Strategic Capacity Choice in Renewable Energy Technologies Under Uncertainty

Abstract

In this paper we discuss optimal renewable energy investment (in wind and solar technology) under uncertainty in a real options approach framework. We consider the combined impact of uncertain production volumes associated with renewable energy power output, policy uncertainty via uncertain remuneration of surplus power and stochastic technological learning, which -- in expectation -- decreases future costs of solar technology. An energy manager who determines the optimal dynamic investment strategy aims at minimizing expected power procurement costs, which consist of investment costs in renewable energy technologies, expected shortfall costs and expected benefits from selling surplus power to the grid. This results in nonlinear costs of power procurement and introduces -- similar to classical portfolio theory -- a diversification effect between wind and solar technology. Concerning the optimal timing of the investment, we show that a staged investment strategy can reduce expected power procurement costs compared to a lumpy investment strategy. Therefore, if technological innovations in solar technology are expected, an early investment in wind technology and keeping the option to expand the energy park can be the optimal strategic renewable portfolio choice.