Conference Agenda

Even with carbon pricing in place, investment in low-carbon technologies have remained below socially optimal levels with additional market failures in place. In this work, we develop a two-period partial equilibrium model to evaluate the welfare effects of de-risking policy instruments when learning externalities occur, future carbon prices are uncertain and risk markets are incomplete. Focusing on the risk transfer away from the producer and into the fiscal budget, we account for the regulator’s exposure to carbon price risk and the opportunity cost of earmarked funds associated with long-term, contingent liabilities such as carbon contracts for difference (CCfDs). This framework allows us to characterise optimal risk sharing between the producer and the regulator when fiscal risk is itself socially costly. For this second-best setting, we show analytically that - even in the absence of private hedging markets - a full transfer of carbon price risk into the public budget is generally not optimal. Our numerical results imply that risk-transferring instruments can play an important role in narrowing the welfare gap to first-best, but that excessive public risk absorption may generate large fiscal costs of risk, hence reducing welfare even below a no-policy benchmark.