Hbox {CO}_2-intensive power generation and REDD-based emission offsets with a benefit-sharing mechanism

Abstract

We propose and explore financial instruments supporting programs for reducing emissions from deforestation and forest degradation (FI-REDD). Within a microeconomic framework we model interactions between an electricity producer (EP), electricity consumer (EC), and forest owner (FO). To keep their profit at a maximum, the EP responds to increasing hbox {CO}_2 prices by adjusting electricity quantities generated by different technologies and charging a higher electricity price to the EC. The EP can prepare for future high (uncertain) hbox {CO}_2 prices by employing FI-REDD: they can purchase an amount of offsets under an unknown future hbox {CO}_2 price and later, when the hbox {CO}_2 price is discovered, decide how many of these offsets to use for actually offsetting emissions and sell the rest on the market, sharing the revenue with the FO. FI-REDD allows for optional consumption of emission offsets by the EP (any amount up to the initially contracted volume is allowed), and includes a benefit-sharing mechanism between the EP and FO as it regards unused offsets. The modeling results indicate that FI-REDD might help avoid bankruptcy of hbox {CO}_2-intensive producers at high levels of hbox {CO}_2 prices and therefore serve as a stabilizing mechanism during the transition of energy systems to greener technologies. The analytical results demonstrate the limits for potential market size explained by existing uncertainties. We illustrated that when suppliers and consumers of REDD offsets have asymmetric information on future hbox {CO}_2 prices, benefit-sharing increases the contracted REDD offsets quantity.