Uncertain Long-Run Emissions Targets, CO2 Price and Global Energy Transition: A General Equilibrium Approach

Abstract

The persistent uncertainty about mid-century CO2 emissions targets is likely to affect not only the technological choices that energy-producing firms will make in the future but also their current investment decisions. We illustrate this effect on CO2 price and global energy transition within a MERGE-type general-equilibrium model framework, by considering simple stochastic CO2 policy scenarios. In these scenarios, economic agents know that credible long-run CO2 emissions targets will be set in 2020, with two possible outcomes: either a hard cap or a soft cap. Each scenario is characterized by the relative probabilities of both possible caps. We derive consistent stochastic trajectories - with two branches after 2020 - for prices and quantities of energy commodities and CO2 emissions permits. The impact of uncertain long-run CO2 emissions targets on prices and technological trajectories is discussed. In addition, a simple marginal approach allows us to analyze the Hotelling rule with risk premia observed for certain scenarios.

Keywords: CO2 Price, Uncertainty, Climatic Change, Energy Transition, Environmental Policy, General Equilibrium

JEL Classification: C68, Q41, Q43, Q52