Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk?

In this paper we show that free entry decisions may be socially inefficient, even in a perfectly competitive homogeneous goods market with non-lumpy investments. In our model, inefficient entry decisions are the result of risk-aversion of incumbent producers and consumers, combined with incomplete financial markets which limit risk-sharing between market actors. Investments in productive assets affect the distribution of equilibrium prices and quantities, and create risk spillovers. From a societal perspective, entrants underinvest in technologies that would reduce systemic sector risk, and may overinvest in risk-increasing technologies. The inefficiency is shown to disappear when a complete financial market of tradable risk-sharing instruments is available, although the introduction of any individual tradable instrument may actually decrease efficiency. We therefore believe that sectors without well-developed financial markets will benefit from sector-specific regulation of investment decisions.investments in productive assets;hedging;systemic risk;risk spillovers

Risk management in electricity markets: hedging and market incompleteness

The high volatility of electricity markets gives producers and retailers an incentive to hedge their exposure to electricity prices by buying and selling derivatives. This paper studies how welfare and investment incentives are affected when markets for derivatives are introduced, and to what extent this depends on market completeness. We develop an equilibrium model of the electricity market with risk-averse firms and a set of traded financial products, more specifically: forwards and an increasing number of options. Using this model, we first show that aggregate welfare in the market increases with the number of derivatives offered. If firms are concerned with large negative shocks to their profitability due to liquidity constraints, option markets are particularly attractive from a welfare point of view. Secondly, we demonstrate that increasing the number of derivatives improves investment decisions of small firms (especially when firms are risk-averse), because the additional financial markets signal to firms how they can reduce the overall sector risk. Also the information content of prices increases: the quality of investment decisions based on risk-free probabilities, inferred from market prices, improves as markets become more complete Finally, we show that government intervention may be needed, because private investors may not have the right incentives to create the optimal number of markets.

Risk spillovers and hedging: why do firms invest too much in systemic risk?

In this paper we show that free entry decisions may be socially inefficient, even in a perfectly competitive homogeneous goods market with non-lumpy investments. In our model, inefficient entry decisions are the result of risk-aversion of incumbent producers and consumers, combined with incomplete financial markets which limit risk-sharing between market actors. Investments in productive assets affect the distribution of equilibrium prices and quantities, and create risk spillovers. From a societal perspective, entrants underinvest in technologies that would reduce systemic sector risk, and may overinvest in risk-increasing technologies. The inefficiency is shown to disappear when a complete financial market of tradable risk-sharing instruments is available, although the introduction of any individual tradable instrument may actually decrease efficiency. We therefore believe that sectors without well-developed financial markets will benefit from sector-specific regulation of investment decisions.

Analysis of energy saving potentials in energy generation: Final results

The introduction of best available technologies in the current fleet of fossil-fuel power generation could generate primary energy savings of 14-18% by 2030, compared to primary energy consumption in 2010. A gradual replacement of power plants at the end of their lifetime, by the best available technology could lead to around 750 Mtoe of total primary energy savings over the period 2011-2030. Total CO2 emissions over the period would be reduced by 2.7 Gt. The largest potential is in Member States with large coal-fired power plant fleets. These potentials are slightly higher than the PRIMES Reference scenario. In addition, around half of the potential in the PRIMES Reference scenario is due to a shift away from fossil fuels, rather than efficiency improvements. The potential is also much higher than the PRIMES Efficiency scenario. In the latter scenario, the shift away from fossil fuels is much less pronounced than in the PRIMES Reference scenario. The results are strongly dependent on the assumptions made, hence care should be taken when interpreting them.JRC.F.6 - Energy systems evaluatio

Market completeness: how options affect hedging and investments in the electricity sector.

The high volatility of electricity markets gives producers and retailers an incentive to hedge their exposure to electricity prices by buying and selling derivatives. This paper studies how welfare and investment incentives are affected when an increasing number of derivatives are introduced. It develops an equilibrium model of the electricity market with risk averse firms and a set of traded financial products, more specifically: a forward contract and an increasing number of options. We first show that aggregate welfare (the sum of individual firms' utility) increases with the number of derivatives offered, although most of the benefits are captured with one to three options. Secondly, power plant investments typically increase because additional derivatives enable better hedging of investments. However, the availability of derivatives sometimes leads to ‘crowding-out’ of physical investments because capital is being used more profitably to speculate on financial markets. Finally, we illustrate that players basing their investment decisions on risk-free probabilities inferred from market prices, may significantly overinvest when markets are not sufficiently complete.

International transport of captured CO2: Who can gain and how much?

If Carbon Capture and Storage (CCS) is to become a viable option for lowcarbon power generation, its deployment will require the construction of dedicated CO2 transport infrastructure. In a scenario of large-scale deployment of CCS in Europe by 2050, the optimal (cost-minimising) CO2 transport network would consist of large international bulk pipelines from the main CO2 source regions to the CO2 sinks in hydrocarbon elds and aquifers, which are mostly located in the North Sea. In this paper, we use a Shapley value approach to analyse the multilateral negotiation process that would be required to develop such jointly optimised CO2 infrastructure. Using the InfraCCS CO2 pipeline network optimisation tool, we perform numerical simulations on the cost burden allocation of a 28 billion euro CO2 pipeline network, which would be required to reach the EU's 2050 climate goals in the PRIMES-based Power Choices scenario. We analyse two EU pipeline policy cases: one with national pipeline monopolies and one with liberalised pipeline construction. We nd that countries with excess storage capacity capture 38% to 45% of the benets of multilateral coordination, with the higher number corresponding to the case with liberalised pipeline construction. Countries with a strategic transit location capture 19% of the rent in the case of national pipeline monopolies. Finally, liberalisation of CO2 pipeline construction reduces by two-thirds the dierences between countries in terms of cost per tonne of CO2 exported. As a side result of the analysis, we nd that the resource rent of a depleted hydrocarbon eld (when used for CO2 storage) is roughly $1 per barrel of original recoverable oil reserves, or 1 euro per MWh of original recoverable gas reserves. This adds 25-600% to current estimates of CO2 storage cost.JRC.F.6-Energy systems evaluatio

Taxation of nuclear rents: benfits, drawbacks and alternatives

The taxation of nuclear energy is studied using a stylized model of the electricity sector, with one dominant nuclear producer and a competitive fringe of fossil-fuel plants. We show that an unanticipated tax on nuclear production can generate significant government revenue in the short run without disturbing the market, but will harm investment incentives in the long run, especially if the government cannot credibly commit to a future tax rate. Even if the government is capable of credibly committing to an optimal long-run tax, government revenues from the long-run tax will be very low due to the market power of the incumbent. Lifetime extension agreements negotiated with multiple potential players, and competitive auctioning of new nuclear licenses are shown to be the most attractive policies. The analytical results are illustrated with a numerical simulation for the case of Belgium.

Technical and Economic Characteristics of a CO2 Transmission Pipeline Infrastructure

Carbon capture and storage is considered one of the most promising technological options for the mitigation of CO2 emissions from the power generation sector and other carbon-intensive industries that can bridge the transition period between the current fossil fuel-based economy and the renewable and sustainable technology era. CCS involves the capture of CO2 from the sources, the transport CO2 through dedicated pipelines and ships, and the storage of CO2 in geological reservoirs, such as depleted oil and gas fields and saline aquifers, for its permanent isolation from the atmosphere. The development of CCS technologies has increased significantly in the last decades; however, there are still major gaps in knowledge of the cost of capture, transport and storage processes. Pipelines have been identified as the primary means of transporting CO2 from point-of-capture to site where it will be stored permanently but there is little published work on the economics of CO2 pipeline transport and most cost studies either exclude transport costs or assume a given cost per tonne of CO2 in addition to capture costs. The aim of this report is to identify the elements that comprise a CO2 pipeline network, provide an overview of equipment selection and design specific to the processes undertaken for the CO2 transport and to identify the costs of designing and constructing a CO2 transmission pipeline infrastructure.JRC.DDG.F.7-Energy systems evaluatio

The Evolution of the Extent and the Investment Requirements of a Trans-European CO2 Transport Network

The large scale deployment of carbon capture and storage (CCS) in Europe will require the development of new infrastructure to transport, using pipelines and ships, the captured CO2 from its sources (e.g. power plants) to the appropriate CO2 storage sites. This report describes the potential evolution of the CO2 transport network on the European scale for the period 2015 ¿ 2050, in terms of physical size and capital cost requirements. These estimates have been made based on an innovative and sound methodology. The results however depend strongly on the assumptions that have been made, especially in view of the long term horizon of the analysis, the uncertainty of CCS deployment rates and timelines, the lack of robust data on CO2 storage sites and the variability of pipeline construction costs. The size of the network grows steadily until 2030, to 8800 km, requiring around 9 billion euros of cumulative investment; followed by a step-change towards 2050, leading to a total investment of around 29 billion euros. This is based on a relatively conservative scenario of CCS deployment, as the amount of CO2 captured in 2050 does not meet the ambition for the decarbonisation of the European society by 2050. Scenarios compatible with the European vision for a decarbonised society by 2050, which will necessitate the capture of almost all CO2 emissions from both the power and the industrial sectors, would obviously be associated with a more extensive and hence more expensive CO2 transport network. By 2030, 16 EU Member States may be involved in cross-border CO2 transport. International coordination is therefore crucial for the development of an optimised trans-European CO2 transport network.JRC.DDG.F.7-Energy systems evaluatio

An edge-based approach for robust foreground detection

Foreground segmentation is an essential task in many image processing applications and a commonly used approach to obtain foreground objects from the background. Many techniques exist, but due to shadows and changes in illumination the segmentation of foreground objects from the background remains challenging. In this paper, we present a powerful framework for detections of moving objects in real-time video processing applications under various lighting changes. The novel approach is based on a combination of edge detection and recursive smoothing techniques.We use edge dependencies as statistical features of foreground and background regions and define the foreground as regions containing moving edges. The background is described by short- and long-term estimates. Experiments prove the robustness of our method in the presence of lighting changes in sequences compared to other widely used background subtraction techniques