Effects of Low-Cost Offsets on Energy Investment - New Perspectives on REDD

20 Pages Posted: 4 May 2009

See all articles by Sabine Fuss

Sabine Fuss

Mercator Research Institute on Global Commons and Climate Change (MCC); International Institute for Applied Systems Analysis (IIASA)

Alexander Golub

Environmental Defense

Jana Szolgayova

Department of Applied Mathematics and Statistics, Faculty of Mathematics, Physics and Informatics - Comenius University, Slovakia; International Institute of Systems Analysis, Austria

Michael Obersteiner

International Institute for Applied Systems Analysis (IIASA); Institute for Advanced Studies (IHS)

Date Written: April 30, 2009

Abstract

Tropical deforestation is one of the major sources of carbon emissions, but the Kyoto Protocol presently excludes avoiding these specific emissions to fulfill stabilization targets. Since the 13th Conference of the Parties (COP) to the UNFCCC in 2007, where the need for policy incentives for the reduction of emissions from deforestation and degradation (REDD) was first officially recognized, the focus of this debate has shifted to issues of implementation and methodology. One question is how REDD would be financed, which could be solved by integrating REDD credits into existing carbon markets. However, concern has been voiced regarding the effects that the availability of cheap REDD credits might have on energy investments and the development of clean technology. On the other hand, investors and producers are also worried that emissions trading schemes like the one installed in Europe might deter investment into new technologies and harm profits of existing plants due to fluctuations in the price of emissions permits. This paper seeks to contribute to this discussion by developing a real options model, where there is an option to invest in less carbon-intensive energy technology and an option to purchase credits on REDD, which you will exercise or not depending on the future evolution of CO2 prices. In this way, unresolved questions can still be addressed at a later stage, while producers and investors hold REDD options to maintain flexibility for later decisions. We find that investment in cleaner technology is not significantly affected if REDD options are priced as a derivative of CO2 permits. Indeed, the availability of REDD options helps to smooth out price fluctuations that might arise from permit trading and thus decreases risk for the producer - thereby being a complement to permit trading rather than an obstacle undermining cap-and-trade.

Keywords: Real Options, Energy Investment, Cap-And-Trade, REDD

JEL Classification: Q23, Q28

Suggested Citation

Fuss, Sabine and Golub, Alexander and Szolgayova, Jana and Obersteiner, Michael, Effects of Low-Cost Offsets on Energy Investment - New Perspectives on REDD (April 30, 2009). FEEM Working Paper No. 17.2009. Available at SSRN: https://ssrn.com/abstract=1397144 or http://dx.doi.org/10.2139/ssrn.1397144

Sabine Fuss (Contact Author)

Mercator Research Institute on Global Commons and Climate Change (MCC) ( email )

Torgauer Straße 12-15
Berlin, 10829
Germany
49303385537224 (Phone)
303385537224 (Fax)

HOME PAGE: http://www.mcc-berlin.net

International Institute for Applied Systems Analysis (IIASA) ( email )

Schlossplatz 1
Laxenburg, 2361
Austria

HOME PAGE: http://www.iiasa.ac.at

Alexander Golub

Environmental Defense ( email )

New York, Nat'l Headquarters
257 Park Avenue South
New York, NY 10010
United States
202-387-3500 (Phone)

Jana Szolgayova

Department of Applied Mathematics and Statistics, Faculty of Mathematics, Physics and Informatics - Comenius University, Slovakia ( email )

Mlynská dolina
SK-842 48 Bratislava, 842 48
Slovakia

International Institute of Systems Analysis, Austria

United States

Michael Obersteiner

International Institute for Applied Systems Analysis (IIASA) ( email )

Schlossplatz 1
Laxenburg, A-2361
Austria

Institute for Advanced Studies (IHS) ( email )

Josefstädter Straße 39
1080 Vienna
Austria

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