CO2-intensive power generation and REDD-based emission offsets with a benefit sharing mechanism

We propose and explore financial instruments supporting programs for reducing emissions from deforestaion and forest degradation (FI-REDD). Within a microeconomic framework we model interactions between an electricity producer (EP), electricity consumer (EC), and forest owner (FO). To keep their profit at a maximum, the EP responds to increasing CO2 prices by adjusting electricity quantities generated by different technologies and charging a higher electricity price to the EC. The EP can hedge against future high (uncertain) CO2 prices by employing FI-REDD: they can purchase an amount of offsets under an unknown future CO2 price and later, when the CO2 price is discovered, decide how many of these offsets to use for actually offsetting emissions and sell the rest on the market sharing the revenue with the FO. FI-REDD allows for optimal consumption of emission offsets by the EP (any amount up to the initially contracted volume is allowed), and includes a benefit sharing mechanism between the EP and FO as it regards unused offsets. The modeling results indicate that the FI-REDD might help avoid bankruptcy of CO2-intensive producers at high levels of CO2 prices and therefore serve as stabilizing mechanism during the transition of energy systems to greener technologies. The analytical results demonstrate the limits for potential market size explained by existing uncertainties. We illustrated that when suppliers and consumers of REDD offsets have asymmetric information on future CO2 prices, benefit sharing increases the contracted REDD offsets quantity