Whether companies invest in new power facilities at a particular point in time, or delay, depends upon the perceived evolution of uncertainties and the investors’ attitudes to risk and return. With additional risks emerging through climate change mitigation mechanisms, the propensity to invest may increasingly depend upon how each technology and company is exposed to carbon price uncertainty. We approach this by estimating the cumulative probabilities of investment over time in various technologies as a function of behavioral, policy, financial and market assumptions. Using a multistage stochastic optimization model with exogenous uncertainty in carbon price, we demonstrate that detailed financial analysis with real options and risk constraints can make substantial difference to the investment propensities compared to conventional economic analysis. Further, we show that the effects of different carbon policies and market instruments on these decision propensities depend on the characteristics of the companies and may induce market structure evolution.
AbadieL. M.ChamorroJ. M. (2008). “European CO2 prices and carbon capture investments.” Energy Economics30 (6): 2992-3015.
2.
BergersonJ. A.LaveL. B. (2007). “Baseload coal investment decisions under uncertain carbon legislation.” Environmental Science & Technology41 (10): 3431-3436.
3.
BernankeB. S. (1983). “Irreversibility, uncertainty, and cyclical investment.” The Quarterly Journal of Economics98 (1): 85-106.
4.
BERR (2008). EU emission trading scheme. Available at www.berr.gov.uk/energy/environment/euets. Birge, J. R. and F. Louveaux (1997). “Introduction to Stochastic Programming.” New York: Springer.
5.
BirgeJ. R.RoseC. H. (1995). “Modeling investment uncertainty in the costs of global CO2 emission policy.” European Journal of Operational Research83 (3): 466-488.
6.
BloomJ. A. (1982). “Long-range generation planning using decomposition and probabilistic simulation.” IEEE Transactions on Power Apparatus and Systems101 (4): 797-802.
7.
BlythW.BradleyR.BunnD.ClarkeC.WilsonT.YangM. (2007). “Investment risks under uncertain climate change policy.” Energy Policy35 (11): 5766-5773.
8.
BodaK.FilarJ. A. (2006). “Time consistent dynamic risk measures.” Mathematical Methods of Operations Research1 (63): 1432-2994.
9.
BunnD.LarsenE. R.VlahosK. (1993). “Complementary modelling approaches for analyzing several effects of privatization on electricity investment.” Journal of Operational Research Society44 (10): 957-971.
10.
BunnD. W. (2004). “Modelling Prices in Competitive Electricity Markets.” Wiley: London.
11.
CaramanisM. (1982). “Investment decisions and long-term planning under electricity spot pricing.” IEEE Transactions on Power Apparatus and Systems101 (12): 4640-4648.
12.
CarraroC.HourcadeJ. C. (1998). “Climate modelling and policy strategies. The role of technical change and uncertainty.” Energy Economics20 (5-6): 463-471.
13.
CheriditoP.StadjeM. (2008). “Time-inconsistency of VaR and time-consistent alternatives.” Finance Research Letters6 (1): 40-46.
14.
CopelandT.AntikarovV. (2003). “Real Options: A Practitioner's Guide.” Texere: New York.
15.
CrooksE. (2009). “EDF calls for support for nuclear industry.” Financial Times: 25.5.2009.
16.
DentonM.PalmerA.MasielloA.SkantzeP. (2003). “Managing market risk in energy.” IEEE Transactions on Power Systems18: 494-502.
17.
DixitA. K.PindyckR. S. (1994). “Investment under Uncertainty.” Princeton University Press: Princeton.
18.
EllermanD.JoskowP. L.SchmalenseeR.MonteroJ.-P.BaileyE. M. (2000). “Markets for Clean Air: The US Acid Rain Program.” Cambridge University Press: New York.
19.
European Commission (2008). “20 20 by 2020: Europe’s climate change opportunity.” COM(2008)30 Final, Communication from the Commission, Brussels 23.1.2008. Available at www.energy.eu/directives/com2008 0030en01.pdf.
20.
FezziC.BunnD. W. (2008). “A vector error correction model of the interactions among gas, electricity and carbon prices.” In F. Gulli (Ed.), Markets for carbon and power pricing in Europe Theoretical Issues and Empirical Analyses: pp. 145-159. Edward Elgar, Cheltenham.
21.
FletenS.-E.NasakkalaE. (2010). “Gas-fired power plants: Investment timing, operating flexibility and CO2 capture.” Energy Economics. Forthcoming.
22.
FordA. (2001). “Waiting for the boom: A simulation study of power plant construction in California.” Energy Policy29 (11): 847-869.
23.
FordA. (2002). “Boom and bust in power plant construction: Lessons from the California electricity market.” Journal of Industry, Competition and Trade 2 (1-2): 59-74.
24.
FrootK. A.ScharfsteinD. S.SteinJ. C. (1993). “Risk management: Coordinating corporate investment and financing policies.” The Journal of Finance48 (5): 1629-1658.
25.
FussS.JohanssonD. J. A.SzolgayovaJ.ObersteinerM. (2009). “Impact of climate policy uncertainty on the adoption of electricity generating technologies.” Energy Policy37 (2): 733-743.
26.
GemanH.OhanaS. (2009). “Time-consistency in managing a commodity portfolio: A dynamic risk measure approach.” Journal of Banking & Finance32 (10): 1991-2005.
27.
GreenR. (2007). “Carbon tax or carbon permits: The impact on generators’ risks.” Available at ftp://ftp.bham.ac.uk/pub/RePEc/pdf/RGreen.pdf.
28.
GribbenR. (2008). “Shell warns Europe on CO2 permits.” Daily Telegraph: 10.4.2008.
29.
GrossR.BlythW.HeptonstallP. (2010). “Risks, revenues and investment in electricity generation: Why policy needs to look beyond costs.” Energy Economics. Forthcoming.
30.
GrubbM.ButlerL.TwomeyP. (2006). “Diversity and security in UK electricity generation: The influence of low-carbon objectives.” Energy Policy34 (18): 4050-4062.
31.
HempsteadJ.SambandamI.ChanI.WobbrockR. (2007). “Storm clouds gathering on the horizon for the north American electric utility sector.” Moody’s Report 103941. Available at www.Moodys.com.
32.
HobbsB. F. (1986). “Network models of spatial oligopoly with an application to deregulation of electricity generation.” Operations Research34 (3): 395-409.
33.
HowardR. A. (1988). “Decision analysis: Practise and promise.” Management Science34 (6): 679695.
34.
HuchzermeierA.LochC. H. (2001). “Project management under risk: Using the real options approach to evaluate flexibility in R&D.” Management Science47 (1): 85-101.
35.
KeeneyR. L.LathropJ. F.SichermanA. (1986). “An analysis of Baltimore gas and electric company’s technology choice.” Operations Research34 (1): 18-39.
36.
KempA. G.KasimA. S. (2008). “A least-cost optimisation model of co2 capture applied to major UK power plants within the EU-ETS framework.” The Energy Journal29 (Special Issue): 99-134.
37.
KettunenJ.SaloA.BunnD. (2010). “Optimization of electricity retailer’s contract portfolio subject to risk preferences.” IEEE Transactions on Power Systems.25 (1): 117-128.
38.
LabattS.WhiteR. (2007). “Carbon Finance: The Financial Implications of Climate Change.” Wiley: Hoboken.
39.
LaGattutaD.SteinJ. C.TennicanM. L.UsherS. E.YoungenJ. (2001). “Cashflow-at-risk and financial policy for electricity companies in the new world order.” The Electricity Journal13 (10): 15-20.
40.
MeierH.ChristofidesN.SalkinG. (2001). “Capital budgeting under uncertainty—an integrated approach using contingent claims analysis and integer programming.” Operations Research49 (2): 196-206.
41.
MetzB.DavidsonO.ConinckH.LoosM.MeyerL. (2005). “Carbon dioxide capture and storage.” IPCC special report. Working Group III of the Intergovernmental Panel on Climate Change, Available from http://arch.rivm.nl/env/int/ipcc/pages media/SRCCS-final/SRCCS WholeReport.pdf.
42.
MilborrowD. (2008). “Electricity generation costs: Little to choose between the options?” Power UK173: 6-8.
43.
MillerA. C.RiceT. R. (1983). “Discrete approximations of probability distributions.” Management Science29 (3): 352-362.
44.
MintonB. A.SchrandC. (1999). “The impact of cash flow volatility on discretionary investment and the costs of debt and equity financing.” Journal of Financial Economics54 (3): 423-460.
45.
MittendorfB. (2004). “Information revelation, incentives, and the value of a real option.” Management Science50 (12): 1638-1645.
NagelT.RammerstorferM. (2009). “Modeling investment behavior under price cap regulation.” Central European Journal of Operations Research17 (2): 111-129.
48.
OttoV. M.ReillyJ. (2008). “Directed technical change and the adoption of CO2 abatement technology: The case of CO2 capture and storage.” Energy Economics30 (6): 2879-2898.
49.
ReedmanL.GrahamP.CoombesP. (2006). “Using a real-options approach to model technology adoption under carbon price uncertainty: An application to the Australian electricity generation sector.” Economic Record82 (S1): 64-73.
50.
ReineltP. S.KeithD. W. (2007). “Carbon capture retrofits and the cost of regulatory uncertainty.” The Energy Journal28 (4): 101-127.
51.
RockafellerR. T.UryasevS. (2000). “Optimization of conditional value-at-risk.” The Journal of Risk2 (3): 21-41.
52.
RoquesF. A.NewberyD. M.NuttallW. J. (2008). “Fuel mix diversification incentives in liberalized electricity markets: A mean-variance portfolio theory approach.” Energy Economics30 (4): 1831-1849.
53.
RoquesF. A.NuttallW. J.NewberyD. M.NeufvilleR. D.ConnorsS. (2006). “Nuclear power: a hedge against uncertain gas and carbon prices.” The Energy Journal27 (4): 1-23.
54.
RothwellG. (2006). “A real options approach to evaluating new nuclear power plants.” The Energy Journal27 (1): 37-53.
55.
SantiagoL.VakiliP. (2005). “On the value of flexibility in R&D projects.” Management Science51 (8): 1206-1218.
56.
SchumacherK.SandsR. D. (2006). “Innovative energy technologies and climate policy in Germany.” Energy Policy34 (18): 3929-3941.
57.
SenS.YuL. T-Genc (2006). “A stochastic programming approach to power portfolio optimization.” Operations Research54 (1): 55-72.
58.
SmithJ. E. (1993). “Moment methods for decision analysis.” Management Science39 (3): 340-358.
59.
SmithJ. E.MccardleK. F. (1998). “Valuing oil properties: Integrating option pricing and decision analysis approaches.” Operations Research46 (2): 198-217.
60.
SmithJ. E.NauR. F. (1995). “Valuing risky projects: Option pricing theory and decision analysis.” Management Science41 (5): 795-816.
61.
SzolgayovaJ.FussS.ObersteinerM. (2008). “Assessing the effects of CO2 price caps on electricity investments—A real options analysis.” Energy Policy36 (10): 3974-3981.
62.
Patino-EcheverriD.MorelB.AptJ.ChenC. (2007). “Should a coal-fired power plant be replaced or retrofitted?” Environmental Science & Technology41 (23): 7980-7986.
63.
ThompsonD.QuinlanT. (2010). “Drax: Half year results six months ended 30 june 2010.” Available at www.draxgroup.plc.uk/.
64.
TsengC. L.BarzG. (2002). “Short-term generation asset valuation: A real options approach.” Operations Research50 (2): 297-310.
65.
UryasevS. (2000). “Introduction to the theory of probabilistic functions and percentiles (value-at-risk).” In S. Uryasev (Ed.), Probabilistic Constrained Optimization: Methodology and Applications: pp. 1-25. Kluwer Academic Publishers.
66.
WallsM. R.DyerJ. S. (1996). “Risk propensity and firm performance: A study of the petroleum exploration industry.” Management Science42 (7): 1004-1021.
67.
YangM.BlythW.BradleyR.BunnD.ClarkeC.WilsonT. (2008). “Evaluating the power investment options with uncertainty in climate policy.” Energy Economics30 (4): 1933-1950.
