Abstract
As a way to alleviate global warming, there have been major initiatives to reduce carbon dioxide (CO2) emission amount across the world. In Western Europe as well as in California, market-based permits for CO2 emission have been a major enabler of such initiatives. In this paper, under the assumption of such market-based permits where permit price is inherently uncertain, we model and analyse a transition process from coal-based to natural gas-based power plants with less CO2 emission based on a real options approach. Specifically, we apply existing real options approach to derive closed-form analytical solutions for such a transition. Subsequent managerial insights and policy implications are provided in the context of CO2 emission reduction and environmental ramifications.
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