EPRG 0625

Roland Ismer, Karsten Neuhoff

Commitments through Financial Options: A Way to Facilitate Compliance with Climate Change Obligations

EPRG 0625 Non-Technical Summary | PDF

Also published in:

• Grubb, M. and Neuhoff, K. (2006), “Allocation and Competitiveness in the EU Emissions Trading Scheme: Policy Overview”, Climate Policy 6(1)

Abstract: Governments willing to commit themselves to maintain carbon prices at or above a certain level face the challenge that their commitments need to be credible both towards investors in low carbon technology and towards foreign governments. The present paper argues that governments can make such commitments by issuing long-term put option contracts on the price of CO2 allowances. It also explains the contract structure that protects against government interference, which potentially threatens the credibility of commitments.

Keywords: investment, uncertainty, Monte-Carlo simulation, operating flexibility