Fuel Input Substitution under Tradable Carbon Permits System: Evidence from Finnish Energy Plants 2005-2008

Following the Kyoto protocol and the European Union climate policies energy plants exceeding 20 MW capacity have been part of the EU’s emissions-trading scheme (ETS) since 2005. However, the users of renewable fuels will not pay for tradable carbon allowances. Advanced energy production technologies enable the switch from fossil fuels to renewable wood fuels, and therefore wood fuels may constitute a competitive substitute for fossil fuels, especially if the price of allowances is relatively high. In this context we analyzed plant level Finnish data from years 2005-2008 with mixed models. Econometric equations were specified and estimated for the wood-fossil fuel ratios, and for the fossil fuel cost shares. We found that the EU ETS has short term impacts on the fuel mixes of the energy plants. The elasticity ofsubstitution between fossil and non-fossil fuels is larger under the ETS. Large plants have adjusted their fuel technology choices toward more wood using and fuel price sensitive forms. The size of energy plants and heterogeneity among them across the industries determine the extent of fuel substitution. However plants’ regional locations have limited roles in the interfuel flexibility.