PURELEC Investment in renewable electricity under climate policy uncertainty

In the coming years, the world will need more electric power from renewable resources, and Norway is well positioned to contribute with additional renewable electricity capacity. Decisions on whether and when to invest in new capacity will depend on uncertainty with respect to future cash flows generated by renewable
electricity projects. One source of uncertainty is climate policy; either with respect to the future climate policy itself or with respect to the impact of existing climate policies on future cash flows. Real option theory can be used to translate climate policy uncertainty into investment risk. A license to build a power plant is a real option, where the investor has the right, but not the obligation, to pay the investment cost to get the cash flow of the project. Faced with a risky irreversible decision, investors will value the opportunity to gain additional information about likely future conditions affecting the project. This could mean delaying investment until uncertainty has been partly resolved. We will test the validity of Real option theory in predicting how investors
respond to climate policy uncertainty.

Our starting point is two data sets on production licenses; one on small hydro power projects and one on land-based windmill projects. Using regression and other quantitative models we will test whether actual investment behavior is consistent with the predictions by Real option models. These studies will be complemented with surveys and interviews with investors and dialog with a stakeholder reference group. Based on our research results we will present extensions of Real option theory as well as suggest how a careful design of new policy instruments may reduce investors risk and thus the social cost of achieving climate policy targets.