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Investment under market and climate policy uncertainty

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Author Info

  • Fuss, Sabine
  • Szolgayova, Jana
  • Obersteiner, Michael
  • Gusti, Mykola
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    Abstract

    Climate change is considered as one of the major systematic risks for global society in the 21st century. Yet, serious efforts to slow the accumulation of emissions are still in their primordial stage and policy makers fail to give proper long-term signals to emitters. These days, investors do not only face uncertainty from volatile prices in the traditional markets, but also from the less conceivable uncertainty of stricter climate change policy. This paper investigates the impact of learning about the commitment of government to a climate policy regime in a real options framework. Two types of uncertainty are distinguished: market-driven price volatility around a mean price and bifurcating price trajectories mimicking uncertainty about changing policy regimes. One of the findings is that the producer facing market uncertainty about CO2 prices invests into carbon-saving technology earlier than if the actual price path had been known on beforehand. This is not a typical real options outcome, but the result of optimizing under imperfect information, which leads to decisions that are different from the optimal strategies under full information. On the other hand, policy uncertainty induces the producer to wait and see whether the government will further commit to climate policy. This waiting is a real options effect. In other words, if learning about government commitment is more valuable than investing into mitigation technologies immediately, the option value exceeds the value of the technology and investment will be postponed. This might lead to supply shortages and limited diffusion of less carbon-intensive technology.

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    Bibliographic Info

    Article provided by Elsevier in its journal Applied Energy.

    Volume (Year): 85 (2008)
    Issue (Month): 8 (August)
    Pages: 708-721

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    Handle: RePEc:eee:appene:v:85:y:2008:i:8:p:708-721

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    Web page: http://www.elsevier.com/wps/find/journaldescription.cws_home/405891/description#description

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    Related research

    Keywords: Policy uncertainty Real options Electricity planning;

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    Citations

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    Cited by:
    1. Tolis, Athanasios & Doukelis, Aggelos & Tatsiopoulos, Ilias, 2010. "Stochastic interest rates in the analysis of energy investments: Implications on economic performance and sustainability," Applied Energy, Elsevier, vol. 87(8), pages 2479-2490, August.
    2. Schenker, Oliver, 2011. "How uncertainty reduces greenhouse gas emissions," MPRA Paper 29591, University Library of Munich, Germany.
    3. Lambie, N. Ross, 2009. "The role of real options analysis in the design of a greenhouse gas emissions trading scheme," 2009 Conference (53rd), February 11-13, 2009, Cairns, Australia 47626, Australian Agricultural and Resource Economics Society.
    4. Brauneis, Alexander & Mestel, Roland & Palan, Stefan, 2013. "Inducing low-carbon investment in the electric power industry through a price floor for emissions trading," Energy Policy, Elsevier, vol. 53(C), pages 190-204.
    5. Hervé-Mignucci, Morgan, 2011. "Rôle du signal prix du carbone sur les décisions d'investissement des entreprises," Economics Thesis from University Paris Dauphine, Paris Dauphine University, number 123456789/8200 edited by Keppler, Jan Horst.
    6. Svensson, Elin & Berntsson, Thore & Strömberg, Ann-Brith & Patriksson, Michael, 2009. "An optimization methodology for identifying robust process integration investments under uncertainty," Energy Policy, Elsevier, vol. 37(2), pages 680-685, February.
    7. Fuss, Sabine & Johansson, Daniel J.A. & Szolgayova, Jana & Obersteiner, Michael, 2009. "Impact of climate policy uncertainty on the adoption of electricity generating technologies," Energy Policy, Elsevier, vol. 37(2), pages 733-743, February.
    8. Neil Ross Lambie, 2010. "Understanding the effect of an emissions trading scheme on electricity generator investment and retirement behaviour: the proposed Carbon Pollution Reduction Scheme," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 54(2), pages 203-217, 04.
    9. Zhang, Dongjie & Liu, Pei & Ma, Linwei & LI, Zheng, 2013. "A multi-period optimization model for planning of China's power sector with consideration of carbon dioxide mitigation—The importance of continuous and stable carbon mitigation policy," Energy Policy, Elsevier, vol. 58(C), pages 319-328.
    10. Elverhøi, Morten & Fleten, Stein-Erik & Fuss, Sabine & Heggedal, Ane Marte & Szolgayova, Jana & Troland, Ole Christian, 2010. "Evaluation of hydropower upgrade projects - a real options approach," MPRA Paper 23005, University Library of Munich, Germany.
    11. Tolis, Athanasios I. & Rentizelas, Athanasios A., 2011. "An impact assessment of electricity and emission allowances pricing in optimised expansion planning of power sector portfolios," Applied Energy, Elsevier, vol. 88(11), pages 3791-3806.
    12. Zhang, Xian & Wang, Xingwei & Chen, Jiajun & Xie, Xi & Wang, Ke & Wei, Yiming, 2014. "A novel modeling based real option approach for CCS investment evaluation under multiple uncertainties," Applied Energy, Elsevier, vol. 113(C), pages 1059-1067.
    13. Cao, M.F. & Huang, G.H. & Lin, Q.G., 2010. "Integer programming with random-boundary intervals for planning municipal power systems," Applied Energy, Elsevier, vol. 87(8), pages 2506-2516, August.
    14. Shahnazari, Mahdi & McHugh, Adam & Maybee, Bryan & Whale, Jonathan, 2014. "Evaluation of power investment decisions under uncertain carbon policy: A case study for converting coal fired steam turbine to combined cycle gas turbine plants in Australia," Applied Energy, Elsevier, vol. 118(C), pages 271-279.
    15. Baccini, Leonardo & Urpelainen, Johannes, 2012. "Legislative fractionalization and partisan shifts to the left increase the volatility of public energy R&D expenditures," Energy Policy, Elsevier, vol. 46(C), pages 49-57.
    16. Walsh, D.M. & O'Sullivan, K. & Lee, W.T. & Devine, M.T., 2014. "When to invest in carbon capture and storage technology: A mathematical model," Energy Economics, Elsevier, vol. 42(C), pages 219-225.
    17. Eryilmaz, Derya & Homans, Frances, 2013. "Uncertainty in Renewable Energy Policy: How do Renewable Energy Credit markets and Production Tax Credits affect decisions to invest in renewable energy?," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C. 150018, Agricultural and Applied Economics Association.

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