Producing energy in a stochastic environment: Switching from non-renewable to renewable resources

Abstract

In this paper, we study the determinants of switching from non-renewable natural resource inputs to renewable resource inputs in energy production. We assume that the stocks of both natural resources are stochastic, and that the adoption of renewable resources is costly and irreversible. Our formulation gives raise to an optimal stopping/switching problem that cannot be solved analytically, then we turn to numerical simulations. Our results suggest that the optimal switching time depends not only on the uncertainty parameters, but also on energy demand, costs, and the relative productivity of the resources.