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The real option to fuel switch in the presence of expected windfall profits under the EU Emission Trading Scheme

Taschini, Luca and Urech, Simon (2010) The real option to fuel switch in the presence of expected windfall profits under the EU Emission Trading Scheme. Journal of Energy Markets. ISSN 1756-3607

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Abstract

This paper develops a simple model to evaluate the value and the activation frequencies of a generation system consisting of coal-fired and a gas-fired power plants using a real options approach, and the notions of clean-spark and clean-dark spreads. Under a cap-and-trade scheme, the use of emission permits represents an opportunity cost. In the energy industry different generation technologies produce different levels of CO2 emissions and, therefore, different opportunity costs. Addressing the question of how expected windfall profits affect the profitability of a generation plant and its activation frequencies, the paper shows that conventional findings are reversed. When the opportunity cost is internalized, the rate of activation of the gas plant decreases while that of the coal plant increases.

Item Type: Article
Official URL: http://www.risk.net/type/technical-paper/source/jo...
Additional Information: © 2010 Incisive Risk Information (IP) Limited
Divisions: Grantham Research Institute
Subjects: G Geography. Anthropology. Recreation > GE Environmental Sciences
H Social Sciences > HA Statistics
JEL classification: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods: General > C13 - Estimation
C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods: General > C15 - Statistical Simulation Methods; Monte Carlo Methods; Bootstrap Methods
Q - Agricultural and Natural Resource Economics; Environmental and Ecological Economics > Q4 - Energy > Q40 - General
Sets: Research centres and groups > Grantham Research Institute on Climate Change and the Environment
Date Deposited: 25 Jan 2016 11:25
Last Modified: 30 Jan 2019 18:21
URI: http://eprints.lse.ac.uk/id/eprint/65130

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