Real options analysis for renewable energy technologies in a GHG emissions trading environment

Green house gas (GHG) emissions have been tied to global climate change. Governments are seeking ways to help improve performance of their countries on this environmental issue through introduction of various policy instruments. One popular policy instrument that seems to have gained credibility with explicit mention of its application in the Kyoto Protocol is the use of permit trading and cap-and-trade mechanisms. Various political regions, countries, and even corporations have introduced, are introducing or seek to introduce this mechanism. Organizations functioning within this environment will need to manage their resources appropriately to remain competitive. Organizations will either have the opportunity to purchase emissions credits (offsets) from a market trading scheme or seek to reduce their emissions through different measures. Some measures may include investment in new technologies that will reduce their reliance on GHG emitting practices. In many countries, large organizations and institutions generate their own power to operate their facilities. Much of this power is generated (or bought) from GHG producing technology. Specific renewable energy sources such as wind and solar photovoltaic technology may become more feasible alternatives available to a large percentage of these organizations if they are able to take advantage and incorporate the market for GHG emissions trading in their analyses. To help organizations evaluate investment in these renewable energy technologies we introduce a real options based model that will take into consideration uncertainties associated with the technology and those associated with the GHG trading market. The real options analysis will consider both the stochastic (uncertainty) nature of the exercise price of the technology and the stochastic nature of the market trading price of the GHG emissions. Managerial and policy implications will be discussed.