Estimating the actual emission cost in an annual compliance cycle: Synergistic generation and carbon trading optimization for price-taking generation companies

Abstract

The annual compliance cycle of the carbon trading system gives generation companies (GenCos) the flexibility to buy allowances at preferred times rather than the same time that emissions happen. How to estimate the actual emission cost under fluctuating carbon prices and make better generation decisions become challenges for GenCos. A synergistic generation and carbon trading optimization method is proposed in this paper with a non-speculative dynamic (NSD) carbon trading strategy. The NSD strategy utilizes stochastic dynamic programming to make optimal carbon trading decisions and to provide accurate emission cost estimations for GenCos to make generation decisions. To control risks, the NSD strategy forbids intentional speculations in the carbon market but allows both buying and selling of allowances according to the yearly total emissions estimated by the generation strategy. A risk control scheme by adjusting the allowance-emission balancing period is proposed so that GenCos can smoothly shift between the traditional daily-balanced carbon trading strategy and the NSD strategy. Properties of the NSD strategy are analyzed and proved theoretically under some sufficient conditions, which makes the strategy interpretable and trustworthy. Numerical simulations verify that the proposed method can help GenCos lower their emission costs and improve their overall profits in a year.