Investment decision-making in clean energy under uncertainties: A real options approach

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Li, Yihua
Major Professor
Guiping Hu
Stephen B. Vardeman
Committee Member
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Industrial and Manufacturing Systems Engineering
The Department of Industrial and Manufacturing Systems Engineering teaches the design, analysis, and improvement of the systems and processes in manufacturing, consulting, and service industries by application of the principles of engineering. The Department of General Engineering was formed in 1929. In 1956 its name changed to Department of Industrial Engineering. In 1989 its name changed to the Department of Industrial and Manufacturing Systems Engineering.
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International commitments on emission reduction and the deterioration of fossil energy resources have caused more research attention to clean energy production. Getting the optimal investment portfolio in infrastructure for energy supply and consumption is a minimum requirement to enable the transition towards a sustainable energy system. Due to their environmental benefits, advanced biofuel and clean power generation are expected to play an important role in the future in transportation sector and electricity sector, respectively. In this dissertation, a real options approach is adopted for valuating clean technology investment portfolios under uncertainty, exploring managerial insights, and examining policy implications. The dissertation consists three parts discussing problems on clean energy investment.

Biofuel production investment, motivated by consumption volume mandates in revised Renewable Fuel Standard, is a long-term irreversible investment facing revenue uncertainty given volatile fuel market. Iowa, rich in agricultural residues like corn stover, is a major player in the fulfillment of the cellulosic biofuels mandate. In this first part, we aim to answer the question: Is now a good time for Iowa to start investing in cellulosic biofuels? Using a fast pyrolysis facility as an example, we present a real options approach for valuating the investment of a new technology for producing cellulosic biofuels subject to construction lead time and uncertain fuel price. We conduct a case study, in which the profitability of the project, optimal investment timing, and the impact of project lead time are investigated.

The second part extended the previous work by incorporating supply risk and dual sourcing. While corn stover is an abundant source of feedstock for biofuels production in Iowa, there is a potential supply risk due to the following reasons: (1) lack of market; (2) low percentage of farm participation; and (3) yield uncertainty due to the changing weather conditions. The decision maker would consider investing in a land to grow his own feedstock, in addition to the investment of biofuel facility. Land option with the growing of dedicated energy crops has a value-adding effect when operating with the fast pyrolysis facility. And with dual sourcing, the impact from supply uncertainty could be mitigated. A real options approach is used to analyze the optimal investment timing and benefits of the dual sourcing. Risk-aversion has an unexpected effect on investment decision-making, which may cause the investment decision of the value-adding option can be very sensitive to the primary underlying uncertainty, and the immediate action towards land investment can no longer be described with a single fuel price threshold.

Policy is deemed as one of the top decisive external factor that impacts the interest of a power producer. All energy projects are prone to policy risk, yet such eventualities are difficult to predict and therefore expensive to insure. In the third part of the study, we extend the uncertainty to the scope of government policy, in addition to considering the critical uncertainty of commodity prices. In this work, we want to examine the timing that an owner of a traditional coal-fired generator adopts in a clean technology when facing two realistic policy uncertainty cases: risk of repealing an existing policy, and risk of a policy change. The investment of a natural gas generator is considered in order to meet the load obligation while maximizing its expected long-run profit with regulated emission-related costs considered. The price uncertainties in electricity, natural gas, and carbon emission, together with policy uncertainty jointly affect profitability and decision-making of the clean technology adoption. A real options approach is applied to investigate the optimal investment decision. The producers are risk avoiding when facing uncertain future policy environment; and this reflects in delaying investment plan and creating a future investment plan that is stubborn to current carbon price. To a risk-neutral price-taking power producer, emission trading is a more effective instrument compared to carbon tax, and shifting from carbon tax to emission permits could more effectively inducing immediate investment in clean technology.

Tue May 01 00:00:00 UTC 2018