Abstract
Although innovation and support schemes are among the main forces that drive investment in renewable energy (RE) technologies, both involve considerable uncertainty. We develop a real options framework to analyse the impact of technological, policy and electricity price uncertainty on the decision to invest sequentially in successively improved versions of a RE technology. Technological uncertainty is reflected in the random arrival of innovations, and policy uncertainty in the likely provision or retraction of a subsidy that takes the form of a fixed premium on top of the electricity price. We show that greater likelihood of subsidy retraction (provision) lowers (raises) the incentive to invest, and, by comparing a stepwise to a lumpy investment strategy, we show how an embedded option to adopt an improved technology version mitigates the impact of subsidy retraction on investment timing. Specifically, we show how stepwise investment facilitates earlier technology adoption compared to lumpy investment, and that, under stepwise investment, technological uncertainty accelerates technology adoption, thus further offsetting the incentive to delay investment in the light of subsidy retraction.
Highlights
Investment in renewable energy (RE) technologies is considerably risky, since it is typically made in the light of various interacting uncertainties, including economic, technological and policy uncertainty
Private firms are required to make accurate investment decisions, while policymakers must take into account how private firms respond to different sources of uncertainty in order to incentivise investment
Greater likelihood of subsidy retraction postpones investment. The implications of this result are crucial from a policy-making standpoint as it quantifies how market participants would act upon their flexibility to delay investment in the light of economic, technological and policy uncertainty
Summary
Investment in renewable energy (RE) technologies is considerably risky, since it is typically made in the light of various interacting uncertainties, including economic, technological and policy uncertainty. The real options literature has grown considerably, models that analyse the implications of policy uncertainty on investment decisions are often narrowly specified, in that technological uncertainty is either ignored or not considered within the context of complex investment opportunities that involve embedded options (Yang et al, 2008; Boomsma and Linnerud, 2015; Ritzenhofen and Spinler, 2016; Zhang et al, 2016a) This implies that the value of the flexibility to adopt improved technology versions may be critical in terms of offsetting the impact of policy uncertainty, yet it is currently overlooked. We develop a real options framework for analysing how economic, technological and policy uncertainty interact to affect sequential investment in successively improved versions of a RE technology; ii. We show how an embedded option to adopt an improved technology version mitigates the impact of subsidy retraction on invest timing, by comparing a stepwise to a lumpy investment strategy; and iii.
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