Input choice under carbon constraint

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English
25 pages
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Niveau: Supérieur, Doctorat, Bac+8
Input choice under carbon constraint Alain Bousquet University of Tours and LERNA, University of Toulouse Anna Creti University Paris Ouest Nanterre La Défense and Università Bocconi March 2010 Abstract This paper assesses the impact of emission trading on short-term input demand as well as on long-term production decisions, tacking into account the possibility of input substitions. After setting a simple model based on standard production theory and aimed at carachteriz- ing the virtual threshold price such that the long term capacity choice is optimal, we discuss the impact of input price uncertainty. Firms decisions will depend on the complex interplay between three e?ects. First, the average e?ect, due to the carbon price, causes a decrease in the input capacity with respect to a reference case where the permits market does not exist. Second, the marginal e?ect or the impact of price variability, which instead leads to an expansion of the installed equipment. Third, in the short term, these decisions interact with the technology e?ect, i.e. substitution between the polluting and clean inputs. Models simulations show that this interaction can result in weak emission reductions. 1 Introduction Most of the literature concerning the e?ect of environmental policy on ?rms? long term decisions focuses on cleaner technology innovation and di?usion and compares di?erent policy approaches, generally arguing that market- 1

  • co2 reduction bene?ts

  • can a?ect

  • european

  • term production

  • input price

  • short term

  • gas-?red units

  • effc coal


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InputchoiceundercarbonconstraintAlainBousquetUniversityofToursandLERNA,UniversityofToulouseAnnaCretiUniversityParisOuestNanterreLaDéfenseandUniversitàBocconiMarch2010AbstractThispaperassessestheimpactofemissiontradingonshort-terminputdemandaswellasonlong-termproductiondecisions,tackingintoaccountthepossibilityofinputsubstitions.Aftersettingasimplemodelbasedonstandardproductiontheoryandaimedatcarachteriz-ingthevirtualthresholdpricesuchthatthelongtermcapacitychoiceisoptimal,wediscusstheimpactofinputpriceuncertainty.Firmsdecisionswilldependonthecomplexinterplaybetweenthreeeffects.First,the"averageeffect",duetothecarbonprice,causesadecreaseintheinputcapacitywithrespecttoareferencecasewherethepermitsmarketdoesnotexist.Second,the"marginaleffect"ortheimpactofpricevariability,whichinsteadleadstoanexpansionoftheinstalledequipment.Third,intheshortterm,thesedecisionsinteractwiththe"technologyeffect",i.e.substitutionbetweenthepollutingandcleaninputs.Modelssimulationsshowthatthisinteractioncanresultinweakemissionreductions.1IntroductionMostoftheliteratureconcerningtheeffectofenvironmentalpolicyonfirms’longtermdecisionsfocusesoncleanertechnologyinnovationanddiffusionandcomparesdifferentpolicyapproaches,generallyarguingthatmarket-1
basedinstrumentsaresuperiortocommand-and-controlregulation1.Lessisknownontheinteractionbetweenend-of-pipeabatementdecisionsandlongterminvestmentinproductivecapacity.Infact,intheshort-term,onlymar-ginalchangesintheproductiontechnologyarefeasible.WhenamarketforpermitsliketheEuropeanTradingScheme(henceforth,EUETS)isintro-duced,eachregulatedfirmfacesabasicchoicebetweenbuying(orselling)allowances,andusingalternativetechnologiestoreduceemissions.Pollu-tioncanbeoffsetintwoways.First,byloweringtheoutputscale.Second,theproductionprocessortheinputsused,suchasfuelsforinstance,canbealtered.Largefirms,inordertoaccomplishthealreadyexistingsevereEuropeanenvironmentalregulations,havemostlyreachedhighenvironmen-talstandardseitherinproductionprocessesorinreducingtheoffendinggasreleasedasaby-productintheair.Therefore,duetosuchadvancedtechno-logicalsituation,coupledwithacharacteristicinelasticdemandforparticularproductssuchaselectricityorore-miningmaterials,2abatingbyreducingtheoutputscalecanbeconsideredastheexceptionratherthantherule.3IntheEUETS,thelargestaffectedsectorthatreceivedtheloweramountofinitialpermits,i.e.thefuel-burnenergyproducers,canuseacheapestshort-term(orend-of-pipe)abatementalternative,i.e.fuel-switching.Thisprocessinvolvesthereplacementofhigh—carbon(sulphur)fuelswithlow—carbon(sulphur)alternatives.ThereisempiricalevidencethatduringtheEUETSPhaseI(i.e.from2005to2007),carbonpricehasinducedsomeemissionsabatement,intheformofintra-fuelsubstitution(browntohardcoal)inGermanyandimprovedCO2efficiencyintheUK(Converyetal,2008).Delarueetal.(2008)calculatetheallowancecostnecessarytoswitchacertaincoal-firedplantwithacertaingas-firedplantinthemeritorder,hencetheallowancecostobtainedisasocalledswitchingpoint.Whencom-paringhistoricEuropeanUnionAllowance(EUA)pricesin2005withthe1Somepapersconsideronlytheincentivesforresearchandinnovationwhileothersstudythediffusionofthenewtechnology(DowningandWhite,1986;Fisheretal.1998,Jungetal.,1996;Millimanetal.1989).Otherpapersfocusonthetimingofenvironmentalpolicyandshowthat,insomecases,thistiminginfluencestherankingofthealternativeinstruments(Jaffeetal.,2002provideanextensivesurveyontechnologicalchangeandenvironmentalproblems).Anotherstrandoftheliteratureisconcernedwiththeimpactoftechnologicalchangeonmarginalabatementcost,inamacroeconomicperspective(forasurvey,seeBakeretal,2007).2Thelargestallocationscorrespondrespectivelytoironandsteelproducers,non-metallicmineralproducersandenergyproducers3SeeSzaboetal.(2006)foramorecomprehensivediscussion.2