Scandinavian Working Papers in Economics

Working Papers in Economics,
University of Bergen, Department of Economics

No 15/02: Input price risk and optimal timing of energy investment: choice between fossil- and biofuels

Pauli Murto () and Gjermund Nese ()
Additional contact information
Pauli Murto: Helsinki University of Technology, Systems Analysis Laboratory, Postal: P.O. Box 1100, FIN-02015 HUT, Finland
Gjermund Nese: Institute for Research in Economics and Business Administration (SNF), Postal: Breiviksveien 40, N-5045 Bergen, Norway

Abstract: We consider energy investment, when a choice has to be made between fossil fuel and biomass fired production technologies. A dynamic model is presented to illustrate the effect of the different degrees of input price uncertainty on the choice of technology and the timing of the investment. It is shown that when the choice of technology is irreversible, it may be optimal to postpone the investment even if it would otherwise be optimal to invest in one or both of the plant types. We provide a numerical example based on cost estimates of two different power plant types.

Keywords: irreversible investment; price uncertainty; biomass; real options

JEL-codes: D81; G31; Q42

31 pages, July 12, 2002

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