Renewables and climate change mitigation: Irreversible energy investment under uncertainty and portfolio effects

Ongoing negotiations under the UNFCCC center around the possibilities for stabilization of greenhouse gases at a “safe” level. New energy technologies are assumed to make major contributions to this goal. However, in the light of scientific uncertainty (e.g. about climate sensitivity, feedback effects, etc.), market uncertainty (e.g. fuel price volatility), technological uncertainty (e.g. availability of renewable technology), socio-economic uncertainty (e.g. development of different macroeconomic factors) and policy uncertainty (e.g. about commitment to specific targets and stability of CO2 prices), it is difficult to assess the importance of different technologies in achieving robust long-term climate risk mitigation. One example currently debated in this context is biomass-based energy, which can be used to produce both carbon-neutral electricity and at the same time offer the possibility of “negative emissions” by capturing carbon from biomass combustion at the conversion facility and permanently storing it. In this study, we analyze the impact of uncertainty on investment decision-making at the plant level in a real options valuation framework, and then use the GGI Scenario Database (IIASA, 2009) as a point of departure for deriving optimal technology portfolios across different socio-economic scenarios for a range of stabilization targets, focusing, in particular, on the new, low-emission targets using alternative risk measures.