The Real Option to Fuel Switch in the Presence of Expected Windfall Profits Under the EU ETS

The Journal of Energy Markets, Vol. 3, No. 2, 2010

21 Pages Posted: 17 Aug 2009 Last revised: 21 Sep 2010

See all articles by Luca Taschini

Luca Taschini

London School of Economics & Political Science (LSE) - Grantham Research Institute on Climate Change and the Environment; University of Verona - Department of Economics

Simon Urech

ETH Zürich

Date Written: August 1, 2009

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.

Keywords: Activation frequency, Dark-spread, Emission permits, Generation Mix, Spark-spread

JEL Classification: C13, C15, Q40

Suggested Citation

Taschini, Luca and Urech, Simon, The Real Option to Fuel Switch in the Presence of Expected Windfall Profits Under the EU ETS (August 1, 2009). The Journal of Energy Markets, Vol. 3, No. 2, 2010. Available at SSRN: https://ssrn.com/abstract=1456406

Luca Taschini (Contact Author)

London School of Economics & Political Science (LSE) - Grantham Research Institute on Climate Change and the Environment ( email )

Houghton Street
London, WC2A 2AE
Great Britain

University of Verona - Department of Economics ( email )

Via Cantarane 24
Verona, Verona 37129
Italy

Simon Urech

ETH Zürich ( email )

Zürichbergstrasse 18
8092 Zurich, CH-1015
Switzerland

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