How Emission Certificate Allocations Distort Fossil Investments: The German Example

Michael Pahle, Lin Fan and Wolf-Peter Schill

No 1097, Discussion Papers of DIW Berlin from DIW Berlin, German Institute for Economic Research

Abstract: Despite political activities to foster a low-carbon energy transition, Germany currently sees a considerable number of new coal power plants being added to its power mix. There are several possible drivers for this "dash for coal", but it is widely accepted that windfall profits gained through free allocation of ETS certificates play an important role. Yet the quantification of allocation-related investment distortions has been limited to back-of-the envelope calculations and stylized models so far. We close this gap with a numerical model integrating both Germany's particular allocation rules and its specific power generation structure. We find that technology specific new entrant provisions have substantially increased incentives to invest in hard coal plants compared to natural gas at the time of the ETS onset. Expected windfall profits compensated more than half the total capital costs of a hard coal plant. Moreover, a shorter period of free allocations would not have turned investors' favours towards the cleaner natural gas technology because of preexisting economic advantages for coal. In contrast, full auctioning of permits or a single best available technology benchmark would have made natural gas the predominant technology of choice.

Keywords: Emissions trading; Allocation rules; Power markets; Investments (search for similar items in EconPapers)
JEL-codes: Q48 Q54 Q58 (search for similar items in EconPapers)
Pages: 29 p.
Date: 2011
New Economics Papers: this item is included in nep-ene, nep-env, nep-reg and nep-res
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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Journal Article: How emission certificate allocations distort fossil investments: The German example (2011)
Journal Article: How Emission Certificate Allocations Distort Fossil Investments: The German Example (2011)
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