How Emission Certificate Allocations Distort Fossil Investments: The German Example

33 Pages Posted: 27 Feb 2011

See all articles by Michael Pahle

Michael Pahle

Potsdam Institute for Climate Impact Research (PIK)

Lin Fan

affiliation not provided to SSRN

Wolf-Peter Schill

DIW Berlin - Department of Energy, Transportation, Environment

Date Written: January 2011

Abstract

Despite political activities to foster a low-carbon energy transition, Germany currently sees a considerable number of new coal power plants being added to its power mix. There are several possible drivers for this "dash for coal", but it is widely accepted that windfall profits gained through free allocation of ETS certificates play an important role. Yet the quantification of allocation-related investment distortions has been limited to back-of-the envelope calculations and stylized models so far. We close this gap with a numerical model integrating both Germany's particular allocation rules and its specific power generation structure. We find that technology specific new entrant provisions have substantially increased incentives to invest in hard coal plants compared to natural gas at the time of the ETS onset. Expected windfall profits compensated more than half the total capital costs of a hard coal plant. Moreover, a shorter period of free allocations would not have turned investors' favours towards the cleaner natural gas technology because of preexisting economic advantages for coal. In contrast, full auctioning of permits or a single best available technology benchmark would have made natural gas the predominant technology of choice.

Keywords: Emissions trading, Allocation rules, Power markets, Investments

JEL Classification: Q48, Q54, Q58

Suggested Citation

Pahle, Michael and Fan, Lin and Schill, Wolf-Peter, How Emission Certificate Allocations Distort Fossil Investments: The German Example (January 2011). DIW Berlin Discussion Paper No. 1097, Available at SSRN: https://ssrn.com/abstract=1767908 or http://dx.doi.org/10.2139/ssrn.1767908

Michael Pahle

Potsdam Institute for Climate Impact Research (PIK) ( email )

Telegrafenberg 31
Potsdam, Brandenburg 14473
Germany

Lin Fan

affiliation not provided to SSRN ( email )

Wolf-Peter Schill (Contact Author)

DIW Berlin - Department of Energy, Transportation, Environment ( email )

Mohrenstra├če 58
Berlin, 10117
Germany

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