Characterizing Optimal Decarbonization Policies and Evaluating Variability

This study uses a two-stage game theoretic approach to derive and characterize optimaldecarbonization policies, focusing on emission taxes and carbon capture and storage (CCS)subsidies. By maximizing a welfare function, the government first selects policy instruments,while carbon-intensive firms subsequently determine production levels and abatement effortsto maximize profit. The derived optimal policies are then analyzed through Monte Carlosimulations to assess their variability and sensitivity under different scenarios. Key findingsare: (1) Emission tax and CCS subsidies are strategic substitutes where pollution damagegoverns this relationship, (2) The optimal policy mix could be a tax-only regime if carbonintensity exceeds a given threshold, otherwise the optimal policy mix either includes bothinstruments (if pollution damage is large enough) or is a subsidy-only regime (if pollutiondamage is not very large), (3) Optimal subsidies are relatively more variable than optimalemission taxes, and (4) Certainty in production and market parameters does not reduceoptimal policy variability, but shifts the focus towards subsidies rather than taxes. These resultshighlight the need for flexible and adaptable decarbonization policies in dynamic marketswith evolving technologies.