Carbon-contract-for-difference (CCfD) and green transition of coal power under dual price uncertainties in the Korean market—a real options approach

Carbon pricing under the Korean Emission Trading System (K-ETS) is the most widely accepted policy for internalizing the externalities caused by greenhouse gas emissions to firms’ production decisions. However, the effect of K-ETS has been questioned because of two problems, namely low level and high volatility of carbon prices and time-inconsistent preferences of governments, which causes firms to hold their investment decisions. Carbon contract for difference (CCfD) can be an effective solution to these problems by serving as a credible commitment vehicle. This study analyzes the optimum investment trigger prices of carbon and subsidy for CACPs based on the Geometric Brownian Motion (GBM). As coal power generates about 80% of the power sector’s carbon emissions in Korea, CACPs are rising as an important alternative to reduce carbon emissions and mitigate the social cost of phasing out coal plants with remaining operational life expectancy. The uncertainty of both carbon prices and subsidy prices is considered. The results indicate that the investment trigger price under the current ETS is 95.0 USD/ton-CO₂ and that under CCfD is 52.5 USD/ton-CO₂. This paper shows that CCfD can reduce the burden that customers must eventually bear to meet Korea’s Nationally Determined Contribution (NDC) goal.