A two stage cap-and-trade model with allowance re-trading and capacity investment: The case of the Chilean NDC targets

In this work, we study an alternative approach for capping and pricing carbon emissions in electric markets: the cap-and-trade paradigm with re-trade of allowances. We model the electric market (generators and allowances’ auctioneer) as a two stage stochastic capacity expansion equilibrium problem, where we allow future investment and re-trading of emission permits among generators. The model studies generation and future investments in the electric sector in two regimes of demand: deterministic and stochastic. The configuration enforces the reduction of carbon emissions by setting a carbon budget, which allows to assess the impact of green policies and pledges concerning an electric system. We use the proposed model to analyze the Chilean electric sector under a cap-and-trade paradigm as an alternative to the existing carbon tax. We show that the Chilean pledge regarding emissions reductions does not encourage a shift to greener technologies. Moreover, we characterize two strategies to comply with the renewable targets by mid-century. On the one hand, a stringent carbon budget that induces high price of carbon permits and phases out coal-based generators. On the other hand, a less stringent target which significantly encourages investment in renewable technologies, but with low remaining shares of coal-based electric generation towards 2050.