Title: Real options and CO₂ reduction policies for climate change

Authors: Laurence G. Chan; Vladan Babovic

Addresses: Faculty of Engineering, National University of Singapore, EW1 02-05, 2 Engineering Drive 2, 117577, Singapore ' Singapore Delft Water Alliance, Faculty of Engineering, National University of Singapore, EW1 02-05, 2 Engineering Drive 2, 117577, Singapore

Abstract: Managing CO₂ emission control policy is a complex problem because of uncertainties in CO₂ emission process and CO₂ uptake, and irreversibility in investment decisions. Traditional method using benefit cost analysis for evaluation of CO₂ reduction policy is not effective in presence of deep uncertainties. Real options analysis approach is an alternative methodology which incorporates uncertainties and flexible timing in decision making. It allows the policymaker to learn and then act when the more information is available to resolve the uncertainties. This paper proposes a methodology with real options analysis for analysing the timing and conditions of adoption of CO₂ reduction policies. CO₂ emission is modelled as a stochastic process and CO₂ observation data are used to statistically estimate the parameters of the stochastic CO₂ emission model. A perpetual time model is developed to investigate CO₂ emission cutback policy and CO₂ concentration abatement policy and closed form analytical solutions are provided.

Keywords: climate change; uncertainty; irreversibility; real options; perpetual time; emissions control; carbon emissions; CO2; carbon dioxide; investment decisions; flexible timing; energy policy; emissions reduction.

DOI: 10.1504/IJSSE.2013.056293

International Journal of System of Systems Engineering, 2013 Vol.4 No.2, pp.140 - 161

Received: 28 Nov 2012
Accepted: 10 Feb 2013
Published online: 28 Apr 2014 *

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