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Real options approach to renewable energy investments in Mongolia

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Abstract

Many developing nations are in transition from non-renewable to renewable energy in electricity generation. This research analyzes this type of changing investment environment for renewable energy projects such as wind farms and solar-thermal plants with the application of real options theory. The main intent is to explore the potential and to provide further insights for such a transition in developing economies through studying the case of Mongolia under coal price uncertainty. To evaluate the comparative attractiveness of either continuing to use non-renewable (coal-based) infrastructure or switching to renewable energy, we formulate social revenue functions for the two environments under the assumptions that coal-based operations generate negative externalities and renewable energy is externality-free. Framing the problem as a type of real options, we arrive at the optimal trigger prices of coal for switching technologies. With this analytical framework, we further pose some possible scenarios with respect to electricity price as well as negative externality valuation, and characterize when renewable energy investments become attractive. In sharp contrast to conventional wisdom in real options theory, we identify some situations where option values for switching technologies become negative in some price domains, and welfare losses are incurred. Overall, the result raises the possible risks in developing nations that waiting to switch energy sources yields huge losses under input price uncertainty. To avoid such a case in Mongolia, the government should remove coal subsidies and increase electricity prices or switch to renewable energy earlier rather than holding the option to wait, especially when people are willing to pay more for the removal of negative externalities.

Suggested Citation

  • Neal Detert & Koji Kotani, 2012. "Real options approach to renewable energy investments in Mongolia," Working Papers EMS_2012_10, Research Institute, International University of Japan.
  • Handle: RePEc:iuj:wpaper:ems_2012_10
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    3. Xian, Hui & Colson, Gregory & Mei, Bin & Wetzstein, Michael E., 2015. "Co-firing coal with wood pellets for U.S. electricity generation: A real options analysis," Energy Policy, Elsevier, vol. 81(C), pages 106-116.
    4. Agaton, Casper, 2017. "Coal, Renewable, or Nuclear? A Real Options Approach to Energy Investments in the Philippines," MPRA Paper 83798, University Library of Munich, Germany.
    5. Zhang, M.M. & Zhou, P. & Zhou, D.Q., 2016. "A real options model for renewable energy investment with application to solar photovoltaic power generation in China," Energy Economics, Elsevier, vol. 59(C), pages 213-226.
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    9. Xian, Hui & Karali, Berna & Colson, Gregory & Wetzstein, Michael E., 2015. "Diesel or compressed natural gas? A real options evaluation of the U.S. natural gas boom on fuel choice for trucking fleets," Energy, Elsevier, vol. 90(P2), pages 1342-1348.
    10. Andreas Welling, 2017. "Green Finance: Recent developments, characteristics and important actors," FEMM Working Papers 170002, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.
    11. Wang, Xingwei & Cai, Yanpeng & Dai, Chao, 2014. "Evaluating China's biomass power production investment based on a policy benefit real options model," Energy, Elsevier, vol. 73(C), pages 751-761.
    12. de Oliveira, Denis Luis & Brandao, Luiz E. & Igrejas, Rafael & Gomes, Leonardo Lima, 2014. "Switching outputs in a bioenergy cogeneration project: A real options approach," Renewable and Sustainable Energy Reviews, Elsevier, vol. 36(C), pages 74-82.
    13. Cuervo, Felipe Isaza & Botero, Sergio Botero, 2016. "Wind power reliability valuation in a Hydro-Dominated power market: The Colombian case," Renewable and Sustainable Energy Reviews, Elsevier, vol. 57(C), pages 1359-1372.
    14. Shunsuke Managi & Zheng Zhang & Shinya Horie, 2016. "A real options approach to environmental R&D project evaluation," Environmental Economics and Policy Studies, Springer;Society for Environmental Economics and Policy Studies - SEEPS, vol. 18(3), pages 359-394, July.
    15. Mingming Zhang & Dequn Zhou & Hao Ding & Jingliang Jin, 2016. "Biomass Power Generation Investment in China: A Real Options Evaluation," Sustainability, MDPI, Open Access Journal, vol. 8(6), pages 1-22, June.
    16. Agaton, Casper, 2017. "Real Options Analysis of Renewable Energy Investment Scenarios in the Philippines," MPRA Paper 83478, University Library of Munich, Germany.
    17. Zhang, M.M. & Zhou, D.Q. & Zhou, P. & Chen, H.T., 2017. "Optimal design of subsidy to stimulate renewable energy investments: The case of China," Renewable and Sustainable Energy Reviews, Elsevier, vol. 71(C), pages 873-883.
    18. Felipe Isaza Cuervo & Sergio Botero Boterob, 2014. "Aplicación de las opciones reales en la toma de decisiones en los mercados de electricidad," ESTUDIOS GERENCIALES, UNIVERSIDAD ICESI, November.

    More about this item

    Keywords

    Alternative energy investment; Real options in discrete time; Coal prices; Stochastic process;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • O13 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Agriculture; Natural Resources; Environment; Other Primary Products
    • Q32 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Exhaustible Resources and Economic Development
    • Q42 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Alternative Energy Sources

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