Does a cap on the carbon price have to be a cap on green investments?
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Policy makers and economists are discussing a regulatory ceiling for carbon prices, acting as a “safety valve” for the protection of regulated businesses from unexpected price surges. While the pros and cons of such a regulatory feature are widely discussed in the literature, the optimal design of such a cap and the attendant economic and environmental consequences have yet to be subjected to quantitative analyses. We employ a Monte Carlo simulation/dynamic programming approach to investigate the impact of different carbon price cap designs on an individual firm in the energy generation industry. Specifically, we model the firm’s choice between a pulverized coal combustion plant and a combined cycle gas turbine plant, a large hydropower plant, a solid biomass plant and an on-shore wind farm. Our results show that the effects of a maximum carbon price set by the regulator is largely independent of its exact characteristics, albeit not of its level. A higher cap favors low-carbon technologies in general. However, due to differences in their cost structures, a price cap has different impacts on the relative attractiveness of the specific alternative technologies investigated.
KeywordsCarbon price Price cap Market design Power sector Investment decision
JEL ClassificationD81 O38 Q55
We thank two anonymous referees for their speedy work and helpful comments as well as the participants of the 2011 meeting of the Austrian Economic Association in Graz for valuable comments. All errors are our own.
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