Investing in power plants: effects of volatile CO2 prices and price caps
A recent study has modelled the effects of carbon dioxide prices and price caps on decisions to investment in new power plants. It found that unstable prices can encourage development of coal-fired power stations fitted with carbon capture and storage (CCS) technology. In addition, low price caps on carbon are not likely to encourage a switch to biomass-fired power plants.
The EU is committed to reducing greenhouse gas (GHG) emissions, supplying more energy from renewable sources and maintaining energy security. However, debate has focused on the most suitable means of achieving all these aims. The EU Emissions Trading Scheme1 has led to fluctuations in the price of carbon, which can influence investment decisions in the energy sector.
Researchers analysed the potential impact of four policy scenarios on the decisions taken by a hypothetical electricity provider looking to open a new power plant, with two different pricing options:
investment under an emission-trading scheme, with a fluctuating carbon price, both with and without CO2 price caps, which were set at 40, 50 and 60 Euros/ton
investment under a carbon tax scheme with a deterministic, or known, but gradually rising, carbon price (both with and without CO2 price caps as specified above, for comparison with the fluctuating price scenario)
Price caps are often regarded as safety valves, smoothing out unpredictability in the carbon price. The cap must, however, be high enough to still encourage a switch to less carbon-intensive energy.
In the hypothetical case studied, options for the new power plants included a biomass-fired or a new coal-fired power plant. Analysis showed that with a deterministic carbon price (essentially an escalating tax), greater profits could be generated from building a biomass-fired power station. If, however, CO2 price caps were introduced, profits from the biomass-fired station would fall considerably (by 33 percent), while a new, coal-fired power station would see profits increasing slightly (about 5 percent).
Under a pure emission-trading scheme, where prices fluctuate, the study showed that a biomass-fired power station would be more exposed to a volatile carbon price than a coal-fired power station. Furthermore, the introduction of a price ceiling would protect coal-fired energy producers. However, biomass-fired power generators would not be similarly protected as there are no plans for a price floor.
Implementation of CCS technology could substantially help reduce emissions and the researchers explored the effects of CO2 price caps on the decision to fit this technology. As long as the price cap was not set too low, neither coal-fired nor biomass-fired power suppliers would be deterred from investing in CCS technology, regardless of the actual level of the price cap. However, in the scenario investigated a price cap below 50 Euros/ton would discourage suppliers from fitting this technology.
The study suggests that stringent price caps would undermine policy efforts to provide incentives for energy suppliers to build new plants from renewable sources. It also suggests that policy makers should provide clear guidance about the future direction of carbon pricing, so that investment decisions can be made to replace ageing power plants by less carbon-intensive technology. In addition, the concerns that volatile CO2 prices may hurt power producers and deter investment in renewables and mitigation technology were not found to be warranted.
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