Carbon and energy prices under uncertainty: A theoretical analysis of fuel switching with heterogenous power plants

European power producers have a major influence on the EU ETS, given that both their CO2 emissions and their EUA (European Union Allowance) allocations account for more than half of the total volumes of the scheme. Fuel switching is often considered as the main short-term abatement measure under the EU ETS. It consists in substituting combined cycle gas turbines (CCGTs) for hard-coal plants in power generation. Thereby coal plants run for shorter periods, and CO2 emissions are reduced. This paper provides the first theoretical analysis of fuel switching, in a context where power plants involved are not equally efficient. We begin with a preliminary work using illustrative examples and sensitivity analyses, which enables us to observe how differences in the efficiency of power plants impact the cost of fuel switching, and how this is related to the level of switching effort. Based on this, we build a theoretical model taking into account the effect of differences in the of power plants involved in fuel switching. We also efficiency investigate the effect of the timing of fuel switching abatements, within the temporally defined environment of our dynamic model. Results demonstrate that the gas price and uncontrolled CO2 emissions act together on the carbon price. We show that the influence of the gas price on the carbon price depends on the level of uncontrolled CO2 emissions, due to heterogeneity of power plants that are used in the fuel switching process. Furthermore, we show that the time of occurrence of uncontrolled emissions matters so that shocks have a stronger impact when they occur in a period that is closed to the end of the phase. (C) 2014 Elsevier B.V. All rights reserved.