The impact of climate policy on heat and power capacity investment decisions

Harri Laurikka

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Capital Investment and Risk Analysis Climate Change Policy and Economics Renewable energy and sustainable power systems

Abstract

Climate policy has become a major source of uncertainty in energy investments. This paper explores how different instruments of climate policy, such as emissions trading and taxes, affect heat and power capacity investment decisions. I start here with an analysis on the role of climate policy instruments in an investment decision process. Secondly, I examine how climate policy instruments affect the key components of a quantitative investment appraisal and how flexibility can help to cope with those impacts. Flexibility characteristics of some existing heat and power generation technologies are discussed. I find that climate policy increases the value of flexibility in energy investments. There are structural differences in flexibility between heat and power generation technologies. Whereas some technologies provide managerial flexibility through the options to alter operating scale and through the option to switch between fuels or products, others provide passive flexibility (robustness).

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References

1993Common risk factors in the returns on stocks and bonds 1964CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK*1994Investment Under Uncertainty.1994Investment under Uncertainty 1965The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets 1975THE VALUATION OF RISK ASSETS AND THE SELECTION OF RISKY INVESTMENTS IN STOCK PORTFOLIOS AND CAPITAL BUDGETS**This paper is another in a series of interrelated theoretical and statistical studies of corporate financial and investment policies being made under grants from the Rockefeller Foundation, and more recently the Ford Foundation, to the Harvard Business School. The generous support for this work is most gratefully acknowledged. The author is also much indebted to his colleagues Professors Bishop, Christenson, Kahr, Raiffa, and (especially) Schlaifer, for extensive discussion and commentary on an earlier draft of this paper; but responsibility for any errors or imperfections remains strictly his own.[Professor Sharpe's paper, “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk” (Journal of Finance, September 1964) appeared after this paper was in final form and on its way to the printers. My first section, which parallels the first half of his paper (with corresponding conclusions), sets the algebraic framework for sections II, III and VI, (which have no counterpart in his paper) and for section IV on the equilibrium prices of risk assets, concerning which our results differ significantly for reasons which will be explored elsewhere. Sharpe does not take up the capital budgeting problem developed in section V below.]1997Industry costs of equity 1978Administrative Behavior: A Study of Decision-Making Processes in Administrative Organization.

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