EPRG 1004

Tim Laing and Michael Grubb

The Impact of Instrument Choice on Investment in Abatement Technologies: A Case Study of Tax versus Trade Incentives for CCS and Biomass for Electricity

EPRG 1004  | Non-Technical Summary | PDF

Abstract: There has been a wide discussion on the different properties between carbon taxes, cap-and-trade schemes and hybrid instruments such as cap-and- trade schemes with price floors and ceilings. There has been less discussion on the incentives to investment that each of these instruments may provide. We build a three-period model to investigate the incentives offered to a large firm with diversified abatement options from such instruments when facing a choice between investing in low-carbon technologies with potential learning benefits. We parameterise our model for a system similar to the EUETS and for two sample technologies, biomass for electricity and coal with carbon capture and storage. For both technologies we find that cap-and-trade schemes generate greater mean returns to such an investment than taxes, but with a wider distribution. We find that introducing price floors increase such mean returns while reducing the distribution, while ceilings further reduce the distribution, but also the mean and thus the overall incentives they offer will depend on the risk preference of the firm and scale of investment in relation to overall compliance costs.

Keywords: Carbon Markets, Investment, Cap-and-trade, CCS, Biomass

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