Option value in low-carbon technology policies

Abstract

The political dilemma presented by the deployment of large-size low-carbon technologies (LCTs) is analysed using a simple dynamic model to investigate the relation between irreversible investments and learning-by-doing within a context of exogeneous uncertainty about the carbon price. It is shown that in some cases when information about the future carbon price is expected, the irreversibility effect holds and fewer LCT plants should be developed. In other cases, this result is reversed, and acquiring information can justify the early deployment of LCT. In particular, marginal reasoning is limited when learning-by-doing, and more generally endogenous technical change, is considered. When acquiring information is expected, the optimal policy can move from a corner optimum with no LCT deployment to an interior optimum with a strictly positive development.

Le dilemme politique présenté par le déploiement de technologies sobres en carbone de grande échelle (« large-size low carbon technologies » – LCTs) est examiné avec un modèle dynamique simple pour étudier la relation entre investissements irréversibles et apprentissage par la pratique au sein d'un contexte d'incertitude exogène sur le prix du carbone. Il est démontré que dans certains cas lorsque l'information sur le futur prix du carbone est attendue, l'effet d'irréversibilité s'applique et moins de centrales de LCT seraient développées. Dans d'autres cas, le résultat est l'inverse et l'acquisition d'information pour justifier un déploiement rapide des LCT. En particulier, le raisonnement marginal est limité lorsque l'apprentissage par la pratique, et plus généralement le changement technique endogène, est pris en compte. Lorsque l'acquisition d'information est attendue, la politique optimale peut se déplacer d'un optimum en coin sans déploiement de LCT à un optimum intérieur à développement strictement positif.

Keywords:

• investment
• irreversibilty effect
• learning-by-doing
• low-carbon technology
• option value

Mots clés:

• investissement
• effet d'irréversibilité
• apprentissage par la pratique
• technologie sobre en carbone
• valeur d'option

Notes

Baker and Shittu (2006) focus on interior equilibria and use first-order conditions and marginal reasoning. By contrast, it is shown here that marginal reasoning is not sufficient because of the non-convexity specific to sunk investments such as R&D and learning-by-doing investments. The global conditions for optimality explain the contrasting result. Schimmelpfenning (1995) only considers a binary choice with respect to the R&D effort, and not the kinds of investments that could be made nor what capacity there is.

Manne and Barreto (2004) discuss the difficulties associated with non-convexity and emphasize that, with standard algorithms, there is no guarantee that a local optimum will also be a global optimum. This issue has been outlined in recent work on the role of uncertainty in climate threshold damage (Keller et al., 2008; Lorenz et al., 2012).

It was also assumed that the demand for electricity plants is inelastic. This assumption is relaxed in the numerical illustration provided in Section 6.

It was assumed that these marginal costs were both positive and constant in the first period and that γ ₁ < c ₁; i.e. the marginal cost of conventional carbon technology during the first period is less than that of LCT.

To better suit the option value literature, the choice of technology in the second period could have been made explicit; e.g. with variable zε{LCT,conv} and cost function Γ(x, z, θ), the uninformed minimization problem would have been min _x,zE[Γ(x, z, θ)], while with information discovery, it would be min _x  E[min _z  Γ(x, z, θ)]. Owing to the linearity of the framework, the former is equivalent to equation (4) and the latter to equation (5), which simplifies notations and exposition.