The decision to invest in emissions reduction technologies based on the real options approach

Abstract

This chapter focuses on a study that illustrates the way uncertainty and social costs can influence a firm's decision to invest in an emission reduction technology. For a case study, this study considers a firm owing aged coal-fired thermal power plants in the United States. The firm has an option to invest in an Integrated coal Gasification Combined Cycle (IGCC) no capture plant, IGCC capture plant, or Natural Gas Combined Cycle (NGCC) for the substitution of the aged power plants. The optimal investment behavior subject to stochastic CO2 emission allowance price, natural gas price, and social cost is calculated numerically in the study by using the Bellman equation and lattice models with few variables. The results show that not only CO2 emission allowance price and natural gas price but also social costs and their uncertainty influence the firm's decision to invest in capture plant, especially at an early date. It is suggested that direct subsidies from government to the firm's capital cost are worthwhile, but social preference that forms the characteristic of the social costs could be a key issue in a firm's decision for the investment in an emission reduction technology.