Awarded best paper in EAP 2015

In this paper we propose a market mechanism for regulated exit of highly emissions intensive power stations from the electricity grid. The starting point is that there is surplus capacity in coal fired power generation in Australia. In the absence of a carbon price signal, black coal generation capacity may leave the market instead of high emitting brown coal power stations. We lay out options for a mechanism of regulated power station closure using a market mechanism. Plants bid competitively over the payment they require for closure, the regulator chooses the most cost effective bid, and payment for closure is made by the remaining power stations in proportion to their carbon dioxide emissions. This could overcome adverse incentive effects for plants to stay in operation in anticipation of payment for closure and solve the political difficulties and problems of information asymmetry that plague government payments for closure and direct regulation for exit. We explore the issues theoretically and provide empirical illustrations. These suggest that closure of a brown coal fired power station in Australia could yield emissions savings at costs that are lower than the social benefits. The analysis in this paper is applicable to other countries.