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Stepwise Green Investment under Policy Uncertainty

Abstract:
We analyse how market price and policy uncertainty, in the form of random provision or retraction of a subsidy, interact to affect the optimal time of investment and the size of a renewable energy (RE) project that can be completed in either a single (lumpy investment) or multiple stages (stepwise investment). The subsidy takes the form of a fixed premium on top of the electricity price, and, therefore, investment is subject to electricity price uncertainty. We show that the risk of a permanent retraction (provision) of a subsidy increases (decreases) the incentive to invest, yet lowers (raises) the amount of installed capacity, and that this result is more pronounced as the size of the subsidy increases. Additionally, we show that increasing the number of policy interventions lowers the expected value of a subsidy and the size of the project. Furthermore, we illustrate that, although an increase in the size of a subsidy lowers the relative value of the stepwise investment strategy, the expected value of a lumpy investment strategy is still lower than that of stepwise investment. Keywords: Investment analysis, Capacity sizing, Renewable energy, Policy uncertainty

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Energy Specializations: Energy Investment and Finance – Project Finance; Energy Investment and Finance – Corporate Strategy; Energy and the Environment – Policy and Regulation; Energy and the Environment – R&D and Emerging Technologies; Energy and the Economy – Energy as a Productive Input; Renewables – R&D and Emerging Technologies

JEL Codes:
G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
D92 - Intertemporal Firm Choice: Investment, Capacity, and Financing
E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General
O32 - Management of Technological Innovation and R&D
O13 - Economic Development: Agriculture; Natural Resources; Energy; Environment; Other Primary Products

Keywords: Investment analysis, Capacity sizing, Renewable energy, Policy uncertainty

DOI: 10.5547/01956574.37.4.mchr

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Published in Volume 37, Number 4 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.