Critical price of sulphur dioxide emission allowances

The paper presents a decision-making model of environmental modernization in a power plant. The goal of the model is to analyse strategies implemented by power producers trying to comply with environmental regulations. Detailed analysis is related to the sulphur dioxide emission. Tradable emission allowances might be a new economic tool in fighting environmental problems in Poland. The model applies the real options approach. The approach is appropriate to model investments that are irreversible and an investor can afford to wait rather than invest immediately. The model assumes price uncertainty. The investment rule takes the form of a critical value optimal for immediate investment. The critical value of the project is calculated using dynamic programming. The project value follows a geometric Brownian motion. The results presented demonstrate that it is possible to calculate a critical price of emission allowances.