On the option to invest in pollution control under a regime of tradable emissions allowances

Abstract

Optimal decisions of a firm facing the option of retrofitting its plant to reduce pollution and thereby eliminate the need to purchase emissions allowances are analysed. The decision is treated as a real option with the price of pollution permits following a known stochastic process. The model is formulated as a set of one-dimensional partial differential equations. At discrete points in time, the firm owner makes optimal decisions about the retrofit, including whether to mothball temporarily. The model is used to analyse a firm's decision to instal a scrubber as a result of the 1990 U.S. Clean Air Act. JEL Classification: Q25, D81, G31Sur la possibilite´d'investir dans le controˆle de la pollution dans un re´gime de permis d'e´mission de pollution e´changeables commercialement. Ce me´moire examine les de´cisions optimales d'une entreprise face a`la possibilite´d'adapter ses installations pour re´duire la pollution, et ce faisant d'e´liminer le besoin de se procurer des permis d'e´mission de pollution sur le marche´. Le de´cision est traite´e comme une option re´elle ou`le prix des permis re´sulte d'un processus stochastique connu. Le mode`le est formule´sous forme d'un ensemble d'e´quations diffe´r-entielles partielles a`une dimension. A des points discontinus dans le temps, le proprie´taire de l'entreprise prend des de´cisions optimales de mise a`niveau des installations -y compris la possibilite´de les fermer temporairement. Le mode`le est utilise´pour analyser une de´cision d'installer un e´purateur suite a`la mise en place de la loi ame´ricaine de 1990 (Clean Air Act).

Valuation of energy storage: an optimal switching approach

“…the local power utilities, are obligated to provide power irrespective of demand. The latter is stochastic so that the LSE faces uncertain demand (volume risk), coupled with uncertain fuel prices (price risk Insley (2003).…”

The Endogenous Price Dynamics of Emission Allowances and an Application to CO2Option Pricing

“…Further, there are several reasonable explanations that can provide elements of irreversibility to fuel-switching decisions. For instance, Insley (2003) discusses the case of fuel contracts with long maturities in order to lock in a particular price premium.…”

The effects of environmental taxes and quotas on the optimal timing of emission reductions under Choquet–Brownian uncertainty

“…The deterministic part of the process (11) is the same as before 14 . To analyze the e¤ects of ambiguity on the value of adopting the environmental policies we adapt Kast, Lapied and Roubaud (2010) and assume that the regulator's beliefs are represented by "c ignorance", so that the new geometric Brownian motion for X t becomes 15 :…”

“…Boundary conditions (14) and (15) re ‡ect the fact that if X t is ever zero, it will remain at zero thereafter. Conditions (16) and (17) are the value matching and the smooth-pasting conditions, respectively.…”

“…Xepapadeas (2001) studies the behaviour of polluting …rms regarding the expansion of abatement capital and location decisions in the presence of emission taxes, tradable permits and subsidies for the abatement investment under irreversibility. Insley (2003) studies the decision of an electric power utility regarding the abatement of sulfur dioxide (SO 2 ) emissions by installing a scrubber, assuming that SO 2 permit prices are stochastic and the construction process includes "time-to-build". Van Soest (2005) analyzes the impact of emission taxes and quotas on the timing of adoption of energy-saving technologies under irreversibility and stochastic arrival rate of the new technologies, and shows that: (i) increased environmental stringency (measured in tax and its equivalent in terms of quota) does not necessarily induce early adoption, and (ii) there is no unambiguous ranking of policy instruments in terms of the length of the adoption lag.…”