European CO2 prices and carbon capture investments". Energy Economics, forthcoming

In this paper we assess the option to install a carbon capture and storage (CCS) unit in a coal-\u85red power plant operating in a carbon-constrained environment. We consider two sources of risk, namely the price of emission allowance and the price of the electricity output. First we analyse the performance of the EU market for CO2 emission allowances. Speci cally, we focus on the contracts maturing in the Kyoto Protocols rst commitment period (2008 to 2012) and calibrate the underlying pa-rameters of the allowance price process. Then we refer to the Spanish wholesale electricity market and calibrate the parameters of the electric-ity price process. We use a two-dimensional binomial lattice to derive the optimal in-vestment rule. In particular, we obtain the trigger allowance prices above which it is optimal to install the capture unit immediately. We further analyse the e¤ect of changes in several variables on these critical prices, among them allowance price volatility and a hypothetical government sub-sidy. We conclude that, at current permit prices, immediate installation does not seem justi\u85ed from a \u85nancial point of view. This need not be the case, though, if carbon market parameters change dramatically, carbon capture technology undergoes signi\u85cant improvements, and/or a speci c governmental policy to promote these units is adopted