International carbon markets under uncertainty

Linking the framework on Reducing Emissions from Deforestation and Forest Degradation as an offset program to major cap-and-trade programs is a promising approach to increase both climate finance and cost-efficiency. However, the coexistence of permits and offsets also creates a classic case of interaction effects. MEDU researchers explored how the availability of multiple compliance instruments affects energy investment incentives. Alternative trading and linkage schemes are compared using a real options model of firm-level investment decisions under stochastic prices and the ability to delay investments. The first critical design factors that drive private investments in the energy sector are therefore isolated, allowing policy regimes that balance the different concerns in the polarized debate for and against the inclusion of forest carbon offsets to be identified.

Figure 1. Investment probability under different scenarios varying the correlation as well as the volatility of permit and offset prices. The unit of the x-axis is years and on the y-axis is the percentage of firms that switch from coal to wind power plants.

Last edited: 16 March 2016