On the pricing of emission reduction purchase agreement contracts

Marcelo Labre, Colin Atkinson

Abstract

ABSTRACT

The vital importance of Emission Reduction Purchase Agreement (ERPA) contracts to the carbon market motivates the development of accurate valuation techniques. We propose a pricing methodology based on the formulation of a generic payout function, with an analysis of the underlying drivers (emissions reduction delivery and carbon prices) leading to their stochastic model representation. Although applicable to any emissions reduction markets and standards, the rationale is developed around ERPAs based on the delivery of Certified Emission Reduction (CER) certificates from Clean Development Mechanism (CDM) project activities. We apply the methodology to the pricing of ERPAs on run-ofriver hydropower CDM project activities in China.