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Uncertainty and Energy Saving Investments

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  • Matti Liski
  • Pauli Murto

Abstract

Energy costs are notoriously uncertain but what is the effect of this on energysaving investments? We find that real-option frictions imply a novel equilibrium response to increasing but uncertain energy costs: early investments are cautious but ultimately real-option frictions endogenously vanish, and the activity affected by higher energy costs fully recovers. We use electricity market data for counterfactual analysis of the real-option mark-ups and policy experiments. Uncertainty alone implies that the early compensation to new technologies exceeds entry costs by multiple factors, and that uncertainty-reducing subsidies to green energy can benefit the consumer side at the expense of the old capital rents, even in the absence of externalities from energy use.

Suggested Citation

  • Matti Liski & Pauli Murto, 2010. "Uncertainty and Energy Saving Investments," Working Papers 1005, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
  • Handle: RePEc:mee:wpaper:1005
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