Stepwise Investment in Alternative Energy Technologies and Capacity Sizing under Policy Uncertainty

Frequent changes and revisions of support schemes in combination with price uncertainty pose a unique complication on green investment decisions, particularly when a firm must determine not only the optimal time of investment but also the size of a project in the form of installed capacity. We develop an analytical framework in order to investigate how market price and policy uncertainty, in the form of random provision or retraction of a subsidy, interact to affect the optimal time of investment and the size of a project that can be completed in either a single or multiple stages. Although high price uncertainty makes a single–stage investment more valuable than a more flexible, yet more costly, stepwise investment strategy when the capacity of a project is fixed, we show that the value of a stepwise investment strategy is always greater than that of lumpy investment when a firm has discretion over capacity and illustrate that this result is more pronounced under policy uncertainty. Additionally, we show how a permanent retraction (provision) of a subsidy increases (decreases) the incentive to invest, yet lowers (raises) the amount of installed capacity, and that this result is more pronounced as the size of the subsidy increases. Finally, we show that increasing number of policy interventions lowers the expected value of the subsidy, and that under infinite provisions and retractions the amount of installed capacity converges to the same level as when the subsidy is absent permanently.