Renewable energy investment and carbon emissions under cap-and-trade mechanisms

This paper develops a model to examine the impacts of cap-and-trade mechanisms on the decisions of a utility firm when it invests in renewable energy and has an existing conventional energy source. Three cap-and-trade mechanisms are considered, No cap-and-trade Mechanism (NM), Grandfathering Mechanism (GM), and Benchmarking Mechanism (BM). We find that the utility firm invests more in renewable energy under either a GM or a BM than that under NM. As compared to GM, the utility firm under the BM invests more in renewable energy, while at the same time it generates more carbon emissions. We also show that investment in renewable energy does not necessarily reduce carbon emissions. When the government sets the unit carbon quota appropriately, however, BM can not only achieve a reduction in carbon emissions, but also ensure that electricity demand will not decrease. The implementation of BM can make the utility firm invest most heavily in renewable energy, while the implementation of GM will produce the lowest carbon emissions. When either a GM or a BM implemented under a lenient unit carbon quota (or total carbon quota), the utility firm can be more profitable. The study provides some new management insights for the policy-maker.