Technology Choice and Capacity Portfolios under Emissions Regulation

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.

Cooperation Modes of Operations and Financing in a Low-Carbon Supply Chain

“…Yang et al [37] investigated the impact of carbon emission trading, carbon tax, and cap-and-trade on channel coordination. Drake et al [38] looked at how cap-and-trade scheme and carbon tax influence the optimal decision of firm. Carl and Fedor [39] analyzed public revenue generated from global carbon tax and cap-and-trade scheme.…”

A framework and risk analysis for supply chain emission trading

“…The literature is common in presenting mathematical models to integrate carbon prices explicitly in green supply chain design and to justify the cost-effectiveness of applying the emission trading policy into the context of supply chain [12][13][14][15][16][17]. This quantitative analysis allows evaluating impacts of different decision alternatives in terms of logistics cost and carbon footprint.…”

OM Forum—Sustainable Operations Management: An Enduring Stream or a Passing Fancy?

“…The analysis inİşlegen and Reichelstein (2011) is multidisciplinary in that it addresses discrete technology choice, while applying costing methodology derived in the energy literature (levelized cost of electricity), and explicitly accounting for differences in U.S. state-level power generation policy. Drake et al (2012) analyze a firm's optimal portfolio of discrete technologies under carbon regulation, advising carbon policy by countering conventional wisdom, showing that the firm earns greater expected profit under cap-and-trade than a carbon tax due to emissions price uncertainty under the former and the option not to produce. 2 The authors also summarize the motivating example from this research in a pedagogical case as a vehicle to communicate their principal findings to students, executives, and policy makers (Drake et al 2013).…”