Using real option analysis for highly uncertain technology investments: The case of wind energy technology

Abstract

This study examines the feasibility of using a theoretical model and empirical analysis methods to value renewable energy (RE) investment from perspective of real option analysis (ROA). Based on use of a ROA approach, the RE value is evaluated with respect to its ability to conform to the main sensitivity analysis of RE investment, as well as an empirical method devised to value RE investment by using actual data. The economic intuitiveness underlying the decision-making process for RE investment is elucidated, while empirical analysis is performed to demonstrate the effectiveness of the options value embedded in current development planning in Taiwan for wind energy. In addition to revealing the advantages of RE development when considering real option, analytical results indicate that ROA is a highly effective means of quantifying how investment planning uncertainty (including managerial flexibility) influences RE development. Besides evaluating the value of current RE investment, this study demonstrates that results of the theoretical model, empirical analysis, and sensitivity analysis correlate well with each other. Restated, the value of developing RE increases when increasing the underlying price, time to maturity, risk-free rate, and volatility. Conversely, the value of developing RE decreases when increasing the exercise price.