Publication: Energy Intensive Infrastructure Investments with Retrofits in Continuous Time: Effects of Uncertainty on Energy Use and Carbon Emissions
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Date
2015-03-31
ISSN
0928-7655
Published
2015-03-31
Author(s)
Framstad, Nils Chr.
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Abstract
Energy-intensive infrastructure may tie up fossil energy use and carbon emissions for a long time after investment, and thus be crucial for the ability to control long-run emissions. Much or most of the resulting carbon emissions can often be eliminated later, through a retrofit that may however be costly. This paper studies the joint decision to invest in such infrastructure, and retrofit it later, given that future climate damages are uncertain and follow a geometric Brownian motion process with positive drift. We find that higher climate cost volatility (for given unconditional expected costs) then delays the retrofit decision by increasing the option value of waiting to invest. The initial infrastructure is also chosen with higher energy intensity, further increasing total emissions, when volatility is higher. We provide conditions under which higher climate cost volatility increases total expected discounted climate damage from the infrastructure, which happens in a wide set of circumstances.
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Publication Energy Intensive Infrastructure Investments with Retrofits in Continuous Time : Effects of Uncertainty on Energy Use and Carbon Emissions(World Bank, Washington, DC, 2013-04)Energy-intensive infrastructure may tie up fossil energy use and carbon emissions for a long time after investments, making the structure of such investments crucial for society. Much or most of the resulting carbon emissions can often be eliminated later, through a costly retrofit. This paper studies the simultaneous decision to invest in such infrastructure, and retrofit it later, in a model where future climate damages are uncertain and follow a geometric Brownian motion process with positive drift. It shows that greater uncertainty about climate cost (for given unconditional expected costs) then delays the retrofit decision by increasing the option value of waiting to invest. Higher energy intensity is also chosen for the initial infrastructure when uncertainty is greater. These decisions are efficient given that energy and carbon prices facing the decision maker are (globally) correct, but inefficient when they are lower, which is more typical. Greater uncertainty about future climate costs will then further increase lifetime carbon emissions from the infrastructure, related both to initial investments, and to too infrequent retrofits when this emissions level is already too high. An initially excessive climate gas emissions level is then likely to be worsened when volatility increases.Publication Infrastructure Investments under Uncertainty with the Possibility of Retrofit : Theory and Simulations(2011-01-01)Investments in large, long-lived, energy-intensive infrastructure investments using fossil fuels increase longer-term energy use and greenhouse gas emissions, unless the plant is shut down early or undergoes costly retrofit later. 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A broad range of such investments, related both to energy supply and demand systems, may commit societies to high and persistent levels of greenhouse gas emissions over time, that are difficult and costly to change once the investments have been sunk. There are, the author argues, several strong reasons to expect the greenhouse gas emissions embedded in such investments to be excessive. One is that infrastructure investment decisions tend to be made on the basis of (current and expected future) emissions prices that do not fully reflect the social costs of greenhouse gas emissions resulting from the investments. A second, related, set of reasons are excessive discounting of future project costs and benefits including future climate damages, and a too-short planning horizon for infrastructure investors. 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