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Investing in biogas: Timing, technological choice and the value of flexibility from input mix

  • Di Corato, Luca
  • Moretto, Michele

In a stochastic dynamic frame, we study the technology choice problem of a continuous co-digestion biogas plant where input factors are substitutes but need to be mixed together to provide output. Given any initial rule for the composition of the feedstock, we consider the possibility of revising it if economic circumstances make it profitable. Flexibility in the mix is an advantage under randomly fluctuating input costs and comes at a higher investment cost. We show that the degree of flexibility in the productive technology installed depends on the value of the option to profitably re-arrange the input mix. Such option adds value to the project in that it provides a device for hedging against fluctuations in the input relative convenience. Accounting for such value we discuss the trade-off between investment timing and profit smoothing flexibility.

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Article provided by Elsevier in its journal Energy Economics.

Volume (Year): 33 (2011)
Issue (Month): 6 ()
Pages: 1186-1193

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Handle: RePEc:eee:eneeco:v:33:y:2011:i:6:p:1186-1193
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  1. Wang, Li Ming & Liu, Li Wen & Wang, Yong Jie, 2007. "Capacity decisions and supply price games under flexibility of backward integration," International Journal of Production Economics, Elsevier, vol. 110(1-2), pages 85-96, October.
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  4. He, Hua & Pindyck, Robert S., 1992. "Investments in flexible production capacity," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 575-599.
  5. Mæng, H. & Lund, H. & Hvelplund, F., 1999. "Biogas plants in Denmark: technological and economic developments," Applied Energy, Elsevier, vol. 64(1-4), pages 195-206, September.
  6. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
  7. M. Moretto & G. Rossini, 2008. "Vertical Integration and Operational Flexibility," Working Papers 631, Dipartimento Scienze Economiche, Universita' di Bologna.
  8. Triantis, Alexander J & Hodder, James E, 1990. " Valuing Flexibility as a Complex Option," Journal of Finance, American Finance Association, vol. 45(2), pages 549-65, June.
  9. Alvarez, Luis H.R. & Stenbacka, Rune, 2007. "Partial outsourcing: A real options perspective," International Journal of Industrial Organization, Elsevier, vol. 25(1), pages 91-102, February.
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