Valuation of marginal CO2 abatement options for electric power plants in Korea

The electricity generation sector in Korea is under pressure to mitigate greenhouse gases as directed by the Kyoto Protocol. The principal compliance options for power companies under the cap-and-trade include the application of direct CO2 emission abatement and the procurement of emission allowances. The objective of this paper is to provide an analytical framework for assessing the cost-effectiveness of these options. We attempt to derive the marginal abatement cost for CO2 using the output distance function and analyze the relative advantages of emission allowance procurement option as compared to direct abatement option. Real-option approach is adopted to incorporate emission allowance price uncertainty. Empirical result shows the marginal abatement cost with an average of Euro 14.04/ton CO2 for fossil-fueled power plants and confirms the existence of substantial cost heterogeneity among plants which is sufficient to achieve trading gains in allowance market. The comparison of two options enables us to identify the optimal position of the compliance for each plant. Sensitivity analyses are also presented with regard to several key parameters including the initial allowance prices and interest rate. The result of this paper may help Korean power plants to prepare for upcoming regulations targeted toward the reduction of domestic greenhouse gases.