Publication: Energy Intensive Infrastructure Investments with Retrofits in Continuous Time: Effects of Uncertainty on Energy Use and Carbon Emissions
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Published
2015-03-31
ISSN
0928-7655
Date
2015-09-29
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. These investments will depend on expectations of retrofit costs and future energy costs, including energy cost increases from tighter controls on carbon emissions. Simulation analysis shows that the retrofit option can significantly reduce anticipated future energy consumption as of the time of initial investment, and total future energy plus retrofit costs. The more uncertain are the costs, the greater the value of this option. However, the future retrofit option also induces more energy-intensive infrastructure choices, partly offsetting the direct effect of having the option on anticipated energy use. Efficient, forward-looking infrastructure investments have high potential for reducing long-term energy consumption. Particularly if energy prices are expected to rise, however, the potential for reduced energy consumption will be eroded if expectations of energy prices do not include environmental costs or future retrofit possibilities and technologies are not adequately developed.Publication Climate Cost Uncertainty, Retrofit Cost Uncertainty, and Infrastructure Closedown : A Framework for Analysis(World Bank, Washington, DC, 2010-02)Large and energy-intensive infrastructure investments with long life times have substantial implications for climate policy. This study focuses on options to scale down energy consumption and carbon emissions now and in the future, and on the costs of doing so. Two ways carbon emissions can be reduced post-investment include retrofitting the infrastructure, or closing it down. Generally, the presence of bulky infrastructure investments makes it more costly to reduce emissions later. Moreover, when expected energy and environmental costs are continually rising, inherent biases in the selection processes for infrastructure investments lead to excessive energy intensity in such investments. Thus great care must be taken when choosing the energy intensity of the infrastructure at the time of investment. Simulations indicate that optimally exercising the retrofit option, when it is available, reduces ex ante expected energy consumption relative to the no-option case. Total energy plus retrofit costs can also be substantially reduced, the more so the larger is ex ante cost uncertainty. However, the availability of the retrofit option also leads to a more energy intensive initial infrastructure choice; this offsets some, but usually not all, of the gains from options for subsequent retrofitting.Publication Multidimensional Auctions for Public Energy Efficiency Projects : Evidence from the Japanese ESCO Market(World Bank, Washington, DC, 2013-06)Competitive bidding is an important policy tool to procure goods and services from the market at the lowest possible cost. Under traditional public procurement systems, however, it may be difficult to purchase highly customized objects, such as energy efficiency services. This is because not only prices but also other nonmonetary aspects need to be taken into account. Multidimensional auctions are often used to evaluate multidimensional bids. This paper examines the bidding strategy in multidimensional auctions, using data from public energy service company projects in Japan. 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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. These issues are illustrated for two alternative cases of climate damages, namely with the possibility of a "climate catastrophe," and with a sustained increase in the marginal global damage cost of greenhouse gas emissions.
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