Policy Uncertainty and Investment in Low-Carbon Technology

Abstract

In the context of an Emission Trading Scheme (ETS), we study how uncertainty over the policy parameter affects firms' investment in low carbon technologies. We develop a three period sequential model that combines the two sectors regulated by the scheme and encompasses both irreversible and reversible investment possibilities for the firms. Additionally, we explicitly model the policy uncertainty in the regulator's objective function as well as the market interactions that give rise to an endogenous price of permits. We find that uncertainty reduces irreversible investment and that the availability of both types of technologies partially eliminates the positive effect of policy uncertainty on reversible technology found in previous literature. Furthermore, we provide a framework that allows to clearly identify the effects of the interplay between different features and actors of different ETS such as the European one.