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Regulation and Investment under Uncertainty: An Application to Power Grid Interconnection

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  • Jean-Daniel Saphores
  • Eric Gravel
  • Jean-Thomas Bernard

Abstract

Using real options, we consider a firm that must undergo a costly and time-consuming regulatory process before making an irreversible, lagged investment whose value varies randomly. We apply our model to Hydro-Québec's proposal to build a 1,250 megawatts interconnection with Ontario. We find that the optimal starts of the regulatory review and of the project construction depend on the randomness of project benefits and on the duration of the regulatory authorization. A sensible limit on the latter allows the regulator to address changing circumstances at little cost to the firm. However, long and uncertain regulatory proceedings make investing less attractive.

Suggested Citation

  • Jean-Daniel Saphores & Eric Gravel & Jean-Thomas Bernard, 2004. "Regulation and Investment under Uncertainty: An Application to Power Grid Interconnection," Journal of Regulatory Economics, Springer, vol. 25(2), pages 169-186, March.
    • Handle: RePEc:kap:regeco:v:25:y:2004:i:2:p:169-186
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    Citations

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    Cited by:

    1. Blum, Ulrich & Growitsch, Christian & Krap, Niels, 2006. "Network Investment and the Threat of Regulation – Preventing Monopoly Exploitation or Infrastructure Construction?," IWH Discussion Papers 7/2006, Halle Institute for Economic Research (IWH).
    2. Lavrutich, Maria & Hagspiel, Verena & Siddiqui, Afzal S., 2023. "Transmission investment under uncertainty: Reconciling private and public incentives," European Journal of Operational Research, Elsevier, vol. 304(3), pages 1167-1188.
    3. Michele Moretto & Paolo M. Panteghini & Carlo Scarpa, 2008. "Profit sharing and investment by regulated utilities: A welfare analysis," Review of Financial Economics, John Wiley & Sons, vol. 17(4), pages 315-337, December.
    4. Dockner, Engelbert J. & Kucsera, Dénes & Rammerstorfer, Margarethe, 2013. "Investment, firm value, and risk for a system operator balancing energy grids," Energy Economics, Elsevier, vol. 37(C), pages 182-192.
    5. Kucsera, Dénes & Rammerstorfer, Margarethe, 2014. "Regulation and grid expansion investment with increased penetration of renewable generation," Resource and Energy Economics, Elsevier, vol. 37(C), pages 184-200.
    6. William Hogan & Juan Rosellón & Ingo Vogelsang, 2010. "Toward a combined merchant-regulatory mechanism for electricity transmission expansion," Journal of Regulatory Economics, Springer, vol. 38(2), pages 113-143, October.
    7. Gregory F. Nemet & Peter Braden & Ed Cubero & Bickey Rimal, 2014. "Four decades of multiyear targets in energy policy: aspirations or credible commitments?," Wiley Interdisciplinary Reviews: Energy and Environment, Wiley Blackwell, vol. 3(5), pages 522-533, September.
    8. Graeme Guthrie, 2006. "Regulating Infrastructure: The Impact on Risk and Investment," Journal of Economic Literature, American Economic Association, vol. 44(4), pages 925-972, December.
    9. Müller, Christine & Growitsch, Christian & Wissner, Matthias, 2010. "Regulierung und Investitionsanreize in der ökonomischen Theorie. IRIN Working Paper im Rahmen des Arbeitspakets: Smart Grid-gerechte Weiterentwicklung der Anreizregulierung," WIK Discussion Papers 349, WIK Wissenschaftliches Institut für Infrastruktur und Kommunikationsdienste GmbH.
    10. Abdullah Almansour and Margaret Insley, 2016. "The Impact of Stochastic Extraction Cost on the Value of an Exhaustible Resource: An Application to the Alberta Oil Sands," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    11. Kang, Sang Baum & Létourneau, Pascal, 2016. "Investors’ reaction to the government credibility problem: A real option analysis of emission permit policy risk," Energy Economics, Elsevier, vol. 54(C), pages 96-107.
    12. repec:vuw:vuwscr:18946 is not listed on IDEAS
    13. Matsukawa, Isamu, 2008. "The effects of average revenue regulation on electricity transmission investment and pricing," Energy Economics, Elsevier, vol. 30(3), pages 696-714, May.
    14. Leuthold, Florian & Jeske, Till & Weigt, Hannes & von Hirschhausen, Christian, 2009. "When the Wind Blows Over Europe: A Simulation Analysis and the Impact of Grid Extensions," MPRA Paper 65655, University Library of Munich, Germany.
    15. Michele Moretto & Chiara D’Alpaos, 2004. "The Value of Flexibility in the Italian Water Service Sector: A Real Option Analysis," Working Papers 2004.140, Fondazione Eni Enrico Mattei.
    16. Graeme Guthrie, 2006. "Regulating Infrastructure: The Impact on Risk and Investment," Journal of Economic Literature, American Economic Association, vol. 44(4), pages 925-972, December.
    17. Guthrie, Graeme, 2006. "Regulating Infrastructure: The Impact on Risk and Investment," Working Paper Series 18946, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.

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