Technology Choice and Capacity Portfolios under Emissions Regulation

33 Pages Posted: 4 Nov 2010 Last revised: 6 Oct 2015

See all articles by David Drake

David Drake

University of Colorado at Boulder - Leeds School of Business

Paul R. Kleindorfer

University of Pennsylvania - Operations & Information Management Department; Paul Dubrule Professor of Sustainable Development & Distinguished Research Professor at INSEAD

Luk N. Van Wassenhove

INSEAD

Date Written: September 30, 2015

Abstract

We study the impact of emissions tax and emissions cap-and-trade regulation on a firm's technology choice and capacity decisions. We show that emissions price uncertainty under cap-and-trade results in greater expected profit than a constant emissions price under an emissions tax, which contradicts popular arguments that the greater uncertainty under cap-and-trade will erode value. We further show that two operational drivers underlie this result: i) the firm's option not to operate, which effectively right-censors the uncertain emissions price; and ii) dispatch flexibility, which is the firm's ability to first deploy its most profitable capacity given the realized emissions price. In addition to these managerial insights, we also explore policy implications: the effect of emissions price level, and the effect of investment and production subsidies. Through an illustrative example, we show that production subsidies of higher investment and production cost technologies (such as carbon capture and storage technologies) have no effect on the firm's optimal total capacity when firms own a portfolio of both clean and dirty technologies, but that investment subsidies of these technologies increase the firm's total capacity, conditionally increasing expected emissions. A subsidy of a lower production cost technology, on the other hand, has no effect on the firm's optimal total capacity in multi-technology portfolios, regardless of whether the subsidy is a production or investment subsidy.

Keywords: Technology Choice, Capacity Investment, Carbon Regulation, Sustainable Operations

Suggested Citation

Drake, David and Kleindorfer, Paul R. and Van Wassenhove, Luk N., Technology Choice and Capacity Portfolios under Emissions Regulation (September 30, 2015). Production and Operations Management. (Forthcoming), INSEAD Working Paper No. 2010/93/TOM/INSEAD Social Innovation Centre, Harvard Business School Technology & Operations Mgt. Unit Working Paper No. 12-079, Available at SSRN: https://ssrn.com/abstract=1702186 or http://dx.doi.org/10.2139/ssrn.1702186

David Drake (Contact Author)

University of Colorado at Boulder - Leeds School of Business ( email )

Boulder, CO 80309-0419
United States

Paul R. Kleindorfer

University of Pennsylvania - Operations & Information Management Department ( email )

Philadelphia, PA 19104
United States

Paul Dubrule Professor of Sustainable Development & Distinguished Research Professor at INSEAD

Boulevard de Constance
77305 Fontainebleau Cedex
France

Luk N. Van Wassenhove

INSEAD ( email )

Boulevard de Constance
77 305 Fontainebleau Cedex
France
(33) (0)1 60 72 42 66 (Phone)
(33) (0)1 60 72 40 49 (Fax)

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