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Investment Propensities under Carbon Policy Uncertainty

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.

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Energy Specializations: Energy Investment and Finance – Public and Private Risks, Risk Management; Energy and the Environment – Climate Change and Greenhouse Gases; Energy and the Environment – Policy and Regulation

JEL Codes:
D81 - Criteria for Decision-Making under Risk and Uncertainty
Q54 - Climate; Natural Disasters and Their Management; Global Warming
E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General

Keywords: Decision analysis, Risk, Sensitivity, Finance, Investment, Energy policy. Programming, Stochastic

DOI: 10.5547/ISSN0195-6574-EJ-Vol32-No1-4

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Published in Volume 32, Number 1 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.