Energy transition: Cap-and-trade and carbon capture and storage for achieving net-zero emissions with sustainable insurance

This paper introduces an energy transition model featuring a carbon-intensive manufacturer that adopts sustainable insurance, participates in a cap-and-trade scheme, and implements carbon capture and storage (CCS) transit, all aimed at achieving the net-zero carbon emission target. The model utilizes a down-and-out call (DOC) approach to evaluate the manufacturer's equity, considering the bankruptcy risk prior to maturity due to carbon intensity. The equity of the life insurer providing funds is assessed using a capped DOC method to address the capped credit risk from the manufacturer. The findings reveal that increased adoption of CCS transit diminishes manufacturer equity, heightens default risk, and reduces insurer equity, with these effects exacerbated by advanced CCS technology and stringent cap-and-trade caps. Both stringent cap-and-trade schemes and rapid advancements in CCS transit practices, particularly with the use of advanced CCS technology, deviate from the net-zero target. A critical policy implication is the necessity for the precise calibration of cap-and-trade schemes and the pace of CCS transit adoption to ensure alignment with net-zero targets.