The Impact of Volatility in Bioenergy Investments: A Real Options Approach

The paper investigates the impact of volatility on irreversible bioenergy investments in the absence of policy support schemes. The effects of different volatility sources and varying investment conditions on the optimal investment rule are studied in a partial equilibrium model which represents the interplay of the global energy market and the local bioenergy and food markets. Volatilities are presumed to stem from normally distributed stochastic shocks to the global energy price and the local food demand. The central assumption of the model is that bioenergy producers have the possibility to temporally suspend production if business conditions worsen. The model is solved numerically using real options based stochastic simulation experiments in combination with genetic algorithms. The results demonstrate that the possibility to limit losses through temporary production suspension may create incentives to invest even at high uncertainty. This effect occurs in the case of both single and multiple uncertainties and is the stronger the higher the variable production costs are in relation to fixed costs. It could also be observed that the presence of investment lags is a necessary condition for the ambiguous effect of uncertainty on investment incentives. The declining investment trigger indicates that the combined effect of time lags, cost structure and temporary production suspension increases the likelihood of extreme profits in good states and, therefore, may not only weaken, but even overcompensate the depressing effect of uncertainty on investments.