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"Investments in energy efficiency under climate policy uncertainty."
Efficiency gains have put a limit to fuel consumption growth in the
past. In addition to energy savings, these improvements have another
basic impact, namely the avoiding of greenhouse gas (GHG) emissions
that go hand in hand with fossil fuel combustion. To the extent that
there is a price for these emissions, curbing them has economic value
for firms that operate in an emissions-constrained environment. This
holds also where no such price exists currently but there is a chance
that climate restrictions will be imposed in the future.
There is a broad consensus that energy
efficiency can play a significant role in curbing GHG emissions while
paying for itself. However, investments that at first glance seem
worthwhile usually are not undertaken. This situation traces in part to
the challenge of attracting sufficient interest from the investment
community. Fortunately, though, energy-efficiency investments lend
themselves to financial analysis. We analyze investments in efficiency
(and savings in energy) from the viewpoint of a firm or individual that
behaves rationally, i.e., in her best economic interest.
The investment or project is valued like a
(real) option that is only exercised at the optimal time and is
irreversible (the firm cannot disinvest should market conditions turn).
The return on this investment is highly uncertain. Uncertainty emanates
from energy prices and emission allowance prices, but regulatory
uncertainty may come on top of them. We aim to determine the optimal
time to invest or, in other words, to learn the conditions under which
the investment should be undertaken.
Our theoretical model comprises two stochastic
processes for fuel (say, natural gas) price, and emission (say, carbon)
allowance price, respectively. With regard to the carbon price, we
consider a standard geometric Brownian motion (GBM) in two different
scenarios: within a given commitment period (e.g., 2008-2012), and
between two succeeding periods (i.e., the current one and the immediate
post-Kyoto period), presumably separated by a change in climate
regulation with an ensuing jump in carbon prices. As for the natural
gas price, we assume a mean-reverting process in which the long-term
equilibrium level grows deterministically over time. The key underlying
parameters in these processes are estimated from actual market prices.
We can then assess energy-efficiency investments in a fairly realistic
setting. As a case study, we consider a potential investment in either
one of two different gas-fired power stations that differ in their
efficiency levels. In particular, we derive the total return to an
increase of a percentage point in the thermal efficiency as a function
of the plant's production factor or availability rate.
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Jose Manuel Chamorro:
Universidad del Pais Vasco (UPV -EHU) / Euskal Herriko Unibertsitatea (UPV -EHU)
Luis Mª Abadie: BBK
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