MARKAL-NL-UU, a techno-economic energy bottom-up model of the Dutch power generation sector and CO₂ intensive industry. WorldScan results show that in 2020, CO₂ prices may vary between 20 €/tCO₂ in a Grand Coalition scenario, in which all countries accept greenhouse gas targets from 2020, to 47 €/tCO₂ in an Impasse scenario, in which EU-27 continues its one-sided emission trading system without the possibility to use the Clean Development Mechanism. MARKAL-NL-UU model results show that an emission trading system in combination with uncertainty does not advance the application of CCS in an early stage, the rates at which different CO₂ abatement technologies (including CCS) develop are less crucial for introduction of CCS than the CO₂ price development, and the combination of biomass (co-)firing and CCS seems an important option to realise deep CO₂ emission reductions.     

A real options model for renewable energy investment with application to solar photovoltaic power generation in China

This paper proposes a real options model for evaluating renewable energy investment by considering uncertain factors such as CO₂ price, non-renewable energy cost, investment cost and market price of electricity. A phase-out mechanism is built into the model to reflect the long-term changes of subsidy policy. We apply the proposed model to empirically evaluate the investment value and optimal timing for solar photovoltaic power generation in China. Our empirical results show that the current investment environment in China may not be able to attract immediate investment, while the development of carbon market helps advance the optimal investment time. A sensitivity analysis is conducted to investigate the dynamics of investment value and optimal timing under the changes of unit generating capacity, subsidy level, market price of electricity, CO₂ price and investment cost. It is found that the high investment cost and the volatility of electricity and CO₂ prices, are not conducive to attract immediate investment. Instead, increasing the level of subsidy, promoting technological progress and maintaining the stability of market are useful to stimulate investment.     

The potential impacts of climate-change policy on freshwater use in thermoelectric power generation

Climate change policy involving a price on carbon would change the mix of power plants and the amount of water they withdraw and consume to generate electricity. We analyze what these changes could entail for electricity generation in the United States under four climate policy scenarios that involve different costs for emitting CO₂ and different technology options for reducing emissions out to the year 2030. The potential impacts of the scenarios on the U.S. electric system are modeled using a modified version of the U.S. National Energy Modeling System and water-use factors for thermoelectric power plants derived from electric utility data compiled by the U.S. Energy Information Administration. Under all the climate-policy scenarios, freshwater withdrawals decline 2–14% relative to a business-as-usual (BAU) scenario of no U.S. climate policy. Furthermore, water use decreases as the price on CO₂ under the climate policies increases. At relatively high carbon prices (>$50/tonne CO₂), however, retrofitting coal plants to capture CO₂ increases freshwater consumption compared to BAU in 2030. Our analysis suggests that climate policies and a carbon price will reduce both electricity generation and freshwater withdrawals compared to BAU unless a substantial number of coal plants are retrofitted to capture CO₂.     

Exploring the price dynamics of CO2 emissions allowances in China's emissions trading scheme pilots

Establishing regional emissions trading scheme pilots in China is a newly transformative and explorative practice. In this paper, we examine the spot price dynamics, asymmetric clustering and regime-switching behaviors of CO₂ emissions allowances in the new China-wide emissions trading scheme (CETS) pilots using AR-GARCH, AR-TARCH and MRS-AR-GARCH models. The regional ETS pilots' design in China vary widely in their coverage thresholds, sector coverage, emissions allocation and caps setting methods, market trading rules and price stabilization provisions. Our empirical results indicate that the spot prices of regional emissions allowances exhibit significant dynamic behaviors, asymmetric leverage effects and regime-switching behaviors in the entire period considered; previous market overreactions in the Beijing, Tianjin and Guangdong pilots have stronger price clustering effects on future conditional variances than do the Shanghai and Hubei pilots. Unexpected market shocks and greater persistence in the Beijing, Tianjin and Guangdong ETS pilots display stronger market volatility and higher market risks, and their asymmetric leverage effects display a decreasing trend in the volatility of the BEA, TJEA and GDEA prices. The BEA and SHEA prices exhibit significant regime-switching behaviors, price jumps and higher volatility; in addition, the changes in the regime-switching phases are often related to the political mechanism design and the fundamental market factors. Those empirical results are beneficial for government decision-makers and market participants to strengthen risk management strategies, support emission-related investment decisions and optimize co-benefits of alternative energy-environmental policies.     

Evaluating the power investment options with uncertainty in climate policy

This paper uses a real options approach (ROA) for analysing the effects of government climate policy uncertainty on private investors’ decision-making in the power sector. It presents an analysis undertaken by the International Energy Agency (IEA) that implements ROA within a dynamic programming approach for technology investment choice. Case studies for gas, coal and nuclear power investment are undertaken with the model. Illustrative results from the model indicate four broad conclusions: i) climate change policy risks can become large if there is only a short time between a future climate policy event such as post-2012 and the time when the investment decision is being made; ii) the way in which CO₂ and fuel price variations feed through to electricity price variations is an important determinant of the overall investment risk that companies will face; iii) investment risks vary according to the technology being considered, with nuclear power appearing to be particularly exposed to fuel and CO₂ price risks under various assumptions; and iv) the government will be able to reduce investors' risks by implementing long-term (say 10 years) rather than short-term (say 5 years) climate change policy frameworks. Contributions of this study include: (1) having created a step function with stochastic volume of jump at a particular time to simulate carbon price shock under a particular climate policy event; (2) quantifying the implicit risk premium of carbon price uncertainty to investors in new capacity; (3) evaluating carbon price risk alongside energy price risk in investment decision-making; and (4) demonstrating ROA to be a useful tool to quantify the impacts of climate change policy uncertainty on power investment.     

Benefits of using an optimization methodology for identifying robust process integration investments under uncertainty—A pulp mill example

This paper presents a case study on the optimization of process integration investments in a pulp mill considering uncertainties in future electricity and biofuel prices and CO₂ emissions charges. The work follows the methodology described in Svensson et al. [Svensson, E., Berntsson, T., Strömberg, A.-B., Patriksson, M., 2008b. An optimization methodology for identifying robust process integration investments under uncertainty. Energy Policy, in press, doi:10.1016/j.enpol.2008.10.023] where a scenario-based approach is proposed for the modelling of uncertainties. The results show that the proposed methodology provides a way to handle the time dependence and the uncertainties of the parameters. For the analyzed case, a robust solution is found which turns out to be a combination of two opposing investment strategies. The difference between short-term and strategic views for the investment decision is analyzed and it is found that uncertainties are increasingly important to account for as a more strategic view is employed. Furthermore, the results imply that the obvious effect of policy instruments aimed at decreasing CO₂ emissions is, in applications like this, an increased profitability for all energy efficiency investments, and not as much a shift between different alternatives.     

Adjusting productivity measures for CO2 emissions control: Evidence from the provincial thermal power sector in China

We examine productivity changes by the types of environmental regulations used to control CO₂ emissions in the provincial, thermal power sector of China from 2009 to 2016. We derive a Törnqvist-type productivity index in which CO₂ emissions are undesirable outputs. The shadow price of CO₂, required for calculating the index, is estimated based on the duality between a revenue and a directional output distance function. Productivity changes are measured using both estimated shadow prices and the actual trading prices of CO₂ in six pilot emissions trading systems. We find that productivity measurement is highly dependent on the choice of CO₂ prices. We also investigate the impact of emission intensity and emissions per se on productivity measurement. We show that productivity measurement depends on the choice of environmental standard.     

An empirical analysis of the CO2 shadow price in Chinese thermal power enterprises

This paper estimates the shadow price of CO₂ and explores its determinants for thermal power enterprises in China. Using a parametric quadratic directional distance function, we evaluate the inefficiency and shadow price of CO₂ for 124 power enterprises in 2004, applying deterministic and econometric methods. A regression analysis is undertaken to examine the factors that drive shadow prices. Our results indicate that there are large inefficiencies in terms of electricity production and CO₂ emissions. The shadow price is a negative function of firm size, age, and coal share, and is positively correlated with the technology level. This correlation between shadow prices and its determinants is not sensitive to changing assumptions regarding directional vectors, although such changes do alter the distribution of shadow prices. The large variation witnessed in shadow prices across power enterprises argues in favor of market-based regulation such as an emissions trading system as opposed to the command-and-control regulation currently used in China to minimize overall abatement cost.     

Competition and environmental policies in an electricity sector

We study the impact of competition and environmental policy (feed-in tariff vs. the EU ETS) on investment, CO₂ emissions and welfare in an electricity sector. We consider different market structures (a planner who maximises social welfare vs. duopoly) and two types of consumers (those whose behaviour depends on the weather vs. those whose behaviour does not). The demand specification is innovative and takes incompressible consumption into account.Given the costs and demand functions, we find that competition can increase CO₂ emissions, as is highlighted by Mansur (2007). In duopoly, the EU ETS seems to be the only efficient policy for reducing CO₂ emissions but also to increase the share of production based on renewable energy sources. The retained feed-in tariff policy seems to be the most expensive policy in terms of “social welfare”. Even if this policy seems to increase “social welfare”, feed-in tariffs increase the CSPE, which is paid for by consumers in the form of higher electricity prices and only benefits new entrants. It is also less effective in terms of emission reduction.     

What explain the short-term dynamics of the prices of CO2 emissions?

Using a Bayesian Structural VAR (BSVAR), this paper analyzes the short-term dynamics of the prices of CO₂ emissions in response to changes in the prices of oil, coal, natural gas and electricity. The results show that: (i) a positive shock to the crude oil prices has an initial positive effect on the CO₂ allowance prices, which later becomes negative; (ii) an unexpected increase in the natural gas prices reduces the price of CO₂ emissions; (iii) a positive shock to the prices of the fuel of choice, coal, has virtually no significant impact on the CO₂ prices; (iv) there is a clear positive effect of the coal prices on the CO₂ allowance prices when the electricity prices are excluded from the BSVAR system; and (v) a positive shock to the electricity prices has a negative impact on the price of the CO₂ allowances. We also find that the energy price shocks have a persistent impact on the CO₂ allowance prices, with the largest effect occurring 6 months after a shock strikes. The effect is particularly strong in the case of the shocks to the natural gas and crude oil prices. Finally, the empirical findings suggest an important degree of substitution between the three primary sources of energy (i.e., crude oil, natural gas and coal), particularly when electricity prices are excluded from the BSVAR system.     

The shadow prices of CO2 and SO2 for Chinese Coal-fired Power Plants: A partial frontier approach

Shadow prices are widely employed in guiding environmental policies. This paper contributes to the literature by developing a novel partial frontier approach for estimating shadow prices. The proposed method is advanced in handling outliers, and provides a precise estimation of the marginal rate of substitution along the production frontier. To cope with the different disposability characteristics of undesirable emissions, SO₂ is treated as an environmental input that is strongly disposable. Because most different undesirable outputs are jointly reduced, this study is the first to use directional derivatives instead of partial derivatives and proposes a new separation method that separates individual directional shadow price from the cost of joint reduction of multiple undesirable outputs. We apply the proposed method to a sample of 93 coal-fired power plants covering six years. The estimated average shadow prices of CO₂ and SO₂ are 69 $/tonne and 2525 $/tonne under the newly developed partial frontiers. When assuming some undesirable output to be strongly disposable, both shadow prices fall (20.32 $/tonne and 1018.23 $/tonne). The present paper suggests the estimated shadow prices will be much different across different levels of disposability. The cost of joint reduction is calculated as 91.05 $/unit given the current production level, which leads to a directional shadow price for the two undesirable outputs of 91.32 $/tonne and 1250.06 $/tonne. The estimated shadow prices for both undesirable outputs dispersed widely under the partial frontiers. Spatial distribution of estimated shadow prices shows that coastal provinces and municipalities have higher CO₂ shadow prices but lower SO₂ shadow prices, whereas the northeast provinces are the opposite. The CO₂ shadow price is comparatively stable over the study period while the SO₂ shadow price fluctuates. Policy implications are discussed.     

Comparison of options for utilization of a potential steam surplus at kraft pulp mills—Economic performance and CO2 emissions

This paper compares different energy‐related investment options that can be implemented in a kraft pulp mill with a potential steam surplus. The options investigated include lignin extraction, electricity production, capturing of CO₂ and black liquor gasification with production of electricity or biofuels, here DME. The investment options are compared with respect to annual net profit and global CO₂ emissions for different future energy market scenarios. A further analysis of how different parameters such as policy instruments and investment costs affect the different technologies also is included. The results show that, generally, for reasonable levels of biofuel support, the best economic performance among the studied technologies is achieved by extraction of lignin valued as oil. However, if the level of support for biofuels is high, black liquor gasification with DME production generally has the best economic performance among the studied options. All the investment options investigated decrease global CO₂ emissions significantly. Capturing and storing CO₂ from the recovery boiler flue gases result in the highest CO₂ emissions reduction and also is an economically attractive option in scenarios with a high CO₂ emissions charge. Copyright © 2012 John Wiley & Sons, Ltd.