A model for energy pricing with stochastic emission costs
Date
2010
Journal Title
Journal ISSN
Volume Title
Publisher
Elsevier
Abstract
We use a supply-demand approach to value energy products exposed to emission cost uncertainty. We find closed form solutions for a number of popularly traded energy derivatives such as: forwards, European call options written on spot prices and European Call options written on forward contracts. Our modeling approach is to first construct noisy supply and demand processes and then equate them to find an equilibrium price. This approach is very general while still allowing for sensitivity analysis within a valuation setting. Our assumption is that, in the presence of emission costs, traditional supply growth will slow down causing output prices of energy products to become more costly over time. However, emission costs do not immediately cause output price appreciation, but instead expose individual projects, particularly those with high emission outputs, to much more extreme risks through the cost side of their profit stream. Our results have implications for hedging and pricing for producers operating in areas facing a stochastic emission cost environment.
Description
Article deposited according to publisher policy posted on SHERPA/ROMEO, June 13, 2012.
Keywords
Energy pricing, Energy derivatives
Citation
Robert J. Elliott, Matthew R. Lyle, Hong Miao, A model for energy pricing with stochastic emission costs, Energy Economics, Volume 32, Issue 4, July 2010, Pages 838-847