A model for energy pricing with stochastic emission costs

Robert J. Elliott, Matthew R. Lyle*, Hong Miao

*Corresponding author for this work

Research output: Contribution to journalArticle

3 Scopus citations

Abstract

We use a supply-demand approach to value energy products exposed to emission cost uncertainty. We find closed form solutions for a number of popularly traded energy derivatives such as: forwards, European call options written on spot prices and European Call options written on forward contracts. Our modeling approach is to first construct noisy supply and demand processes and then equate them to find an equilibrium price. This approach is very general while still allowing for sensitivity analysis within a valuation setting. Our assumption is that, in the presence of emission costs, traditional supply growth will slow down causing output prices of energy products to become more costly over time. However, emission costs do not immediately cause output price appreciation, but instead expose individual projects, particularly those with high emission outputs, to much more extreme risks through the cost side of their profit stream. Our results have implications for hedging and pricing for producers operating in areas facing a stochastic emission cost environment.

Original languageEnglish (US)
Pages (from-to)838-847
Number of pages10
JournalEnergy Economics
Volume32
Issue number4
DOIs
StatePublished - Jan 1 2010

Keywords

  • Emissions uncertainty
  • Energy derivatives
  • Energy pricing
  • Project valuation

ASJC Scopus subject areas

  • Economics and Econometrics
  • Energy(all)

Fingerprint Dive into the research topics of 'A model for energy pricing with stochastic emission costs'. Together they form a unique fingerprint.

  • Cite this